Tuesday, July 7, 2015

Greek Choices: A German's Perspective

My 6Wunderkinder Microsoft colleague James Duncan Davidson penned some beautiful notes on the Impossible Greek Choices that happened effectively during his wedding and honeymoon (congratulations!!), to the people he has grown to know and, in some cases, love. It's a wonderful piece that I highly recommend. There were some calls for a German perspective, which is by necessity going to be less personal, but I hope it can provide some additional background.

The Referendum

The Greek Referendum was an odd one, because it asked voters whether to accept or not accept an offer by the 18 other Euro states and the IMF that was, in fact, no longer on the table. So that's at least a little weird, as there really wasn't a choice to make, and from here it looked like pure grandstanding / political theater.

I don't know how it was perceived in Greece, but from here it looked like the government presented the choices as "bow to German dictates" vs. "we can do without them". And the capital controls imposed by the Greek government because the banks were effectively insolvent were described as "terrorism" perpetrated by the EU. That's a bit rich when you take into account that the only thing keeping the country afloat was EU funds and the money that is still available is coming from EU emergency funds. If "terrorists" are people who give you money, I want some more terrorists around me.

Even weirder is the fact that Tsiprias seems to think that the No vote will strengthen his position in future negotiations, that now he will be able to negotiate a better deal. I have a feeling that this will go down as one of the biggest political miscalculations in history, but I may be wrong and he will now get everything he wanted.

The "German" View

The German perspective on the Greek debt crisis is really quite simple: you can't live beyond your means indefinitely. You can do it temporarily by taking on debt, but at some point that debt has to be repaid. At that point you have to not only revert to living within your original means, but significantly below because you have the debt to repay.

I think this is completely obvious and non-controversial, as it relies on no more than basic arithmetic. But then again, I am German.

This doesn't mean you can never take on debt. For example, it makes sense to time-shift availability of things. Or to invest in things that increase your earning potential. Or one-time events, especially with a strong time component. But never to lift your general standard of living. There is no way that can work.

The Keynesian View

Keynesians say that governments are different from private individuals, and the debt they take on is different from normal household debt. Important is the role of government debt in a recession: the government should take on more debt to minimize economic contraction and spur growth. The worst thing a government can do in a recession is start saving and imposing "austerity": the economy will contract even more, and apart from hurting citizens, this actually tends to make the debt problem worse. The reason is that government debt is generally measured relative to GDP, because GDP/economic output is a pretty direct indicator of a country's ability to pay back its debt.

While not quite as uncontroversial, I think this is also largely trivially true.

Although these two views are often described as contradictory, for example Krugman criticizes the "Austerians" by showing how Keynesian predictions turn out to be true, I don't think they are. After all, you can pick up debt in a crisis and then pay back the debt when the economy is doing well, and IIRC, that is exactly what Keynes said governments should do, behave anti-cyclically.

Of course, this requires discipline: why should I do something uncomfortable when things are going well? After all, the fact that things are going well proves that what I am doing is right, right? Empirically, governments do not seem to pay back debt in any significant way shape or form, for reasons I do not fully understand. Part appears to be simple expediency, why cut spending (=happy voters) when you don't absolutely have to? Part might be that our pensions systems tend to depend on having "safe" government debt to invest in. Financial markets also appear to be fine with a small-ish permanent fiscal deficit.

I personally think this is hugely problematic and undermines democratic principles, because governments sell out their sovereign (the voters) to the financiers for a little bit of extra spending money. Panem et circenses.

A Third Way (I)

Of course, there is a way of living beyond your means without having to suffer the consequences, which is to have someone else pick up the tab, for example by not repaying your debt. The most obvious way is a default, but if you are a country and the debt is in your own currency, you get more subtle options such as devaluation, where you just lessen the value of the debt (and of all the money in circulation, but hey...) or high inflation, which has the same effect but stretches it out over time so it is less noticeable.

In the past, at least Italy and Greece used to do this all the time, but of course this means that people are much less willing to lend you money, and they will demand much higher interest payment, pricing in actual or potential inflation and risk of devaluation or default. In the worst case, people will stop lending you money altogether.

Without control over a currency and attached printing press for said currency, inflating or devaluing your way out of trouble is no longer an option, which is why joining the Euro area was contingent on meeting "convergence criteria" on inflation and public debt.

Whereas Italy made a real effort to meet the criteria, Greece never really did. Even the official figures were at best marginal, but these had been doctored by US money house and vampire squid Goldman Sachs.

However, private money lenders were unaware (possibly willfully) of this, and lent Greece money at Euro-group rates, way, way below previously attainable rates. Greece, freed from the difficulty and expense of obtaining debt, went on a debt-fueled spending spree: GDP skyrocketed, from Euro introduction in 2001 to the start of the financial crisis in 2008 by a factor of 2.3!

Did the Greek economy become super-competitive in this time, did exports soar, did tourism? As far as I know, the answer to these questions is "No", the rise in GDP was largely fueled by cheap debt. The Euro area in general did well during this time, but for example Germany's GDP in 2008 was only 50% higher than the high point in the mid 90ies.

Greece piled on public debt in this period at >10% of the budget.

The Greek Problem

When the financial crisis hit, the toxicity of all the debt held by pretty much everyone became evident, but for some reason, Greece was particularly hard hit, despite the fact that their overall debt levels were not that much worse than everyone else's. However, how bad existing debt is is very much influenced by your creditworthiness, because debt is constantly refinanced and a bad credit rating means that what used to be sustainable levels of debt can become unsustainable, a self-fulfilling prophecy.

Well, our favorite vampire-squid Goldman Sachs announced that something was "fishy" with Greece. How did they know this? Easy, as we saw above they were the ones who had helped Greece cook the books in the first place! Suddenly Greece's credit load was unsustainable, because rates skyrocketed. Well, Greece's rates reverted to pre-Euro levels, because it became known that the information that had been used to justify low Euro-area rates (meeting the "convergence criteria") had been falsified.

Without those falsifications, Greece's borrowing costs would have been much higher, and those high borrowing costs would have prohibited taking on as much debt as had been taken on to fuel Greece's GDP bubble. Added factors were that Greece no longer had the option of devaluing creditors' assets by devaluing or inflating debt away, but at the core is trustworthiness: do I, as a creditor, believe that my debtor will pay back their debt to me in full? If I am 100% certain, rates are low, with every bit of doubt rates rise until they are infinite, i.e. you can't borrow.

Greece simply was never trustworthy, and for most of history this was well known, except for the period between 2001 (Euro introduction) and 2008 (financial crisis). Of course, it could have been known if the banks lending Greece money had bothered to look. But they didn't look, which was reckless, beyond the lie that Goldman Sachs had helped Greece sell, which was criminal.

So what I think should have happened (aside from the debt never accumulating in the first place because of people and institutions not lying and doing their jobs properly) is that Greece should have defaulted on those debts, the banks that recklessly lent that money took the hit they deserved to take and then sued Goldman Sachs and the Greek government(s) and the officials for the damages.

What happened instead was the typical and sickening socialization of private losses, while profits from those same transactions continued and continue to be privatized.

At this point, we could have taken the economically correct Keynesian approach of helping the Greek economy recover with the help of possibly even more debt, but debt that becomes sustainable because GDP rises faster than debt and thus the all important debt/GDP ratio falls.

Instead we got the mess we're in now, with GDP down 25% from peak, though still significantly higher than before the Euro. Why? As far as I can tell, a large part of the reason is that no one in the EU trusts pretty much any Greek government with a scheme that entails "you get stuff now, and you will do the right things later". No one.

The reason for this is that, in the context of the EU, successive Greek governments have flouted every rule, broken every agreement, ignored every regulation on the books. Consistently. Over the last 30 plus years. All while receiving billions in EU funds that are contingent on compliance with those rules. Rules that every other EU country had to abide by, and when non-compliance was detected, funds were withheld. This includes the old countries as well as the newest. Except Greece.

For example, one of the largest pieces of the budget is the Common Agriculture Policy (CAP), a system of farm subsidies. Every country is required to have specific electronic reporting systems in order to receive CAP funds. The new states all had to install them, even the poorest, and when they did not, CAP funds were withheld. Except Greece, which to this day does not have such a system.

The plastic olive trees used to obtain additional farm subsidies are legendary, but sadly not mythical. Having better controls would make this sort of creative farming (and accounting) much more difficult.

There are also requirements for good governance and tax collection standards, for example you need to have a land registry in order to collect property tax (and protect property rights). Greece does not have such a registry, which is pretty novel for an ostensibly developed nation.

They were required to have one. Didn't bother successive Greek governments. At one point they got significant EU funds to build such a system (€100m IIRC UPDATED: I initially recalled incorrectly that it was €400m, the correct figure is €100m). After a couple of years, an EU official was sent to check. At first, the Greek authorities didn't know what he was talking about. Then they remembered. Of course, not a thing had been done to create a registry.

After being reminded that they had received (and accepted) €400m in funds specifically dedicated to the purpose of building such a registry, they offered to "refund" half the amount, €200m. The mind boggles.

Of course, tax collection is a huge domestic problem in Greece, with often huge wealth and income taxed at best theoretically. Real estate plays a huge role in this, and this is why a land registry is not popular with the elites. When the tax collectors come to these quite fabulous houses, nobody there knows who the hoses belong to.

I still really like Volker Pispers's idea of tax collection via bulldozer: knock at the first house on the block. If an owner can't be found, knock it down. I am pretty certain tax compliance will improve markedly.

Anyway, as far as I can see, Greek governments see flouting EU rules as their birthright, as something that cannot possibly have consequences, a view that they has never been challenged until now. So I think their indignation at actually being held accountable is quite real, and they do see enforcement of rules as cruel and certainly unusual punishment, because for them it is just that: unusual, unexpected, unfamiliar.

And of course, EU institutions that let them get away with, well, everything over so many years certainly share some of the blame. But only some, not nearly as much as Greek politicians would like everyone to believe.

When Syriaza was voted into power, I was hopeful that things would improve, but they almost immediately started placing their relatives in well-paid positions, and apparently their proposals are just as vague about finally taxing the actual significant wealth that exists, and just as concrete about squeezing lower incomes to enrage public opinion and effectively use these people as human shields to protect the wealthy. I think I've used the word "sickening" before.

A Third Way (II)

Duncan writes:
What should be on the table is a decision by Europe to strengthen the economic union by sharing the eurozone’s debt. While the particulars of the Greek situation sent them over the edge first in the financial meltdown of 2008, sharing a currency between states without sharing debt is unsustainable in the long term for the entire eurozone. This isn’t news.
I confirmed with him that he meant "debt + fiscal" union. Yes. It is the only way a monetary union can work, in the long run. This has been pointed out many times, by many people. Alas, he adds:

The only surprising thing at this point is that states like Germany insist on keeping Greece under the weight of a debt that can’t ever be repaid.
I take exception to that on several levels:
  1. Nobody forced Greece to take on loans (from private banks) that it knew it couldn't repay
  2. Nobody forced Greece to cheat in order to obtain those loans, which it would never have had access to without cheating.
  3. Nobody forced Greece to avoid certain default, with all the awful consequences that we are now only beginning to see, by accepting a bailout using public/taxpayer money. Which came with certain conditions. If you don't like to conditions, don't take the money.
That said, I don't think anyone in the remaining Eurozone governments has any illusions about Greece avoiding having to default on at least part of that debt. After all, said governments already negotiated a partial default, with both public and private lenders taking a hit.

However, those governments have a justified interest in the same thing not happening again and again. The easiest way to do this would be to have a fiscal union, with member states giving up some chunk of their sovereignty over spending. However, national governments currently balk at this, most vehemently the Greek government with their referendum and "national pride" demagoguery.

Given that fiscal union is not on the table, the other alternative are stringent reforms. And given the simple fact that Greek governments have not been the least bit trustworthy, including this one, the only way to get those reforms is "under the gun". This is unfortunate, and economically stupid, but there does not appear to be any alternative other than letting Greece continue to spend as it wishes with others picking up the tab from time to time. And that is also not an option.

So yeah, it's complicated, and life sometimes sucks, especially for all the people that get to suffer from the consequences of their governments' actions.

The Seldon Crisis You Ordered Is Ready, Where Would You Like It Delivered?

Coming back to Euro, my view of the Euro project was always that it was never really about monetary union. The people who instigated it were dedicated Europeans, a view I share. They wanted political union. They knew that political union was not possible at the time. So they created monetary union, which was politically possible, knowing that over time it would create a situation that would force political union as the only reasonable alternative. A classic Seldon crisis. The only weird thing is that the crisis is here and yet it is not being used to create the fiscal and political union as one would expect. There were plans, it seems, but these were not acted upon. Is it because our current crop of leaders are too fearful, too used to just waiting it out, whatever "it" is? Are they too timid to take the bold leap required to create something great? Or maybe the crisis just isn't deep enough yet? I truly don't know, and am completely flabbergasted.

Of course, things are always a bit more complicated, for example the Euro was also a precondition for German unification, demanded by various European "partners", particularly France in order to limit German power post-unification. The fact that the Euro is now described as an evil German master plan to subjugate the proud southern European nations make this somewhat ironic, or more likely demonstrates how off-base and populist those types of claims are.

The US angle

You've probably noticed the central role of US investment bank and favorite vampire squid (sorry for the repitition, I just can't resist writing that...) Goldman Sachs in this saga: not only were they absolutely instrumental in creating the problem, they then blabbed about at the exact worst possible moment, in the middle of the worst financial crisis the world has seen in the last 80 years or so.

While I am not much into conspiracy theories, this is just too much of a coincidence to be... a coincidence, especially when you keep in mind the revolving door between GS and various parts of the US government and the fact that the US is not very fond of the EU, and absolutely hates the Euro.

When taken together, the EU is the world's largest economic power, with more people than the US and a greater GDP. If and when it gets its political act together, it will also be a significant political power, with 2 seats on the security council, a nuclear arsenal, unparalleled economic might and much less hatred for it in the world than the US. Having the EU get its political act together is not in the US's national interest, and as the NSA affair amply demonstrated (not that it was ever in dispute), there are no friendships at this level, just national interests that may coincide from time to time.

While the EU as such is a problem for US interests, the Euro presents an actual real danger. Not only is it a central piece of getting to political union (not just, but especially if my idea that it was intended to hasten the process is true), it has started to become an alternative to the dollar as a petro-, trade- and reserve-currency.

Why is this problematic? One of the mysteries of the US economy is how it has been able to have huge trade deficits, expand the money supply ("print money") and do all sorts of other things, without ever being punished by the usual consequences: high inflation and high interest rates.

While part of the answer is the "confidence fairy" that Professor Krugman ridicules in other contexts (people just think that the US will continue to be a good investment), a huge part is the use of dollars by other countries, which soaks up the dollars you just printed and spent.

An alternative reserve-/trading-currency means that those dollars will not just no longer be soaked up, but even worse existing reserves will likely be released, so all those dollars flood the market and cause the effects that were previously avoided. Which could be financially disastrous.

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