Stocks, Flows, GDP Warrants, Negotiating Constraints, Inter-Blogger Tension: Greece

So, if we were to make a little leap of faith, how could SYRIZA and the troika, or eurogroup, or shall we just say the Euros, come to an agreement?

The first issue, I think, is that any agreement needs to pass two tests. It needs to be both acceptable, or it wouldn’t be agreement, and it needs to be effective, or it would be pointless. The red-lines on both sides are pretty clear. SYRIZA went to the polls demanding some measure of debt relief. I take that to mean a reduction in the face value of the outstanding stock of debt to the Eurozone, plus the ECB, plus the IMF. Angela Merkel has stated that no further “haircut” is acceptable. Everyone assumes she is the ultimate veto actor on the Euros’ side.

On the other hand, as everyone seems to think, the debt service, i.e. the interest on the outstanding stock of debt, isn’t a big deal and therefore the stock of debt isn’t either. What matters is the primary surplus, the net transfer from Greece to the Euros, that the current agreement requires every year from here on in. The test of an effective agreement is whether it reduces this enough to restart the Greek economy. The Euros’ target is 4.5% of GDP. Yanis Varoufakis, Greek finance minister and everyone in the blogosphere’s new best mate, wants to cut it to between 1 and 1.5%. Clearly, agreement is possible somewhere between the two values, especially as nobody on the Euros’ side has committed to veto any particular number.

Ironically, the parties can agree on quite a few different options that would work to a greater or lesser extent, but they can’t accept them politically. This is of course better than the other way around. Arguably, the other way around is what we’ve had so far – acceptable, but ineffective.

A lot of people would also agree that the outstanding stock of debts is not really very important. It is, per Krugman, an accounting fiction, per Daniel Davies, the means by which the Euros try to control the Greek government budget, in order to impose something called “structural reform”. Alan Beattie, in a superb blog post, points out that the phrase “structural reform” is nonsensical.

First of all, there is no such thing as “reform” as such. You can’t ring up and order 20 40′ containers full of reform. Reforms are, more than anything else, inherently specific and context-dependent. The enterprise of structural reform is based on the idea that the market knows best, as it embodies the diffuse wisdom of those most concerned. But the reforms are meant to be chosen and delivered by civil servants parachuted (or rather, airlanded) in from some other country, usually isolated from everyone but the airport-to-hotel cab driver. This is at least ironic, and arguably perverse.

Second, reform has goals and in this case the goal is the delivery of the 4.5% annual primary surplus. Looking at this from a sectoral-balance point of view, if the public sector is to net-save 4.5% of GDP, either the private sector must take on a similar amount of net debt, or else the country must run a similar current-account surplus. So far, Greece has tried to reduce its CA deficit by demand destruction, or in other words, cutting down trees around Athens to save on fuel oil. What the structural reformers have in their heads, though, is that Greece increases its exports.

This implies both that somebody else imports them, and also that the Greek private sector increases its capacity. Firms expand by using more capital, one way or another. This seems unlikely in the context of debt-deflation. Reform very often costs money; when Germany carried out what it now thinks of as structural reform in the early 2000s, it blew its budget deficit targets with the Euros quite comprehensively.

Also, the difference between Alan Beattie and Daniel Davies is that Alan accepts that structural reform can be, and often is, stupid. Beattie’s archetypal Christmas-tree program includes a mixture of ideas anyone could agree with, ideas that are impossible to implement, and ideas that in context are insane, but might, tragically, be implemented. Capacity has to go up but demand has to go down. The private sector needs to borrow to invest, but credit has to be tighter. Pensions must be cut to increase the pensioners’ competitiveness in the cut-throat business of retirement. Daniel Davies’ Aunt Agatha doesn’t just want you to do language classes; she also wants you to wear earplugs during them, and also attend the right sort of church like the right sort of people, just to show willing, like.

There is surely a case that the Greeks are the best placed to know what their problems are, and further that SYRIZA is the party that is least complicit in keeping the problems that way. That means, of course, that the reforms must be acceptable to them.

But we already know that the level of the primary surplus is negotiable. We’ve established that. The point is how to deliver something that amounts to debt relief in Greece, but not to a write-off at face value. How can we get to yes?

Here’s an important chart, showing the annual repayments in euros for the various official loans.


You’ll notice that in the short term, the IMF predominates. You’ll also notice that a lot of the repayments are in the really long, we-are-all-dead run, out to the 2040s and 2050s. This is the very definition of a political number. And who owns it? You might be surprised.

Everyone always says Germany, but out of the €194bn owing to Eurozone sovereigns, €104bn came from France, Spain, and Italy together. When the history is written, it should take note that Spain in its troubles put its hand in its pocket for serious amounts of money. At the time, there was a lot of talk that the EFSF-and-then-EFSM-and-then-ESM had no credibility because they stood behind it. The record shows they came through. Of course, this makes the idea of a southern front against austerity so much more difficult, as they can afford to lose the money so much less.

This is, I think, where there is a bit of play in the mechanism. The Greeks are floating the idea of linking the debt repayments to growth, like an income-contingent student loan or perhaps more like a debt-for-equity swap. This is, of course, rather like the GDP warrants proposal that was fashionable a couple of years back.

In context, this means that the payoff comes through if the reforms actually work; a discipline never before imposed on such a programme, although of course they always want it for everyone else. This is substantially better than the other option, which is just to extend-and-pretend again.

Although the payoff structure is equity-like, it’s still an obligation of the same face value, so it does not constitute a write-off in the strict sense. As it doesn’t require a cash transfer until some target is reached, though, it is debt relief in a very important sense from a Greek point of view. In an accounting sense, of course, it is – the risk-adjusted net present value would be lower by some percentage depending on your guess about the path of Greek GDP in the fairly distant future.

The further out you go, of course, the easier this is, but then again, the test of effectiveness is what happens to the primary surplus requirement – right? And a swap of bonds for warrants with terms out in the 2040s is a better bet, I think, than hoping for a European fiscal union with actual transfers and without balanced-budget amendments.

As for the IMF, well, will this mean another story about the Europeans hoping the Americans will lend a hand?

Swiss time was running out

The reviews are in on the Swiss National Bank (SNB) abandoning its CHF 1.2 per Euro minimum peg and they are unfavourable. It seems people are shocked that Switzerland might act in a unilateral fashion and without seeing the need to coordinate with other countries.

Anyway, the departure point for many analyses seems to be an assumption that nothing was especially wrong with the peg. Sure, the SNB was committed to buying unlimited quantities of foreign currency, and thus unlimited growth in its balance sheet, but what exactly was the constraint on that? Well, for one thing, it was producing some economic outcomes that Swiss voters — remember those people? — didn’t seem to especially like, not least rapid growth in asset prices such as housing and questions about huge holdings of foreign currency assets.

But let’s take the liquidity trap diagnosis at face value. Switzerland has been at risk of deflation, and the tendency of investors to pile into its currency at the same time forces it to appreciate, making the deflation problem even worse. The peg was supposed to solve that, but the domestic politics around that was turning sour. One way to break the deflationary cycle: get people thinking that the SNB might be just a little crazy and liable to do things at short notice which make investing in the currency not such a good idea. And furthermore, realizing that your peg is going to crack at some point in the future, acting abruptly now in a way that causes the exchange rate to, er, “overshoot” its true higher long run value so that investors expect it to depreciate over the foreseeable future, meaning rising prices and … more incentive to spend today!

Yes. it sounds crazy. But the liquidity trap is itself crazy. This particular exit option just might fit the times.

It’s Baaack: Looming Greek Elections Threaten To Re-ignite the Euro Crisis

If at first you don’t succeed, try, try again……  aka third time unlucky.

The Euro crisis has all the signs of being back amongst us, and this time it may be here to stay. After two earlier false alerts – one in July around the collapse of the Portuguese Banco Espirito Santo, and another in October over the state of the Greek bailout negotiations – the announcement this week that the Greek presidential decision was being brought forward to December has sent the markets reeling off into a complete tizzy. Continue reading

The Japanisation Of Europe

By now it should be clear that the monetary experiment currently being carried out in Japan (known as “Abenomics”) is fundamentally different from the kind of quantitative easing which was implemented  in the United States and the United Kingdom during the global financial crisis. In the US and the UK QE was implemented in order to stabilize the financial system, while in Japan, and now the Euro Area (EA) the objective is to end deflationary pressures and reflate economies which are arguably caught in some form of liquidity trap. Continue reading

Secular Stagnation Part III – The Expectations Fairy

“So what’s going on here? Well, it might sound like a hokey religion, but central banking is really a Jedi mind trick. Just saying something can be enough to make it happen. That’s because the power of the printing press gives their words a distinct power. Well, that and the fact that the economy is already one big self-fulfilling prophecy.” – Matt O’brien,  “Abenomics has only worked because foreigners think it willContinue reading

What Is The Risk The Euro Crisis Will Reignite?

The euro zone crisis is not back — at least not yet.

Recent movements in global markets following concerns about Portugal’s Banco Espirito Santo really had as much to do with market nerves after a long spell of repressed volatility as it did with the state of the bank’s balance sheet. Despite the current calm, everyone knows that volatility will return one day, and no one wants to be caught on the back foot when it does arrive. So the initial response is to hit the “sell” button and then ask questions.

Beyond this context, there is a lack of certainty in the market about which way bond yields for the so-called “peripheral” euro zone countries are heading in the near term — and what exactly the risks associated with holding them really are. Riding the yield compression, in the case of the Portuguese 10-year bond from over 7 percent to under 3.5 percent was a one-way-bet no-brainer once the impact of Draghi’s July 2012 speech became crystal clear. Continue reading

Olli Rehn: a tribute

Olli Rehn’s last ECOFIN press conference has just finished. AFOE would like to take this momentous occasion as an opportunity to salute Rehn’s towering achievements, and Matthew Yglesias passes on exactly what we need.


Yes, we know he was Enlargement Commissioner. But seriously folks, Rehn took office as Commissioner for EMU on the 9th of February 2010. If you were to overlay those two charts, the lines would diverge essentially right then.

And, desperately, he thinks he’s done a brilliant job:

It’s only topped by the astonishing fact that some Iraq War advocates not only continue to claim that Iraq had weapons of mass destruction, but claim that the weapons are still present to this day.

Mario Draghi’s Ongoing Faustian Pact

Word has it that Mario Draghi is busily working up a new version of his “whatever it takes” methodology. This time the objective is not saving the Eurozone, but maintaining the region’s inflation at or near the ECBs official 2% inflation objective. The first time round the President of the Euro Area’s central bank had it easy, since market participants took him at his word and he effectively needed to do nothing to comply. This time though, as they say, it will be different.

Continue reading

The Growing Mess Which Will Be Left Behind By The Abenomics Experiment

According to wikipedia, “overdetermination is a phenomenon whereby a single observed effect is determined by multiple causes at once, any one of which alone might be enough to account for (“determine”) the effect.That is, there are more causes present than are necessary to generate the effect”.  In this strictly technical sense Japan’s deflation problem is overdetermined – there are multiple causes at work, any one of which could account for the observed phenomenon. Those who have been following the debate can simply choose their favourite – balance sheet recession, liquidity trap, fertility trap – each one, taken alone, could be sufficient as a cause. The problem this situation presents is simply epistemological – in a scientific environment the conundrum could be resolved by devising the requisite, consensually grounded, tests. Continue reading

Could Mario Draghi Implementing QE At The ECB Possibly Help Matteo Renzi Raise the Italian Deficit?

What a convoluted title! Still, the lack of formal elegance might just be compensated for by its communicative efficacy. The aim of the above header is to link two names in people’s minds, both of them Italian: Mario Draghi and Matteo Renzi. Naturally the idea is not original, the FT’s Peter Spiegel  recently published an entire blog post ( Does Renzi owe his job to Draghi?) trying to establish some sort of  connection between the arrival in office of Italy’s Matteo Renzi and the recent German Constitutional Court ruling – in the process casting the central bank President in the role of midwife. Indeed, according to the FT,  Italy itself is currently rife with rumours about what might actually lie behind Renzi’s meteoric rise, and  again the role alloted to Mr Draghi seems to be  rather more than an incidental one. Continue reading