When effort and outcome is not the same thing – the case of Greece

Greece has made yet another other deal with the EU and IMF on its debt situation. Or rather as one EU official described it to the Financial Times “If it looks like we are kicking the can down the road that is because we are”.

Said in another way, this is not really a deal to solve the fundamental problem, but rather a deal to avoid dealing with the fundamental problem.

So what is the fundamental problem? Well, at the core of this is that the Greek government simply is insolvent and can’t pay its debts, but at the same time the EU is refusing to accept this fact.

The IMF seems to understand this and probably so do the eurocrats, but politically it seems impossible to accept because that would mean the EU would have to accept that the strategy to deal with Greece’s problems has been wrong and it would mean accepting a major debt write-down on Greece sovereign debt something with likely would not be popular with voters in for example Germany or the Netherlands.

Some are arguing that Greece haven’t done enough to solve its own problems and that letting Greece off the hook with a major debt write-down would just encourage even more bad habits and that is probably right, but it does change the fact that it is very hard to see how Greece will be able to pay of the debt.

Furthermore, it is wrong when some are arguing that Greece hasn’t done anything. In fact, Greece has done more fiscal austerity than any other nation in Europe. So if we for example look at the accumulative tightening of fiscal policy in Greece since 2009 then we will see that Greece in this period has tightened by 18-20% of GDP (measured as the accumulative change in IMF’s measure of Greece’s structural budget deficit). By any measure, this a massive fiscal tightening.

However, one thing is the effort another thing is the outcome and here the story is quite different. Hence, since 2009 Greek public debt has grown from 108% of GDP in 2008 to more 180% of GDP this year. Hence, despite of massive fiscal austerity public debt has continued to grow every single year since 2008.

Greece debt and fiscal policy

The reason for this depressing development is the fact that Greece has seen a massive collapse in economic activity. Hence, since 2008 nominal GDP in Greece has dropped by nearly 30%. A true economic disaster. No matter how fiscally conservative a country is it is impossible to stabilize the debt ratios with such an economic contraction.

Therefore, to fundamentally solve Greece’s debt problem it is needed to solve Greece’s growth problem and that is not easy. Fiscal stimulus could of course be a solution, but Greece don’t have the money for that and the markets will not be willing to finance a fiscal stimulus package.

Another solution is massive structural reforms and that is somewhat more promising that fiscal stimulus, but given the depth of the crisis even the most comprehensive reform package is not likely to be enough and that leaves on one solution – monetary easing.

But since Greece is not in control of its own monetary policy because the country is a member of the euro zone that is not really possible either. Or rather it is – if Greece decides to leave the euro area. That seems like a very risky strategy, but it is blatantly obvious that this is really the only solution that would work.

Therefore, it is not a question whether we will get a ‘Grexit’, but rather when it will happen. The German taxpayers will not forever be willing to pay the price for kicking the can down the road.

PS Marcus Nunes also comments on Greece.

PPS The IMF has a new paper, which once again shows that Greece is insolvent and urgently needs a debt write-down.


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The continued unraveling of the ‘dollar bloc’

Over the past year I again, again and again have argued that the tightening of US monetary conditions will cause the ‘dollar bloc’ to fall apart – meaning that more and more countries will give up their de facto pegged exchange rate policy against the US dollar.

The process is well underway and is likely to continue – especially because the Federal Reserve is overly eager to hike interest rates.

The most important member of the dollar bloc other than of course the US has been China, but we all know that China has started the process of de-coupling from the dollar. This is from Bloomberg today:

China’s central bank weakened its currency fixing to the lowest since March 2011 as the dollar strengthened.

The reference rate was lowered by 0.3 percent to 6.5693 per dollar. A gauge of the dollar’s strength rose to a two-month high Tuesday as traders boosted wagers that U.S. interest rates will rise. The yuan weakened 0.1 percent to 6.5636 in a third day of losses as of 10:27 a.m. in Hong Kong.

A resurgent greenback is shaking up a strategy that the People’s Bank of China pursued over the past three months — a steady rate against the dollar, combined with depreciation against other major currencies. Traders are now pricing in a better-than-even chance of the Federal Reserve boosting borrowing costs by its July meeting, with officials lining up to indicate their willingness to support such a move, should the current strength in the economy be sustained.

And this will continue and more contries will follow. The dollar bloc is falling apart and that is great news for the global economy.

The verdict from G20 Money Base growth: Money is TIGHT

We hear it all the time – central banks are printing money like no time before and it is not working and now there is nothing more central banks around the world can do to fight deflation.

However, this is all a myth and this is what I will demonstrate in this post by looking at global money base growth.

We start by looking at the level of total money base of the G20 countries measured in US dollars.

G20 money base gap.jpg

The graph is clear – since early 2014 the G20 money base (denominated in US dollars) has flatlined.

Contrary to the popular perception there is not massive global money creation. Rather it is hardly surprising that we continue to see strong deflationary tendencies many places in the world as there essentially is no global money creation.

Now lets look at the same data now just in yearly growth rates instead of in levels.

G20 money base growth.jpg

Again the same picture emerges – G20 money base growth has come to a grinding halt particularly from early 2014, but in fact since early 2012 G20 money base growth has been below the pre-crisis growth rate of 15½% y/y.

Hence, it is very clear that judging from the G20 money base global monetary conditions have been tightening at least since early 2014. This of course coincide with when Janet Yellen became Federal Reserve Chair in February 2014 and US quantitative easing was coming to an end.

Ending quantitative easing in the US might or might not have been the right thing for the US economy, but it is clear that the impact on global money base growth has been significantly negative.

Tremendously stable global money base-velocity

Obviously one can question whether the money base is a good measure of monetary conditions. For this to be the case we would need to have a fairly stable development in global money demand and hence in global money base-velocity.

G20 base velocity

The graph above shows that G20 money base velocity in fact has followed tremendously stable development for the past 15 years.

Hence, over the past 15 years G20 money base-velocity has closely followed a downward trend declining on average 2,75% every quarter.

That said, since 2000 we of course have seen one major negative shock to G20 money base velocity in relationship to the onset of the Great Recession in October 2008 as the graph below  shows.

G20 velocity quarterly growth

However, from 2009 G20 money base-velocity developments more or less has been in line with the pre-crisis trend and as long as this continues to be the case I think it is fair to consider G20 money base growth as a reliable indicator of global monetary conditions. Not the only indicator, but certainly a very important indicator.

Money base slowdown at the core of the EM crisis and the drop in commodity prices

Having the sharp slowdown in G20 money base growth in mind it is hard to ignore that this more or less have coincided with a sharp drop in global commodity prices and considerable turmoil in Emerging Markets around the world.

Just have a look at the graph below.

CRB and G20 money base growth

There is far from a perfect correlation between commodity prices – he measured by Reuters CRB index – and G20 money base growth, but it is nonetheless notable that as G20 money base starts to slow down in early 2014 commodity prices fall of a cliff.

For the same reason I also think that it is wrong to attribute the drop in global commodity prices only to supply factors – such as Saudi Arabia’s oil policy or the return of Iran to the global oil markets. In fact I think the tightening of global monetary condition is the main cause of the drop in commodity prices since early 2014.

In the last couple of months we have seen a bit of a rebound in global commodity prices. This to some extent reflects supply side factors – such as increased tensions between Saudi Arabia and Iran – but again it is hard to ignore the fact that the outlook for G20 money base growth has changed in a slightly more positive direction as the Fed has softens its hawkish stance a bit.

That said, we haven’t seen a pick up in actual money base growth yet and unless we see that it is hard to see a more sustained recovery in commodity prices.

The question, however, remains whether we will actually see a pick-up in G20 money base growth going forward.

Three ways to higher G20 money base growth

Essentially there are three ways to higher G20 money base growth.

First, the Federal Reserve could re-start quantitative easing. That obviously would increase global money base growth, but right now it seems rather unlikely that the Fed is about to increase money base growth and the Fed still is overly hawkish.

Second, a sharp drop in the US dollar would by definition increase G20 money base growth denominated in US dollars, but again unless the Fed softens its rhetoric further we are unlikely to see any major correction in the dollar in the near-term.

Third, the other major central banks of the world could move into action and here I believe that it will be of particularly importance what the People’s Bank of China (PBoC) does with monetary policy. Here it is particularly notable that the PBoC has started to de-link the renminbi from the dollar and as such is gaining a larger degree of monetary sovereignty.

These three ways to increase money base growth also illustrate why the ‘dollar bloc’ is falling apart and more and more countries are likely to give up their close link to the dollar.

China has already started the process and a number of commodity exporters such as Kazakhstan, Azerbaijan and Angola have devalued their currencies substantially again the US dollar and other ‘dollar peggers’ are very likely to give up their close link to the dollar in the coming year – particularly if we do not see an increase in G20 money base growth either as a result of high US money base growth and/or a sharp drop in the value of the dollar.

Conclusion: Global monetary conditions have tightened considerably

So the conclusion is that global monetary conditions have been tightening significantly over the past two years and it is therefore hardly surprising that we have seen turmoil in Emerging Markets, collapsing commodity prices and continued global deflationary pressures.

We can see this by observing global financial markets, but as I have shown in this blog post the signal from G20 money base growth is also very clear and unless the major central banks of the world do not move into action to spur money base growth the global economy will continue be in a state of deflation.

It is about time for central banks around the world to acknowledge that they are far from helpless and take responsibility for ensuring nominal stability. Today central banks around the world unfortunately are failing to do so.

And no, negative interest rates will not do this – only more money creation will curb global deflationary pressures.

HT Jens Pedersen.

Update: the good thing about writing a blog is that you don’t have to worry about formalities, but on this one I would have put a source on the data. The source is IMF, local central banks, MacroBond and own calculations.


Ambrose: “Eurozone recovery wilts as sugar rush fades, deflation lurks”

The Telegraph’s Ambrose Evans-Pritchard has a good article on the risk of renewed troubles for the euro zone. See here.

Ambrose qoutes me:

“The recovery is not gaining any traction. I am really quite worried about another spasm of the debt crisis over the summer,” said Lars Christensen from Markets and Money Advisory.

“Markets are beginning to lose faith that the European Central Bank can deliver stimulus, and we are seeing the return of problems in public finances in Portugal, Spain, and Italy. That is becoming a key story,” he said.

Krugman finally acknowledges that it is all about monetary policy

Paul Krugman has a very interesting blog post on the relative economic performance of the US and the euro zone.

Krugman starts out with this graph.


Krugman then goes on to give a complete (Market) Monetarist explanation for this development:

Things really go off track only in 2011-2012, when the U.S. recovery continues but Europe slides into a second recession…

…What was happening in 2011-2012? Europe was doing a lot of austerity. But so, actually, was the U.S., between the expiration of stimulus and cutbacks at the state and local level. The big difference was monetary: the ECB’s utterly wrong-headed interest rate hikes in 2011, and its refusal to do its job as lender of last resort as the debt crisis turned into a liquidity panic, even as the Fed was pursuing aggressive easing.

This is of course what Market Monetarists have been saying forever – we even have a term for it: The Sumner Critique.

According to the Sumner Critique the budget multiplier will be zero if the central bank has a strict nominal target such as inflation targeting or a nominal NGDP target. This means that any shock to aggregate demand/nominal spending from fiscal policy will be offset by monetary policy – not only because the central bank activity will ease monetary policy, but also because under a credible nominal target markets will do must of the lifting by anticipating the easing of monetary conditions.

It is particularly interesting that Krugman essentially acknowledges that monetary policy remains highly potent also when interest rates are at the Zero Lower Bound (ZLB) – something he normally is not willing to acknowledge. In fact, the Fed fast cut the fed funds rate essentially to zero, while the ECB until very recently has kept interest rates positive.

Keeping this in mind then have a look at the accumulative tightening of fiscal policy in the euro zone and the US respectively since 2010 (since the period of fiscal tightening was initiated).

fiscal tightening US EZ

I have calculated this by adding up the yearly changes to the IMF’s measure of the structural deficits in the US and the euro zone.

The graph is clear – in the years of ‘austerity’ (2010-2013) the US undertook significantly more fiscal tightening than the euro zone did. According to Krugman’s normal argument that should have caused a major depression in the US economy.

However, as Krugman’s graph above shows the US economy continued to expand in 2013 despite of a US structural budget deficit being cut by 3%-point of GDP. The reason of course was – as Krugman now seems to finally realize – that ‘monetary offset’ kept US nominal GDP growth – and therefore also real GDP growth – on track in 2013.

The problem was never fiscal in Europe. It was always about too tight monetary policy in the euro zone.

Now I could of course show the traditional Market Monetarist graph with the level of nominal GDP in the US and euro zone, which shows that there has been no NGDP growth in the the euro zone.

However, that graph I have done so many times before so lets be a bit more old-school monetarist and instead have a look at M2 growth in the US and the euro zone.

M2 Euro zone USA

M2 growth shows the same story as other monetary indicators – US monetary policy became broadly neutral in 2010-11, while euro zone monetary conditions have been very tight until Mario Draghi and the ECB initiated proper quantitative easing in early 2015 (see my post from then here).

Paul Krugman finally embraces the Sumner Critique

Concluding, the ‘natural experiment’ of the economic development in the euro zone and the US particularly from 2010 is a very good test of the relative importance of fiscal policy versus monetary policy and I think it is fair to say that the monetarists have been proven right – monetary policy is highly potent and budget multiplier is zero (given a proper nominal monetary policy target. Even Paul Krugman seems to acknowledge now. This is somewhat of a u-turn given that Krugman less than a month ago claimed that monetarism “failed”.

PS In the beginning of the post I wrote that Krugman’s post was “very interesting”. That is in fact not entirely correct as there is nothing new in what Krugman is saying – he is just repeating what Market Monetarists like Scott Sumner, David Beckworth, Nick Rowe, Marcus Nunes and myself have been saying for years. The “interesting” thing is that Krugman now seems to agree with us.

PPS In the case of the US I think we need more of the same – we need fairly deep budget cuts as the US structural budget deficit likely is around 3% of GDP and at the same time we need a clear rules based monetary policy – with a 4% NGDP level target. At the moment we are clearly undershooting 4% NGDP growth so monetary easing – rather than monetary tightening – is warranted.

PPPS Scott Sumner also comments on Krugman here.