Perspectives on the Greek challenge
These days, there is a flood of articles and comments of varying quality and importance on Greece and the eurozone. With the following quotes I would like to draw attention to a small selection of contributions which may be relevant beyond the day.
Both supporters and opponents of the plans of the Greek government cite moral arguments why Greece should, or should not, have its way in the current situation. Opponents point to the risk of moral hazard. As Joseph Stiglitz put it: “There is a fear that if Greece is allowed to restructure its debt, it will simply get itself into trouble again, as will others.”
Joseph Stiglitz tells another morality tale as the following excerpts from his article show. Furthermore, he reminds us that the current crisis is not a Greek problem but deeply rooted in the structure of the eurozone:
“When the euro crisis began a half-decade ago, Keynesian economists predicted that the austerity that was being imposed on Greece and the other crisis countries would fail. It would stifle growth and increase unemployment – and even fail to decrease the debt-to-GDP ratio. Others – in the European Commission, the European Central Bank, and a few universities – talked of expansionary contractions. But even the International Monetary Fund argued that contractions, such as cutbacks in government spending, were just that – contractionary.”
“[L]et us be clear: Greece could be blamed for its troubles if it were the only country where the troika’s medicine failed miserably. But Spain had a surplus and a low debt ratio before the crisis, and it, too, is in depression. What is needed is not structural reform within Greece and Spain so much as structural reform of the eurozone’s design and a fundamental rethinking of the policy frameworks that have resulted in the monetary union’s spectacularly bad performance.”
The Greek example points to a fundamental problem. It reminds us “how badly the world needs a debt-restructuring framework. Excessive debt caused not only the 2008 crisis, but also the East Asia crisis in the 1990s and the Latin American crisis in the 1980s. It continues to cause untold suffering in the US, where millions of homeowners have lost their homes, and is now threatening millions more in Poland and elsewhere who took out loans in Swiss francs.
Given the amount of distress brought about by excessive debt, one might well ask why individuals and countries have repeatedly put themselves into this situation. After all, such debts are contracts – that is, voluntary agreements – so creditors are just as responsible for them as debtors. In fact, creditors arguably are more responsible: typically, they are sophisticated financial institutions, whereas borrowers frequently are far less attuned to market vicissitudes and the risks associated with different contractual arrangements.”
“So it is not debt restructuring, but its absence, that is “immoral.” There is nothing particularly special about the dilemmas that Greece faces today; many countries have been in the same position. What makes Greece’s problems more difficult to address is the structure of the eurozone: monetary union implies that member states cannot devalue their way out of trouble, yet the modicum of European solidarity that must accompany this loss of policy flexibility simply is not there.”
When Syriza won elections on a pledge of ending austerity policies and seeking debt relief one immediate question was who is still exposed to Greece. Silvia Merler provided statistics which indicate that on the creditor side the situation is far less dramatic than a few years ago. She observed:
“Since the start of the crisis, the structure of Greek debt has changed considerably (almost 80 percent of government financial liabilities are now accounted for by loans, against slightly less than 20 percent back in 2008). At the same time, the weight of public creditors has increased among the creditors of the government. … At the end of 2013, debt due to official creditors amounted to 216 billion of loans (IMF/EU loans) and 38 billion of securities (under SMP). This means that, at the end of 2013, official creditors accounted for about 94 percent of the total loans due to non-residents and 89 percent of the total securities held by non residents.”
“The data show, however, that since 2012 (when the ECB introduced the OMT programme) private investors have been timidly and slowly coming back to Greece. While exposures of euro area banks are still at very low levels compared to the pre-crisis period, it is tempting to interpret this as a first trace of normalisation and a resumption in confidence, which the present political turmoil risks reverting.”
ECB interference and the game of a “bankrupt country”
As the Greek government is in danger to run out of money soon, all eyes focus on the role of the European Central Bank (ECB). What on earth is the ECB up to? asked Frances Coppola as the central bank lifted the waiver under which it had been prepared to accept Greek sovereign bonds as collateral for liquidity. Referring to the timing of the decision Frances in a passionate rant questioned the legitimacy of its interference. Furthermore, she pointed to the fact that the ECB has pursued this strategy before:
“The ECB is acting far beyond its mandate in seeking to influence negotiations between Eurozone member states regarding the terms and conditions under which member states lend to their distressed partners. It has no business interfering in fiscal policy: if the Greek government decides to run 1.5% fiscal surpluses instead of 4.5%, hike minimum wages and create lots of government jobs, it is none of the ECB’s business. The ECB’s monetary policy failures are legion: it should put its own house in order, rather than interfering with the conduct of fiscal policy. And worse, its persistent interference in fiscal policy is a clear conflict of interest, as the Advocate General of the European Court of Justice noted in relation to the OMT programme. It should not be a member of the Troika at all, and certainly should not use changes in fiscal policy by a democratically-elected sovereign government – even one that has inherited an economy in tatters with a massive debt burden – as justification for limiting liquidity to that country’s banking system. Monetary policy should never be used to serve fiscal or political ends. Not ever.”
“Over 6 months ago, Varoufakis predicted that the ECB would attempt to pull funding from the Greek banks. …
[P]ulling ELA from Greek banks would cause their sudden disorderly collapse. The ECB has used this trick before: it threatened to pull ELA from Irish banks in 2010, and it actually pulled ELA from Cyprus’s Laiki Bank and the Bank of Cyprus, forcing immediate closure and restructuring. This second piece of brinkmanship resulted in the worst bank bailout decision in the history of the planet, which was (fortunately) subsequently overturned by the Cypriot legislature. Undermining deposit insurance is almost criminally insane.”
As the Greek finance minister Yanis Varoufakis has a background as an expert in game theory many observers were musing about the strategy behind his decisions. Frances Coppola came upon a very interesting approach which explains how in a game called “coercive deficiency” weakening Greece’s position could actually strengthen its hand. [The footnotes in the following quote all refer to a piece by Jacques Sapir which you might be interested to check.]
“In this strategic game, it is clear that Greece has deliberately chosen the strategy qualified by Thomas Schelling, one of the founders of game theory, but also of nuclear dissuasion, as «coercive deficiency». In fact, this term of «coercive deficiency» was imagined by L. Wilmerding in 1943 in order to describe a situation where agencies enter into expenses without prior financing, knowing that morally the government will not be able to refuse funding them . Schelling’s contribution consists in showing that this situation can be generalized and that a situation of weakness can reveal itself to be an instrument of coercion upon others. He also showed how it can be rational for an actor knowing himself to be in a position of weakness from the start, to increase his weakness in order to use it in negotiation. Reversing Jack London, one can speak in this instance of a “strength of the weak.” . It is in this context that we must understand the renunciation by the Greek government of the last slice of aid promised by the so-called «Troïka, » amounting to 7 billion euros. Of course, having rejected the legitimacy of said “Troïka, » it could not logically accept to take advantage of it. But, in a more subtle way, this gesture is putting Greece voluntarily at the edge of the abyss and demonstrates all at once its resolve to go the bitter end (like Cortez burning his ships before moving up to Mexico) and to increase the pressure on Germany.”
Central bank rules versus discretion
The role of the ECB is also the topic of this article by Karl Whelan. He discussed the extent to which ECB decisions are rule-bound:
“One of the key uncertainties surrounding the situation in Greece is the relationship between the Greek banks and the ECB. Lots of press coverage is suggesting the ECB has a set of well-established rules that mean it will not be able to lend to Greek banks in March unless the government negotiates a new EU-IMF program to replace the one expiring at the end of this month. …
As a general matter, the idea that the ECB is considering pulling funding from the Greek banks seems to be true. But, as is often the case when the world’s press attempts to understand the ECB, the reports get most of the details wrong.”
“… the ECB has almost complete discretion over which banks it lends to. I have written about the ECB’s Risk Control Framework before and it’s been rolled out regularly in the years since I wrote that post. The bottom line is that the ECB can single out specific institutions and decide to not lend to them for pretty much whatever “risk-related” reason they feel like putting forward. Still, this approach, if taken, isn’t based on any hard and fast rules.”
“… the idea of “junk-rated bonds are only eligible if a country is in a program” being part of “the ECB’s rules” is an over-statement. In truth, the ECB makes up these rules as it goes along and the “in again, out again” routine with Greek government bond eligibility is a long-standing one at this point.”
“… Greek banks were using at most €8 billion in Greek government debt in December as collateral for loans from the Eurosystem. Set against the total loans of €56 billion owed to the Eurosystem this is fairly small beer. (Factoring in haircuts, its share in collateral would be even less than this comparison suggests).
So, on its own, the eligibility of Greek government bonds is just not that big a deal.”
“The ECB is pretty clearly playing from its tried and tested playbook in their current stand-off with the Greek government. Governing Council members know they can cut off lots of credit from the Greek banks in March and many of them are happy to tell the world they are thinking about doing this. As a result, they hope to get Greece’s new government to sign a new deal with the EU and IMF. But don’t believe for a minute that this is a technocratic thing to do with “the ECB having to follow its rules.””
“I fully expect the ECB-as-heavy-hearted-technocrat angle to dominate press coverage of this story this month. That’s a pity because the “ECB in politicised mission creep while helping trigger a bank run” story is more interesting and closer to the truth.”
Lessons from history
In a knowledgeable and highly readable article which has too many important points to do it justice here Michael Pettis put the current conflict in Europe into historical perspective. Here are some snippets:
“European nationalists have successfully convinced us, against all logic, that the European crisis is a conflict among nations, and not among economic sectors. …
This is absurd. The European debt crisis is not a conflict among nations. All economic systems— and certainly an entity as large and diverse as Europe— generate volatility whose balance sheet impacts are mediated through different political and economic institutions, among which usually are domestic monetary policy and the currency regime. With the creation of the euro as the common currency among a group of European countries, monetary policy and the currency regime could no longer play their traditional roles in absorbing economic volatility. As a result, for much of the euro’s first decade, a series of deep imbalances developed among various sectors of the European economy. Because Europe’s existing economic and political institutions had largely evolved around the national sovereignty of individual countries, and also because the inflation and monetary histories of individual countries varied tremendously before the creation of the euro, it was probably almost inevitable that these imbalances would manifest themselves in the form of trade and capital flow imbalances between countries.”
“Resolving a debt crisis involves nothing more than assigning the losses. In the current crisis these costs have to be assigned to different economic sectors within Europe, but to the extent that the assignation of costs can be characterized as exercises in national cost allocation, it is easy to turn an economic conflict into a national conflict.”
“Most currency and sovereign debt crises in modern history ultimately represent a conflict over how the costs are to be assigned among two different groups. On the one hand are creditors, owners of real estate and other assets, and the businesses who benefit from the existing currency distortions. One the other hand are workers who pay in the form of low wages and unemployment and, eventually, middle class household savers and taxpayers who pay in the form of a gradual erosion of their income or of the value of their savings. Historically during currency and sovereign debt crises political parties have come to represent one or the other of these groups, and whether they are of the left or the right, they are able to capture the allegiance of these groups.
Except for Greece, in Europe the main political parties on both sides of the political spectrum have until now chosen to maintain the value of the currency and protect the interests of the creditors.”
“By early 1871, the French army was roundly defeated by Prussia, which during that time had unified the various German states as the German Empire under the Prussian king … [One] consequence was the French indemnity. As part of the privilege of conquest and as a condition for ending the occupation of much of northern France, Berlin demanded war reparation payments originally proposed at 1 billion gold francs but which eventually grew to an astonishing 5 billion, at least in part because of an explicit decision by Berlin to impose a high enough burden permanently to cripple any possible French economic recovery. …
[But] France was able to raise the money very quickly, mostly in the form of two domestic bond issues in 1871 and 1872, which were heavily over-subscribed …”
“One important point is to distinguish between financial crises that occur within a globalization cycle and those that end a globalization cycle. Whereas the latter are often devastating and mark the end for many years of economic growth, the former — like the 1994 Tequila crisis or the 1997 Asian crisis, or even the 1866 Overend Gurney crisis — may seem overwhelming at first, but markets always recover far more quickly than most participants expect. When markets are very liquid, and in their leveraging-up stage, they can absorb large debt obligations easily, and because they can even turn these obligations into “money”, they almost seem to be self-financing.
The 1858-73 period was one such “globalization period”, with typical “globalization” characteristics: explosive growth in high-tech communications and transportation (mainly railways), soaring domestic stock and real estate markets, booming international trade, and a surge in outflows of capital from the UK, France, the Netherlands and other parts of Europe to the United States, Latin America, the Far East, the Ottoman Empire, and other financial “frontiers”.
“From an “asset-side” analysis, as I discuss in my January 21 blog entry, the transfer of capital over three years from France to Germany equal to more than 20% of either country’s annual GDP would have had very predictable impacts — they should have been very negative for France, as Berlin expected, and very positive for Germany. In fact the actual results were very different. This is because there are monetary and economic conditions under which liability structure matters much more, and conditions under which it matters much less. Economists and the policymakers they advise are too quick to ignore these differences, perhaps because there is not as well-formulated an understanding of balance sheets in economics theory as in finance theory, so that when someone like Yanis Varoufakis proposes that there are ways in which partial debt forgiveness increases overall economic value, instead of merely creating moral hazard, worried economists often recoil in horror, while finance or bankruptcy specialists (and an awful lot of hedge fund managers) shrug their shoulders at such an obvious statement.”
“What does all of this have to do with Syriza? A few weeks ago I was discussing with a group of my Peking University students Charles Kindleberger’s idea of a “displacement”, and I proposed, as does Kindleberger, that the 1871-73 French indemnity is an especially useful example of a displacement from which we can learn a great deal about how financial crises can be generated.(4) It then occurred to me that the French reparations and their impact on Europe could also tell us a great deal about the euro crisis and, more specifically, why by distorting the savings rate wage policies in Germany in the first half of the last decade would have led almost inexorably to the balance of payments distortions that may eventually wreck the euro.”
“[T]here are three important things to remember:
1. There is an enormous economic cost, not to mention social and perhaps political, to any delay. I worry about the terrifyingly low level of sophistication among policymakers and the economists who advise them when it comes to understanding balance sheet dynamics and debt restructuring. Greece’s debt overhang imposes rising financial distress costs and increasingly deep distortions in the institutional structure of the economy over time, and the longer it takes to resolve, the greater the cost. …
2. From what I read, much of the focus of the restructuring will be aimed at determining an acceptable and manageable debt-servicing cashflow for Greece. There is a mistaken belief that this is the only “real” variable that matters, and the rest is cosmetics. I don’t agree. Greece’s nominal debt structure will not just affect the debt-servicing cashflows but will also determine future behavior of economic agents. …
3. In fact the overall restructuring must be designed so that the interests of Greece, the producers who create Greek GDP, and the creditors are correctly aligned. To date sovereign debt restructurings have almost never included the instruments that reflect the instruments in corporate debt restructurings that accomplish this alignment of interests …
Yanis Varoufakis should really take the lead in designing an entirely new form of sovereign debt restructuring, not just for Greece but for the many countries, in Europe and elsewhere, that will soon follow it into default.”
The derivatives issue
There is one aspect which in contrast to earlier stages of the euro crisis, this time seems to play a minor role in public debates. This is what Mark Melin called the derivatives issue. But, possibly, this has been resolved behind the scenes already. Reviewing a Goldman Sachs research analysis Mark Melin argued that in agreeing to not seek to reduce the total amount of their debt through forgiveness Greece has given up “its most important bargaining chip”. He wrote:
“This last issue is key, because the derivatives that underlie the financial system are said to be significantly exposed to sovereign debt default and related interest rates. Had Greece sought debt forgiveness, it might have created a daisy chain reaction in many of the large bank unregulated derivatives positions. Such an event is a national security concern …
The Goldman Sachs report did not address the derivatives issue, as the bank is among the largest issuer of such “insurance” contracts.
One of the key components discussed in the Goldman Sachs report is the potential for a “Grexit,” which Goldman says could cause significant market volatility, labeling the issue “systemic” as magnitude was considered. “The intensity and persistence of such volatility would depend on the process by which Grexit occurred, and on the nature of the policy and political response to it in other Euro area countries.”
What the report didn’t say is that if a Grexit were to occur, it would probably occur as relations are strained and a demand for debt forgiveness was the central issue. In other words, a Grexit correlation to a sovereign bond default might be a high probability relationship. The Greeks, however, are unlikely to trigger the bank’s derivatives exposure. The cost would simply be too high.”
In particular with respect to the last aspect I would like to conclude modifying an earlier quote from Karl Whelan:
Don’t believe for a minute that this is a European policy thing to do with Greece, its economy or its people.