Spain’s domestic economy is booming, or so the story goes, and in no small part this boom comes thanks to the arrival of what is being termed the “good kind of deflation”, the sort everyone would like to have, a world where prices fall, real incomes rise, jobs are created, and everyone gets to live happily ever after. Let’s not worry that in the process the boom is steadily transforming an export lead recovery into a domestic consumption – or import driven – one. Continue reading
An interesting twitter debate between Alan Beattie and Frances Coppola, regarding the connection between Greek “structural reforms” and the macro-economy.
Alan argues that shortening business-to-business payment terms and improving contract enforcement should just generally be a good thing and shouldn’t have any macro effects in the short term.
Frances retorts that it’s always cash flow that causes businesses to fail, and anything that tightens cash flow will cause more business failures as the first-round effect.
Alan responds that companies who benefit from going slow on payments are usually just well-connected rent seekers and that they’re exploiting ones that have more potential upside.
I think we can be a bit more precise here. If money gets rid of the need for a double coincidence of wants, finance gets rid of the need for a double coincidence of timing. I don’t necessarily need to wait to sell in order to buy, if I can use trade credit, for example. One of the earliest known financial instruments is just a bill issued by one business that gives the customer 30 or 90 days or whatever to pay, and can be assigned to someone else.
The point here is to increase the value of economic activity that you can carry out before you have to draw on your working capital to pay a bill in cash. The presumption is that businesses are usually constrained by their cash flow, and trade credit is a way of relaxing this constraint and using their holdings of cash more intensively. In that sense, it’s a social mechanism that increases the money supply by increasing the velocity of circulation.
It’s possible to create a huge credit bubble based just on this financial technology – Kindleberger is full of them – even if the cash paid in final settlement is gold or silver or big rocks.
If we now intervene in some way and insist that people settle up their accounts, for cash, faster, what happens? Well, one way of looking at it is that all this informal credit is non-monetary economic activity. Now, it has to become monetised, which means that the demand for money has increased sharply. Another way of looking at it was the one I hinted at earlier. If we count the trade credit as an increase in the supply of money, then either the rest of the money supply must expand to accommodate it, or else the money supply must shrink.
Whether we look at this as an increase in the demand for money, or a reduction of the supply of money, it does mean that the marginal borrower’s interest rate is going up, possibly dramatically, and they also face liquidity risk. Here’s your contraction.
Now of course this can be solved; monetary policy can change.
In practice, the most likely route by which the outstanding bills get monetised is through a bank, because where else do you go to get cash? We can get around this problem if the banking sector’s balance sheet expands enough to take on the outstanding trade credit, or alternatively, if the monetary authority puts more money into circulation. (This is the same thing, in a sense – imagine an economy with one bank.)
The first option means that the banks may need more capital, because they are taking up a bigger share of outstanding risks, the second, that monetary policy must be adjusted. In fact, taking up the first option will probably involve some of the second, as the banks bring more paper into the central bank discount window. But if the banking sector is structurally constrained in some way, and the monetary authority is located in some other country, well, yes, the reform will be contractionary. Better, it will be contractionary, full stop, unless someone does something to counter it.
It’s true, as Alan Beattie says, that slow payment might be one of the ways rent-seekers exploit their suppliers. Anyone who’s ever been involved with a small business will know that there are a lot of unreliable payers out there. However, this is true of the UK and probably of Finland. It’s also idiosyncratically true, not the sort of thing easily accessible by airport-to-hotel reformers. And it’s more true that small businesses will be more likely to run out of cash, if there’s a general drive to collect on bills quicker, than big ones.
The classic mechanism of an economic crisis in an economy that runs on store credit is set out very well in Kindleberger. Chains of bills, representing the outstanding volumes at risk, grow until something happens and causes the marginal creditor to demand cash money. Then a cascade-failure of bankruptcies occurs. It is not obvious, to say the least, that this is desirable.
Yes, this reform is contractionary, and implementing it requires that the monetary authority pushes against the contraction.
It’s probably worth keeping an eye on German elections at the moment. Hamburg voted today, and the results below will update as more results come in, via Der Tagesspiegel. Basically, the SPD won big but will need a coalition partner, probably the Greens, the FDP and the Left had a respectable showing, the AfD version of the far-Right just, just scraped into a western German parliament for the first time, and the CDU had a nightmare, literally their worst result ever.
Click on “Gewinn/Verlust” for the changes in % terms – the CDU lost 5.9%, the AfD picked up 5.8%. Ouch. But most of all, the Non-Voter Party had a great night, picking up 44.5% of the vote.
— Don Annuntiator (@Annuntiator) February 15, 2015
On that score, I expect the main effect to be “That’s over with now” rather than “Chase the AfD”.
This is old news now, but it’s a good example of a theme we should be watching in the Greek negotiations – as it were, Euro-European tensions. Conflict in the EU, whether between nations, parties, lobbies, or individuals, tends to be expressed as conflict between the institutions.
So Jean-Claude Juncker has quietly said that the Commission could accept the withdrawal of the troika mission from Greece, which matters because a lot of the staff will be from the Commission. In this, of course, he’s accepted a Greek negotiating point although not a very important one.
He immediately gets a blast of verbal from Volker Kauder, the chairman of the CDU parliamentary party, who says he’s going soft and the identity of Europe is at risk and Juncker doesn’t get to decide what the Bundestag thinks. Get that combination of the identity of Europe on one hand, and pseudo-eurosceptic tractors-off-our-lawn stuff!
But then again, it’s not as if Kauder has any right to tell Juncker what to do. As he knows very well, if there is an agreement, he will have to pass the bits that affect bilateral treaties through the Bundestag, and of course he will. That’s what party whips do in life. When Merkel says so, he’ll spring to it, knowing that the job is a great platform if he wants to be chancellor one day.
There’s probably a good case to be made that the Greeks are right in trying to pick off Juncker and the Commission. The whole point of the Commission as an institution is that being in charge of the administration and the policy staff support is important. Traditionally, it gets to set the agenda, and the member states get to use a veto.
Things are more complicated these days, with the stronger parliament and the intergovernmental institutions like the High Representative for Foreign Affairs and the Eurogroup, but I for one wouldn’t bet on any final text being very heavily influenced indeed by the Commission staffers who drafted it and who will watch over its implementation.
Also, the Commission is more committed than any other institution to The Project, with which it is deliberately synonymous. And it has a lot of independence. Juncker only needs the support of his own institution to act, while even the Germans need to line up a coalition in the council of ministers or the eurogroup if they want to do anything positive.
The ECB is a bit like this, too, but it actually has less independence, as its directorate is chosen by the national central banks and actually reports back to them. By contrast, although politicians always try to give orders to European commissioners, the commission is meant to reject this.
It’s an interesting question which institution would jump which way on the question of a Cyprus-like scenario, staying in the € with capital controls in place. Both the Commission and the ECB are highly committed to keeping the project going, but it comes down to which of them is more committed to the original vision of open borders and free trade. The national finance ministers can accept a Cypriot solution most of all. Neither institution would like it, but the ECB could trigger it.
Probably, Greece is hoping to manage the ECB into not doing anything drastic, while convincing the Commission, so that the Council of Ministers can adopt a text the Commission cooks up.
At the extraordinary meeting of interior ministers in Paris back on the 11th January, immediately after the Charlie Hebdo attack, the following statement was issued. Nobody paid it much mind at the time, but there was something genuinely interesting in there:
We hope to swiftly finalize work engaged under the auspices of the Commission to step up the detection and screening of travel movements by European nationals crossing the European Union’s external borders. To that end, we will more extensively detect and monitor certain passengers based on objective, concrete criteria which respect smooth border crossings, fundamental liberties and security requirements.
Furthermore, we are of the opinion that the rules of the Schengen Borders Code should be amended in a timely fashion to allow for broader consultation of the Schengen Information System during the crossing of external borders by individuals enjoying the right to free movement.
This is some high-grade diplospeak, so let’s unpack this a bit.
External borders here mean the borders that demarcate the member states of the European Union from the wider world. Sometimes, the external border of the EU is also the external border of the Schengen zone. Inside this zone, there are normally no controls on the internal borders between the participating countries.
Obviously, there’s no problem with consulting the Schengen Information System, SIS II – the enormous shared database of suspects maintained jointly by the Schengen states – in this case. However, the EU external border isn’t always identical with the Schengen zone external border, because not all EU member states are also Schengen participants. If you’ve managed to cross from the Schengen zone into some non-Schengen EU state, your identity won’t be checked against SIS II when you cross the external border out of the EU. Nor will you be checked against it when you cross the external border back into the EU. But because you’re an “individual enjoying the right of free movement”, you’re unlikely to be bothered much there either.
So, “amend the rules in a timely fashion to allow for broader consultation of the Schengen Information System during the crossing of external borders by individuals enjoying the right to free movement” can be translated as something like “the non-Schengen EU countries are going to integrate their border control databases into SIS II”.
Which is why the first thing I said when I saw the statement was: “It looks like we just joined Schengen”. (It was easy – my dad predicted this years ago.) And now, just under a month later, GOV.UK lights up with the following statement:
The Second Generation Schengen Information System (SISII) will provide law enforcement alerts on wanted criminals, suspected terrorists, missing people, and stolen or missing property. A meeting of ministers in Europe has formally approved the UK joining the system on 13 April 2015.
Not, of course, that they’re going to take down the border posts – don’t expect to leave your passport at home any time soon. They’ve definitely signed up for the big database, though. As usual, the UK is much more integrated into the EU than either it, or the EU, would admit.
One of the things that the HSBC whistleblower Hervé Falciani has pointed out is the mess the HSBC computer system was with all the inherent safety risks involved, not to mention that it made it difficult for the bank to have any meaningful overview.
There are several reasons why Falciani’s statement does not come as a surprise. The Anton Valukas’ report on Lehman tells i.a. the story of a big bank with a patchwork of computer systems and applications. And there have been several spectacular IT failures in banks, i.a. at the RBS in December 2013 when the bank admitted to underinvestment in IT “For decades…”
Also, over the years sporadically talking to people working on IT in banks, I got the clear idea that IT costs were a source of irritation for many managers: many of them found it difficult to understand the costs and what benefit could be derived from the suggested improvements. IT people are or at least were low in the banking pecking order.
Lehman – a patchwork of over 2600 computer systems
The share size of the Lehman system was staggering: “The available universe of Lehman e?mail and other electronically stored documents is estimated at three petabytes of data – roughly the equivalent of 350 billion pages.”
When Valukas set about to organise the operation of mining the Lehman system for his report he was faced with the daunting task of extracting information from a patchwork of over 2600 computer systems and applications. The way the report deals with this attempt and success in mastering the material feels to be a story told with some understatement. But the share size was only part of the problem (emphasis mine):
Many of Lehman’s systems were arcane, outdated or non?standard. Becoming proficient enough to use the systems required training in some cases, study in others, and trial and error experimentation in others. In numerous instances, the Examiner’s professionals would request access to a particular system, expend the time necessary to learn how to use the system and only then discover that access to two or three additional systems was required to answer the necessary questions. Lehman’s systems were highly interdependent, but their relationships were difficult to decipher and not well documented. It took extraordinary effort to untangle these systems to obtain the necessary information.
This was the system in a big bank where nothing was spared when it came to bonuses and pay. In a sense Lehman was like a palace with shitty basement toilets, which no one cared about because they were out of sight anyway. Except of course that an “arcane, outdated and non-standard” computer system poses a real security risk, which a ditto toilet does not.
IT staff – low in the banking pecking order
I have heard computer system staff in banks complain about the lack of IT understanding among those who hold the spending power. Those with such power were seen to weigh spending according to parameters of immediate visible effect. Spelling out the disasters that might happen, when nothing has happened for a long time or ever, can be a difficult bargaining position.
A case in point was the RBS computer glitch, which severely affected clients in December 2013. Following the incident RBS admitted the following: “For decades, RBS failed to invest properly in its systems… It will take time, but we are investing heavily in building IT systems our customers can rely on.” – It would be interesting to know exactly what was done and if this has been a sustained process.
This too late – and often too little – has unfortunately very much been the pattern: the promises to do better and invest in IT have come only after the public incidents. It would be interesting to know if the RBS IT staff had been fully aware of the problems and how much it had tried to avert senior managers to the problem.
From IT employees in banks I have over the years heard loud complaints about senior managers who have little understanding for the importance of keeping the systems up to date and investing in the proper IT infrastructure. Asking for funds for IT was (is?) normally met with complaints about costs.
One employee told me that managers were normally reluctant agreeing to costs for things unless they understood the issue at stake themselves and which could be shown to increase profits. Since the level of IT understanding among senior managers was generally low IT was generally seen as only cost.
Banking – where the science of big data has not been appreciated
As many banks in particular those that aim at speedy international growth, HSBC grew by i.a. buying banks. Its Swiss operation where Falciani worked had been bought; the same with the Mexican branch where HSBC was found to have facilitated money laundering for drug lords, resulting in fines of $1.9bn in December 2012.
Banks are in enterprises with old roots and many of them seem to suffer from lack of technical insight among their highest echelon of power. Many senior bank managers in their fifties and older have never been exposed to much technological stuff other than their smart phones.
Over the last many years many big banks seem to have been focusing on growth and inventing new financial products. The feeling is that RBS and Lehman are not the only banks where IT systems have lagged behind, not only in terms of security but also in terms of how to have the best systems for overview. How can internal audit i.a. be meaningful in an international bank with 2600 systems, some of which are “arcane, outdated and non-standard”? Or in a bank with IT underinvestment for decades?
If senior HSBC managers did not know at the time as they have insisted of the bank’s massive failures, both in Switzerland and Mexico, it is also because the proper technology was not in place and probably had not been thought to matter.
Big data, the ability to sift through and derive information from a large set of data can of course be used in many ways within a bank. One of many uses should be to keep track of behaviour that could potentially be criminal. With the kind of patchwork system Lehman had that would hardly have been possible.
True, Lehman collapsed over six years ago, Falciani was working at HSBC eight years ago but the RBS glitch happened only just over a year ago. Banks might have worked miracles on their IT systems lately but the doubt lingers on especially because the IT insight and understanding might still be lacking at the top.
It’s going to be a busy seven days, and not a good one for a pan-European blog to be offline.
Greece’s calendar: confidence vote (10); T-Bills auction (11); Eurogroup (11); EU summit (12); Eurogroup (16); ECB/ELA review (18).
— Frederik Ducrozet (@fwred) February 9, 2015
The other day, someone on twitter said it felt like the news was working up to an end-of-season finale, a big finish for the longest running of TV shows. On Thursday, as Yanis Varoufakis and Wolfgang Schäuble were failing to agree on whether or not they agreed in Berlin, Angela Merkel and Francois Hollande were heading in their respective Airbus A310s to Kiev and then Moscow. Diplomats must be delighted at times like this; suddenly the job is as important as they spend their time making out it is.
As it turned out, Merkel and Hollande‘s mission only resulted in agreement to look at a draft ceasefire implementing the Minsk agreement from last year, a document widely considered to be a dead letter. The new content in it seems to have been more concessions of territory to the pro-Russian side.
All this diplomacy was triggered by the Americans floating the idea of providing Ukraine with modern armaments. Back in Germany, Merkel was rather sceptical about the idea at the NATO security conference in Munich, saying variously that there seemed to be plenty of weapons around and that no amount of them would impress Putin. (There may be plenty of AKs, tanks, and artillery, but the US proposal focuses on communications and electronic warfare, and perhaps anti-tank guided weapons.)
In general, the level of anxiety about the situation seems to have spiked in the last few days. Hollande has been saying that he fears total war. You might well ask what on earth is happening in the Donbass if it’s not war, but the fear is that it might get worse, moving from a so-called hybrid conflict confined to the area around Donetsk to a full-scale Russian invasion of Ukraine. Carl Bildt thinks it is possible; Anders Fogh Rasmussen thinks it is possible; former NATO deputy supreme commander Sir Richard Sherriff thinks so, and wonders where the British prime minister has got to. (Good question.)
Here’s a question. Hollande and Merkel are working from the assumption that handing over a bigger area of territory to the separatists would end the conflict, and that their territorial control reflects the wishes of the population. On the other hand, though, they are also working from the assumption that it’s not the separatist leadership who decides. Hollande and Merkel didn’t address themselves to Alexander Zakharchenko in Donetsk, but rather to Vladimir Putin in Moscow. In a real sense, they clearly believe that it’s Putin who decides what happens there.
If the Ukrainians were to accept such a proposal, and offer to give up the whole Donbass, would Putin accept it? I am not sure he would.
A DNR entity of real size and contiguity, a Republic of Novorossiya, would be disturbingly big and independent, and likely to make trouble. It would, however, still be small enough that the Ukrainians might hope to take it back one day. It would also set a precedent Putin would hate – as well as orange-clad protestors occupying city squares in the hope of joining Europe, he would have to worry about sovok or natsbol types with AKs hoping to join the Soviet Union, as it were, by setting up their own novorossiyas. Insurgency would have become an option for his own constituency. Annexing it to Russia would be massively provocative and would pose the question of how to demobilise and disarm the DNR.
Further, if you want to join NATO or the European Union, the rules are clear – you have to leave your irredenta at the door. The precondition of membership is that you wind up any geopolitical conflicts you have open. Nobody wants to attach the trigger of the NATO air forces to a checkpoint dispute outside Luhansk – it’s too risky. So long as the conflict in Ukraine is not resolved, Ukrainian membership of NATO is ruled out. The little green men are the guarantee. On the other hand, a Ukraine reeling from the loss of the Donbass would be very likely to do anything at all to get under the NATO security guarantee for the rest of the country.
Just keeping the conflict going, however, suits Russian interests rather well. Anyone who has an interest in the matter has to go to Moscow first. Ukrainian NATO membership is ruled out. The DNR stays deniable, but also dependent, so the level of violence can be turned up or down as is expedient. As some people from Transdniestria turned up in Crimea, it could act as a pool of proxy fighters for use elsewhere, in the Caucasus, the Baltics, or against Russian dissidents. And the horse may sing; the option of a counter-Maidan movement based there is kept open, although the chances of that happening must be minimal now.
Polling seems to suggest that a solution keeping the Donbass in Ukraine has strong public support, including in the rebel zone, although it’s not obvious to me how they surveyed it. If it’s a matter of a form of words that grants Donetsk what might be termed devo-max within Ukraine, though, I can’t help doubting anyone would fight for that so tenaciously, or with such means – main battle tanks, artillery in such quantity that the shells are delivered by the trainload. And such a deal has been on the table for months. Clearly, it’s the conflict that matters, not any particular political arrangement, and it seems there is only one man who can call a halt.
On the other hand, arming the side fighting against what looks more and more like the Russian regular army is a frightening prospect. No-one should doubt that for a moment, and I imagine the Russians will take care to remind us on a regular basis. Also, we need to think hard about getting the Ukrainians some money before they run out of foreign exchange completely.
– Forget economics, politics is key to understanding the Eurozone
The cries of the Grexit criers lately have mostly been a repetition of an earlier discourse: in February 2012 Citi’s economists Willem Buiters and Ebrahim Rahbari coined the term “Grexit,” by July 2012 estimating its likelihood to 90%. Cheered on by the media, economists have taken over the debate of the Eurozone which is why much of it has been such a futile exercise: it is not economics, which ties the Eurozone together but the political determination of its leaders to make the euro work. With political will likelihood of any exit is 0. Ergo, Grexit is as unlikely now as it has always been in spite of the EU brinkmanship. One route Greece seems to be exploring is a tried and tested one: the “bisque clause” from 1946.
In December 2009 the European Central Bank, ECB, published a working paper, Withdrawal and expulsion from the EU and EMU; some reflections (recommended read, clear and intelligent), by Phoebus Athanassiou. As Athanassiou pointed out, talk of ‘secession’ from the European Union, EU and European Monetary Union, EMU would earlier “have been next to absurd, considering the EU’s contribution to lasting peace and stability in Europe,” not forgetting successful enlargement. Athanassiou concluded that “negotiated withdrawal from the EU would not be legally impossible… a Member State’s exit from EMU, without a parallel withdrawal from the EU, would be legally inconceivable; and that … a Member State’s expulsion from the EU or EMU, would be legally next to impossible.” – But legal aspects are one thing, economics another and politics yet a separate aspect.
The eurocrisis has hit EU’s economy; economists and the financial media have led the crisis discourse. But the euro is a political construction, built on political will and at the root of the crisis there are politics: there has been a political unwillingness in the EU to be more than fair-weather friends. Fearing loss of sovereignty ministers have been unwilling to yield power to the various EU institutions (Athanassiou has some intriguing observations on sovereignty). – This is in essence what Mario Monti wrote in the summer of 2011 in a timely Financial Times article where he partly blamed the eurocrisis on the EU being too deferential and too polite to its member states.
With the crisis and hesitant action it has been ever more difficult to portray the EU as a success in spite of earlier glory. Much of the political demagogy on the left and right ends of the political spectrum in Europe is nourished by politicians from the established parties who have been far too willing to blame the EU for their own failures.*
Now Greece has voted in a new government who though critical of how the Troika, i.e. EU Commission, European Central Bank, ECB and the International Monetary Fund, IMF, has dealt with Greece makes no mention of Grexit and claims it wants to repay its debt. In a BBC interview minister of finance Yanis Varoufakis stressed that Greece was not going to toy with “loose or fast talk of Grexit” and fragmentation, which would only unleash destructive forces.
“Grexit is not on the cards,” Varoufakis said. At the same time, the government is hell-bent on finding a way to tackle what Varoufakis has called a “humanitarian crisis” in Greece, in addition to scutinising earlier privatisation and renegotiating, perhaps with an eye on the so-called “bisque-clause” from 1946.
Renegotiating, or whatever term will be found, is no mean feat also because all solutions are bound to be relevant for other problem countries. The Irish found a clever way though with their Promissory Notes, did it unilaterally with the ECB governor Mario Draghi commenting dryly that the ECB “took note” of it. – EU has always been brilliant at finding compromises though arguably its comprises have not always been brilliant.
The changing euro sentiment
On August 14 2007 ECB governor Jean-Claude Trichet stated that the bank was paying great attention to developments in the market, i.e. nervousness, increased volatility and ‘significant re-appreciation of risks’ which could be ‘interpreted as a normalisation of the pricing of risk.’ The bank had provided liquidity ‘needed to permit an orderly functioning of the money market… We are now seeing money market conditions that have gone progressively back to normal,” was Trichet’s reassuring conclusion.
Two years and some months later, in December 2009, it was clear that Trichet’s hopeful words were just that: hopeful. Ireland was under crisis clouds after the Irish government had been forced to fulfil its blanket guarantee of the banking sector. The situation in Portugal and Spain looked ominous not to mention Greece. All of this made Athanassiou’s paper a timely one.
Fast forward from Trichet’s 2007 statement to the ECB’s recent statement of a monthly asset purchase amounting to €60bn, at least until September 2016. ECB governor Mario Draghi has repeatedly stressed that the bank alone will not pull the EZ out of stagnation and slow growth. The political appetite for growth stimulus and the structural reforms needed has been negligible and attempts to challenge growth-quenching corruption, where needed, even less. It might even be argued that with the asset purchase, aka “quantitative easing,” into austerity-ruled EU the Union is like a boat rowing in opposite directions.
“The boom, not the slump, is the right time for austerity at the Treasury”
Jean-Claude Juncker’s €315bn fund is too little too late; a nod in the stimulus-direction rather than a real u-turn. After over six years of austerity the EU seems slow in revising on the 1930s lesson that the state has to step in when the private sector is sluggish. Greece now seems to want a realistic solution. Although only 2% of the EZ GDP it might inject new ideas into the Troika solutions, i.e. forcing reality instead of unsustainable solutions – effectively, earlier measures for Greece did not solve the problem and everyone involved knew it.
Simon Wren-Lewis’ summary of the obvious lessons from the Great Recession is: “Give any student who has just done a year of economics some national accounts data for the US, UK and Eurozone, and ask them why the recovery from the Great Recession has been so slow, and they will almost certainly tell you it is because of fiscal austerity.” Further, Wren-Lewis has recently summed up the necessary lessons from earlier attempts to debt restructuring, with a timely focus on Greece, saying the “Troika should welcome the opportunity to put right earlier mistakes.”
Yet and yet, austerity was the first and still is the strongest reaction to the eurocrisis. The IMF, for its part, has to a certain degree acknowledged its part in the mistaken routes chosen. For Greece there was a certain woeful blindness as to what the measures in 2012 would achieve in terms of growth, inflation, fiscal effort and social cohesion; this should not happen again as Reza Moghadam former head of the IMF European department wrote recently in the Financial Times, admitting to his share of the responsibility since he was part of Troika discussions 2010 to 2014 and pleading for halving Greek debt.
The new Greek government has plenty of research to bolster its case. In a 2013 paper, Òscar Jordà and Alan M. Taylor have shown “that austerity is always a drag on growth, and especially so in depressed economies: a one percent of GDP fiscal consolidation translates into 4 percent lower real GDP after five years when implemented in the slump rather than the boom.” And as John Maynard Keynes wrote in 1937, quoted by Jordà and Taylor: “The boom, not the slump, is the right time for austerity at the Treasury.”
To a certain degree the faith in austerity has been steered by predictable party politics as Simon Wren-Lewis covers here. Not surprisingly Wolfgang Schäuble claims that “austerity is the only cure for the eurozone.” With policies earlier belonging to the political right having to a great degree permeated the left, New Labour being the arch-example, there has been remarkably little left opposition to austerity. The political antagonism within the crisis countries has tended to be between parties in power, enforcing austerity and the opposition, opposing austerity so as to gain from the unpopular austerity measures.
Austerity is the easy route – structural reforms the really difficult one
But the last few years of austerity in Europe have also shown that although austerity is a tough path to follow, structural reforms are even harder. The Troika prescriptions for program-countries have all come with a list of structural reforms, which have been far tougher to fulfill. Though the structural reforms advised have often been sensible domestic politics and interest groups block them. The latest IMF review on Greece, from June 2014, lists the tough reforms still lacking, i.a. tax administration and public sector reforms.
The fact that there has often been little ownership of measures in the program countries has been part of the problem. One reason why Iceland sailed relatively smoothly through its IMF program was Iceland’s strong ownership of the program. Execution will be easier if the Greek government can renegotiate a sustainable plan it believes in contrary to earlier measures, which all involved knew was to a certain extent little but wishful thinking.
Consequently, scrutinising Troika programs it seems that although a tough path to follow austerity has been the easy route compared to structural changes where strong interest groups and politics clash.
Corruption – the dirty porn of EU politics
It is intriguing to note that the worst hit EZ countries are also countries where sentiment of corruption is high, as can be seen in the Eurobarometer. Yet, corruption has not been high on EU political agenda.
Only in 2011 did the EU Commission establish an Anti-Corruption report to monitor and assess efforts of individual EU countries to address corruption. The first report was published in 2014; reports will now be published every two years.
Given the fact that the cost of corruption is assumed to be 5% of GDP on a world scale, and clearly higher in corrupt countries, it has taken the EU scarily long to turn its attention to this problem. Again, that is no doubt partly due to the politeness Mario Monti had in mind – corruption is an embarrassing and dirty word in the EU, truly the dirty porn of EU politics.
Foreign media mostly focused on Syriza’s presumed anti-EU sentiments even though majority of Greeks want to stay in the EU and the euro. But Greeks noticed that Syriza broke with the norm of silence on corruption and campaigned on fighting it. Any step in that direction will be a great political achievement – and an example to follow for other countries. The fact that Syriza campaigned on the issue of corruption is already inspiring other countries, most notably the Spanish Podemos party.
It has caused some concern abroad that Syriza is going to stop or review the on-going privatisation. There is however indication that assets have been sold not on best price but best connection; something the Troika should not be too politie about, not least in a country with the sorry reputation of corruption. Privatisation will not be popular in Greece if people see state assets sold in a corrupt way.
Demagogues and the German problem
In 2009 it was easy for Athanassiou to refer to the success of the EU and the euro. Now the story in many EU countries, even in stoic and earlier so staunchly pro-EU Finland, is the rise and rise of anti-EU demagogical parties. So far, these are fringe parties, very often indirectly nurtured by politicians blaming the EU of their own failings.
But it is equally worrying that German Chancellor Angela Merkel is increasingly irritating other EU leaders with her moralising on other countries. After almost a decade as the leader of EU’s most powerful country, Merkel seems to be falling pray to the inherent law of power: the longer time in power the more myopic a leader is, ever more occupied with his or her legacy. This has not proved positive for her European engagement.
Given her long time in power Merkel has followed the course of the crisis countries from well before the crisis. She has had ample opportunities to speak out or warn her colleagues. Greece had for example been running a budget deficit more or less uninterrupted since the early 1980s enabled by German banks financing much of this deficit.
German banks, though prudent at home (or rather, Germans are prudent borrowers) were large lenders not only in Greece but also in other crisis countries, also in Iceland. German banks have behaved like the kind of teenagers who are faultlessly polite at home but run wild when partying at friend’s place cutting up the furniture and peeing in the corners.
Merkel did not seem worried until the problems in Greece and elsewhere threatened German financial stability. With the Troika involvement the German risk migrated to public sector lenders and the German banks avoided facing their risky behaviour.
It’s not the economy stupid, it’s the politics
Merkel herself is aware of the political dimension of the euro, or rather the lack of its political anchor. Her predecessor Helmut Kohl and his contemporary European leaders constructed a monetary union without a proper political dimension. More could not be achieved at the time; the wishful thinking was that the missing political part would come later. According to a German official Merkel thinks the euro, with the political part missing, is “a machine from hell” that she is still trying to repair. – As things stand now the machine will hardly be repaired any time soon– the one legacy likely to elude Merkel.
All through the eurocrisis the politics have lagged behind. As shown convincingly by Philippe Martin and Thomas Philippon concerted action such as the Outright Monetary Transactions, OMT already in 2008 and not as late as 2012 would have made the world of difference, not least for Greece.
Those running the “machine from hell” were slow in figuring out how to deal with the crisis. Domestic politics in the EZ were pointing in all and sundry direction. Merkel’s way of tackling any problem is to move slowly, very slowly. Her sluggishness has cost the Greeks dearly. But since the destiny of Germany and Greece are tied together in the euro the German sluggishness certainly has come at a cost to the Germans themselves.
Apart from the lack of political union to back up the euro – or at least some mechanism to deal with crisis – the EU made bad uses of what little mechanisms in place. This is what Mario Monti, wiser after his time as a European commissioner, pointed out in 2011, i.a. regarding Greece: “As for politeness, would Greece have been able to run for years public deficits vastly above its officially published figures – until the excess became known in late 2009 – had Eurostat had the power to conduct serious investigations to check the adequacy of nationally produced statistics? Of course not.”
Had the ECB been allowed to react already in 2008 with some form of OMT (yes, wishful thinking but let us assume these measures were conceivable already then though clearly not politically palatable) it would have run into the problem of ELSTAT where gathering statistics has turned into a political thriller still running: as late as January this year an ELSTAT supervising commission, one of whose members is from Eurostat, expressed concern and disappointment that some officials tried to influence ELSTAT’s reassessment of debt and deficit figures Brussels had called for. – Tackling the problem of ELSTAT would strengthen the trustworthiness of the new government.
The price of politeness is also evident in EU’s unwillingness to acknowledge the problem and cost of corruption (as I have pointed out earlier); unwillingness, which in itself a political vice among the EU countries. The EU countries are in it together but shrink from sifting through their neighbours’ dustbins to come up with compromising material.
Greece – with appetite for “bisque”?
Yanis Varoufakis and his team have had ample time to study the best approach but time is limited. Deposits are flowing out of Greek banks and the present Troika program ends on February 28, which jeopardises i.a. the ECB’s Emergency Liquidity Assistance, ELA.
Proselytising on Greek debt makes little sense – the debt is there not only because of Greek appetite for debt but for banks’ willingness to lend. The banks have sold off their Greek debt, IMF and ECB gobbled it up. It is too late to punish the original lenders, now it is only the Greek borrower left. There are many ideas floating around, here is Fistful of Euros’ Alex Harrowell summing up some of these ideas.
The problem with Greece is not just its debt, but the fact that the country is ever more crippled by earlier non-solutions as Syriza has stressed. Yet, the new Greek leaders have emphasised that they want to repay its debts to its lenders, ECB and the IMF as Alexis Tsipras said in a statement January 31. Greece is clearly trying to come up with a route that might suit everyone but is at the same time adamant that it must be allowed to run expansionary policies at home. Hiring Lazard as adviser shows the government pays attention to the markets as well as expecting tough talks.
The Troika loans amount to €226.7bn, ca. 125% of GDP, roughly two-thirds of total public debt of 175% of GDP. As Syriza has pointed out the unfortunate thing here is that the GDP has been shrinking making the debt ever less sustainable. This is i.a. part of the vicious circle that is dragging Greece down.
One way of going about the Greek problem might be to learn from history. The Stiglitz report, Report of the Commission of Experts of the President of the United Nations General Assembly on Reforms of the International Monetary and Financial System, from 2009 refers to the so-called “bisque-clause” from 1946:
There might also be alternative ways of ensuring flexible payment arrangements that would allow automatic adjustment for borrowers during bad times. For instance, one possibility is for coupon payments to remain fixed and for the amortization schedule to be adjusted instead. Countries would postpone part or all of their debt payments during economic downturns and would then make up by pre-paying during economic upswings. A historical precedent was set by the United Kingdom when it borrowed from the United States in the 1940s. The 1946 Anglo-American Financial Agreement included a “bisque clause” that provided a 2 percent interest payment waiver in any year in which the United Kingdom’s foreign exchange income was not sufficient to meet its pre-war level of imports, adjusted to current prices.
Sources have mentioned to me that the “bisque-clause” has inspired the approach being advocated by the new Greek government.
The “erroribus” of exit
“The world works thus that some help erroribus to circulate and others then try to erase it – and thus, both have something to do,” professor of antiquity at the University of Copenhagen Árni Magnússon (1663-1730) wrote.
Athanassiou’s conclusion was that “negotiated withdrawal from the EU would not be legally impossible even prior to the ratification of the Lisbon Treaty, and that unilateral withdrawal would undoubtedly be legally controversial; that, while permissible, a recently enacted exit clause is, prima facie, not in harmony with the rationale of the European unification project and is otherwise problematic, mainly from a legal perspective; that a Member State’s exit from EMU, without a parallel withdrawal from the EU, would be legally inconceivable; and that, while perhaps feasible through indirect means, a Member State’s expulsion from the EU or EMU, would be legally next to impossible. This paper concludes with a reminder that while, institutionally, a Member State’s membership of the euro area would not survive the discontinuation of its membership of the EU, the same need not be true of the former Member State’ s use of the euro.”
For those who have nailed their professional reputation to Grexit it might be hard to swallow that nope, Grexit is apparently not on the agenda – not for the new Greek government, not for the German government and, so far, no other EU government. German politicians may talk bravely about contained contagion from Grexit but dream on, who is willing to test the containment?
In order to understand the eurocrisis and find sustainable solutions forget the economics and focus instead on the politics. After all, the euro is a political construction, based on political will and as long as this will is there among Europe’s leaders there will be no Grexit or any other exit. Neither the ECB nor any EU institution will pull the rug from under Greece – this is not a question of some technical trick to force an end no government in Europe wishes for.
The euro is not just a currency, but the tangible sign of a union in which the earlier success of the internal market and enlargement was to be joined and entwined. For a few years it worked well, further cementing earlier progress. There are those who say it could never have worked and they are among the loudest in the Grexit choir as is, unsurprisingly, part of the UK media.
So far, the EZ countries have solved one problem after the other – yes, (too) often it has been too little too late, not always glorious. However, the political will to solve EZ troubles has been there and still is. Which is why it would be more fruitful to focus on the possible solutions – as the Greek government seems to be trying to do – rather than fable about Grexit.
* Þórólfur Matthíasson professor at the University of Iceland and I have argued that the eurocrisis has to a large degree been symptom of underlying problems in the crisis-countries, ignored or not solved in time, to be solved at national level.
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.
Who owns Greek debt – mostly Germany, unsurprisingly. Credit to Open Europe and ABN Amro. From The Times today pic.twitter.com/d0aCYjlOfZ
— Philip Aldrick (@PhilAldrick) January 27, 2015
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?