The two sensible choices

There are two sensible and realistic choices for solving the Euro crisis. The sensible and realistic choices are:

  • Surplus areas like Germany give deficit areas like Greece free money, indefinitely, or,
  • Weak economies like Greece and Spain leave the Eurozone.

These really are the sensible and realistic choices. You need one of these if you want roughly equal purchasing power across the Eurozone. Otherwise, money will flow from unproductive deficit areas to productive surplus areas, people in surplus countries will get steadily richer, people in deficit countries will get continually poorer, and eventually this will come to a head by revolt or other radical means.

Free money recycles this flow, exchange rates stop it. Economically the first is better because more flow of goods and services and money turns the economy forward and makes everyone consume more in aggregate. The latter choice aims for fairness, sacrificing total volume of trade and industry in the process.

Right now we’re still discussing the free money idea. Free money could be given as tax-and-transfer grants like most states do internally, as endless monetary expansion like the US, or by recurrent debt default and restructuring. The only advantage of the third option is it makes a policy look like an accident.

If free money won’t fly, leaving the Eurozone is the choice. Greece should have left the Eurozone… any time from 2001 till tonight would be good. Cynics would say stay until 2011 while the free money vision of Europe looked ascendant, but certainly Greece should have dropped after that. Greece should leave now.

Dropping out of the currency union has only advantages for the weaker economy. The disadvantages for the stronger economy are that it stops the flow of funds from the poor to the rich and removes demand for their exports. Germany selfishly wants the Euro. Greeks are stupidly attached to it because they equate the Euro with the EU and three decades of progress.

There are also a couple of totally fantastical choices that people might believe would fix the Eurozone, but they won’t work.

  • Economies like Germany and Greece become similarly productive any time soon.
  • Regions fix trade imbalances through fiscal discipline and austerity.

These are myths. It would be great if Greece was a bit more prosperous like Germany and that would take a venture investment ethos, congenial labour relations, an orientation to global markets, nourishing a boutique economy, branding, IP rights, stability and democracy. Well, at least Greece has democracy.

Different economies may become more alike, but they won’t become the same. The Mississippi delta is less productive than Silicon Valley and that’s why the meagre social policies of the US transfer funds indefinitely from rich Californians to poor Louisianan’s. Convergence doesn’t remove the need for transfers, it makes them smaller.

As for austerity, austerity is the null policy. Austerity means to just accept the dynamic of unproductive regions being steadily poorer and productive regions being steadily richer without asking for free money to mitigate it. And fiscal discipline means don’t try the free money by monetary expansion or default routes.

Until 2011 it looked like Europe was going to work like a superstate using free money transfers. This would have been better for all, including Germans. This idea now looks dead. Weak economies should ditch the Eurozone, now.

What Grexit looks like

Now that Greece voted No in the referendum it’s likely the institutions will seek a quick compromise to avoid serious damage to themselves and the Euro. In that case we’re looking at a more reasonable bankruptcy negotiation between Greece and the creditors, within the Euro. There will be capital controls for a while, like Cyprus, but eventually they’d be lifted.

The alternative is the Grexit scenario. However Grexit doesn’t mean that Euro deposits get redenominated to drachmas overnight. There’s no legal basis to do that. Euro deposits are obligations of Greek banks to individual depositors. They’re supposed to be guaranteed by the ECB, except last week the ECB decided to stop honoring that obligation. That decision will bite them, but it’s another matter.

Anyway Euro deposits are not the business of the Greek state or the bank of Greece. They could not redenominate Euros to drachmas, except by seizure. Also, there’s no incentive to do so. When the ECB withdraws its guarantee, Euros in Greece are precious hard currency like gold coins. Whatever Euros Greeks have, they’ll want to keep. Why would you convert perfectly good Euros to less valuable drachmas?

So on Monday, after a no vote, we have a scenario where Greek banks have Euro liabilities (deposits) and outstanding Euro loans, and they’re not guaranteed. There’s no lender of last resort for Euros in Greece. Banks would have to be super-prudential about handling Euros in this scenario, with deposits equal to reserves or close. Any MFI creation of Euros through loans would be extremely risky.

Of course banks are much more exposed than this. Soon, because of bad loans or the ongoing bank run, Greek banks go insolvent in Euros. At that point, the Bank of Greece steps in and guarantees deposits, but in Drachmas. And that’s how the conversion happens.

There’s a haircut on deposits until the Euro accounts of banks drop to the super-prudential level they’d need to be to operate safely. That means deposits equal reserves plus really safe loans. Greek banks continue to operate Euro accounts in this way thereafter, to facilitate transactions in tourism, import/export, etc. Euro loans will be hard to make and they’d only be made to businesses with good short-term collateral such as outstanding invoices. Not mortgages. Euro will effectively stay in Greece as a business currency.

The remainder (the amount that was haircut) gets converted to drachmas. So if you had €1000 in the bank and after haircut you’re left with €600, you also get the equivalent of €400 in drachmas, courtesy of the Bank of Greece. People can’t really complain about this change, because it’s the big bad ECB that haircut your Euros and the Greek state (Bank of Greece) saved you by giving you drachmas in compensation.

Thereafter the two currencies exist in parallel. Banks operate both types of accounts. Euros are not guaranteed, hence super-prudential: hard to get Euro loans, no Euro credit cards. The Banks of Greece acts as lender of last resort for drachmas, like a normal central bank. Drachmas operate with all banking services immediately and eventually notes and coins are introduced. Businesses that deal with tourism or import/export will surely maintain both Euro and drachma accounts. Everyone will have to declare their Euro and their drachma income separately and pay taxes in each.

Ordinary people like pensioners and dentists will either run out of Euros eventually, or they’ll use them for savings (bad idea, not guaranteed), or they’ll accept some offer to close their Euro account and convert to drachma. Pensions, salaries, house purchases, utility bills, and other big domestic prices will be negotiated in drachmas. Shops will post two prices, at least for a few months.

Eventually anything that’s related to tourism or imports, like electronics, will post both prices. Everyday domestic trade like street markets for food, plumbers, English lessons, hairdressers etc. will transact pretty much only in Drachmas. The Drachma has to be the official currency and there’s enough need for money for it to be accepted. The Euro just has to be legal to circulate, it doesn’t need any encouragement.

And then life will be good!

Having your own currency does three things: It makes imports expensive relative to domestic goods; it lets you pursue monetary policy; and it lets you devalue to make your exports price-competitive. The first two are crucial for Greece. The third is moot.

Greece is in a mess with external Euro debt because individuals prefer to buy imports than to pay taxes and so Euros leave the country. After the switch, businesses that earn Euros will have Euros to spend and they’ll have to be responsible because Euro loans will be super hard to get. Everyone else will face a Euro/Drachma exchange rate when buying imported goods. It’ll make iPhones expensive if you’re not directly earning Euros, and that’s really the worst part of the whole transition to drachmas thing.

The macro effect is Greeks will be buying more basics such as food, housing, and services which are predominantly domestic. They’ll be buying fewer discretionaries such as cars or electronics which are imports. Some essentials such as oil, clothing, and medicines require imports but currently those imports are cheap and there’s some production capacity in Greece for these sectors. That’s a very fortunate configuration for Greece’s balance of trade.

More importantly, the Bank of Greece will finally be able to run monetary policy in a way that fits Greece and not the gold standard delusions of Germany. Obviously it’ll be an expansionary Keynesian policy and the drachma will drop, but not alarmingly. Greece’s economy isn’t a basket case because of inflationary tendencies, By now it’s in a hard currency straitjacket.

Greece has massive unemployment, it’s demand-side limited, and there’s a huge amount of informal debt because of lack of liquidity. The plumber owes the teacher, the teacher owes the dentist, etc. and no-one has any money. As soon as money of any kind flows into the economy people will start paying their bills and the economy will pick up be amenable to taxation. Even if the Greek state makes up a few percent of fiscal spending with monetary easing that’s unlikely to yield so much drachma inflation to be a problem.

The third aspect of having a weak floating currency is that Greece could devalue it, deliberately or by letting it slide, to make its exports more attractive. If only Greece had exports, that would be a great idea. Greece makes its Euros from tourism and in the Grexit scenario that income would be the same or slightly less. Tourism is price sensitive but it’s not that scalable. If you have capacity for a million visitors you can’t bring in two million by being slightly cheaper the way you can scale up industrial production.

Greece’s other exports are oil product (basically running a refinery, it has no wells) and things like ore and agricultural goods. Again, what is Greece going to do? Grow twice as many tomatoes? Greece’s competitiveness problem is not having industrial, not that they’re expensive. The idea of being more competitive by devaluing the currency is beside the point for Greece. Greece’s long term competitiveness needs to come from things like boutique exports and tech startups, and there’s nothing about Grexit that works against these. Sweden is not in the Euro and full of tech startups.

Overall the supposedly disastrous scenario of Greece leaving the Euro won’t be disastrous. For Greece. It may be disastrous for the Euro, or for the careers of some politicians and mainstream economists because Greece will be doing spectacularly better almost immediately and various parties will begin to question what benefits the Euro really delivers.

Ranking outcomes

Greece and the creditors are in last last-ditch negotiations where the creditors aim to keep Greece in the Eurozone and avert default. Greece aims to secure a bankruptcy deal that’s friendly to the poor and which makes growth possible. In subtext, the creditors want Greece to surrender unconditionally to the institutions to discourage similar movements elsewhere, while Greece aims for sovereignty to carry out a democratic mandate.

Recently it looks like a deal might be reached. Would that be a good outcome? I don’t think so. In my opinion the situation has deteriorated enough that walking away is better. Also we must not lose sight of better outcomes that are currently closed, opportunities that are squandered. To keep everything in context, here’s my ranking of possible outcomes from best to worst.

1. A better model for the Eurozone

The best possible outcome would be to change the architecture of the Eurozone to one that suits all economies. Currently the Euro is architected like the Deutschmark, a strong currency with very tight monetary policy similar to the gold standard and strict fiscal discipline. That has been a German political demand, but such an architecture doesn’t suit the UK (who opted out), Latin countries, and least of all weak undisciplined economies like Ireland and Greece. If the Euro were changed to be a weaker and more volatile currency like the dollar, and the ECB pursued loose monetary policy at times of trouble like the US Federal Reserve, weak economies would be better performing in general and would get out of crises easily. I’m not sure how a weak Euro would hurt Germany except psychologically.

2. A Europe with social transfers

The next best thing, if loose monetary policy and moderate inflation are out of the question, is a Europe with social transfers. A hard currency and strict fiscal discipline for governments, but a European safety net to bail out people (rather than governments) when times are bad. These would be things like EU-wide basic pensions, unemployment, and poverty line income support. Really basic stuff. Right now this is anathema in Europe, as relatively well off taxpayers in relatively prosperous economies resent paying social benefits to poorly off taxpayers in weak economies. But this is exactly the system in the United States. Individual US states and large cities routinely go bankrupt, but federal programs like food stamps and Medicaid support their poorest citizens. Is Europe really unwilling to offer the meagre social benefits that the US does?

3. Positive reform for Greece (a good deal)

After several years of deceit and mismanagement, Greek voters managed to fire the corrupt political dynasties that took turns in power and bring in outsiders (SYRIZA) intent on serious reform. Inexplicably, the creditors decided that they’d rather deal with the old guard that committed financial fraud at their expense and proceeded to undermine SYRIZA at every step. This is a squandered opportunity. For the first time in decades Greece has a morally sound government with a strong mandate and a credible agenda for reform. The same reform that Europe wants: Modern public administration, effective tax collection, making it easy to start a business. If the creditors would take Greece’s proposals seriously and engage in good faith, rapid progress would be made. Except success would look bad and Podemos in Spain would want the same.

4. Leaving the Euro and staying in the EU (no deal)

The best outcome currently open, in my view, is for Greece to walk away from negotiations and leave the Eurozone while staying in the EU. Dropping the Euro and introducing a national currency does two things: It lets the state create and circulate money in the domestic economy, and it makes imports expensive relative to domestic goods. For Greece that means the domestic economy will quickly return to health and poverty will be quickly alleviated. Food, housing, and services will be cheaper as they’re domestic. Technology imports and foreign services such as studying abroad will be expensive. The standard of living, which is mainly supported by domestic goods, will rise but Greece will feel a little backward for lack of imports. People will be able to consume more tomatoes and fewer iPhones. Greeks won’t like that because they love their iPhones, but right now tomatoes are more important.

Some common misconceptions about the impact of Greece leaving the Euro:

Greece’s debt is a separate matter from staying in the Euro. Greece owes more Euros than it can realistically pay, so in the end it’ll realistically pay less. If Greece stays in the Euro the creditors have more leverage to ruin Greece, making repayment harder. If it leaves, Greece has more prospects to recover and could decide to default with fewer consequences. Leaving the Euro is not the same thing as defaulting on debt.

In economic textbooks, leaving a currency union and devaluing is good for competitiveness. That works for an industrial economy whose output can scale a lot with small differences in producer prices. Greece produces olive oil and tourism. Tourism is price-sensitive, but it already faces strong market discipline and it’s not that scalable. If Greece drops the Euro it’ll become cheaper, it’ll sell a few more more holidays and foods, and overall it’ll make a bit less in Euros. The competitiveness argument is moot.

If Greece leaves the Euro the financial fallout will be small. The Anglo-Saxon investors already took their losses and generally acted businesslike in this drama. European governments bailed out their investors and are now holding the bulk of Greece’s debt. Because Greece’s economy imploded, this debt is worth less than face value. If Greece leaves European governments can realise this loss, they can continue to hide it, or they can reflate it with ECB money creation – the same choices they face now.

On the other hand if Greece leaves the political fallout will be large. Being in the EU or EEA but outside the Euro is increasingly looking like the better option. It’s where the UK, Denmark, Norway, and Iceland chose to be. If Greece makes the transition relatively painlessly other countries will sooner or later follow and the Euro will either unravel or lose many of its members and become a new Deutschmark for countries west of the Rhine. For Germany, this will be a large political failure.

5. Parallel currencies

Various technical proposals are being floated about Greece issuing some currency in addition to the Euro. The idea is you’d have Euros and Drachmas in your wallet and you could use either, but Drachmas would be easier to come by and worth less. These proposals aim to quit the Euro in substance while retaining it for morale, for appearances, or for the convenience of travellers. Most view them as temporary measures. Parallel currencies are a risky proposition. They work well at small scale. At large scale they’ve been tried by Latin American countries in crisis, with mixed and hard to disentangle results. Overall, depending on the technical details, parallel currencies work out about the same as leaving the Euro or significantly worse. They’re a great plaything for economists, though.

6. Continued austerity (a bad deal)

If Greece accepts the creditor’s demands it will be a bad outcome for all sides. The creditors insist on austerity and prioritising debt repayments over growth, as they have for the past five years. Continuing on this path will keep Greece impoverished and heavily indebted for the foreseeable future, and will bring further suffering and extremism. The creditors appear less concerned with fostering growth or ending the crisis, and more intent to prevent any country from going bankrupt in the Eurozone and then recovering. It’s Europe of debt servitude. The only good thing about this outcome is that it’s pacified. The empire wins, the rebels are crushed, and there’s an unhappy stability. Greece will still be broke and recurrent debt crisis will be the new normal.

7. Capital controls (like Cyprus)

One officially sponsored outcome that’s worse than austerity is what happened to Cyprus. people in Cyprus use a currency that’s called Euro and looks like the Euro, but a Euro in a Cypriot bank or in your pocket is worth less than a Euro in France or Germany because you can’t take it out of Cyprus. What happened to Cyprus is a remarkably cynical way to fracture a currency union and punish a state (for accepting the money of rich Russians) while claiming your shiny currency union is intact. After seeing the kindness of Europe, Cypriots probably wish they’d stayed a British possession.

8. Continued uncertainty

A marginally worse outcome is continuing the uncertainty that we’ve had since January. Since SYRIZA was elected, creditors have been refusing to roll over Greece’s debts and instead are asking Greece to pay them off as they come due. The ECB cut off one form of finance to Greek banks and is reviewing the other kind (ELA) on a regular basis, effectively inciting a bank run. It’s like the US Fed announcing that Michigan state banks could go belly-up any moment now. This strategy aims to damage Greece’s finances and banking system so that Greece will more easily pay its debts, presumably.

9. Leaving the EU

There’s much good in the EU besides an ill-conceived and damaging single currency system. For poor and troubled nations like Greece the EU brings stronger human rights, freedom to settle and work in any member state, and an open market which for ordinary people means freedom from profiteering of various sorts. The great achievement of the EU is that we can be in each other’s countries as citizens, not as barely tolerated guests. We put up with stupid bureaucratic rulings on bananas and cookies to retain this privilege. It is important not to throw the EU out with the Eurozone.

10. Political meltdown

The worst possible outcome for Greece is a disorderly collapse of SYRIZA and the rise of the nazi Golden Dawn party as “national savours”. Greece is closest to the abyss, but throughout Europe the social damage of the new order of austerity is fuelling far-right parties. In France, Le Pen is on the rise. In the UK, UKIP. It would be a sad legacy for Ms. Merkel, our de-facto European president to bring about the rise of fascism everywhere but in Germany.

As said, I think the best outcome currently within reach is number 4, leaving the Eurozone. Taking a bad deal, such as the creditors insist, is currently a worse outcome, and there are many worse ones. There are also better outcomes that would be possible. Currently, the three best outcomes for Europe are politically blocked by Germany.

Why can’t Greece just agree to the creditor’s terms?

Talks between Greece and its creditors collapsed over the weekend with both parties appearing intransigent. The sticking point is pensions. Greece spends 16% of GDP on pensions and the IMF wants Greece to cut this. Greece. refuses. Why does the Greek state have this large pension burden in the fist place?

The answer is Greek pensions are of the “defined benefits” tax and transfer variety. The state taxes the current working generation and transfers the money to pensioners. It’s a passthrough mechanism, not an investment fund. As the economy has collapsed, tax revenues from the active economy have dropped and the pension burden is harder to bear. It’s a very similar situation to Detroit.

That might conjure up a bloated state sector with stalinist factories building tanks or a comically uncompetitive airline. OK, Greece had these two. They’re gone. For the most part though the high pension burden IS NOT indicative of a state sector that needs purging. The majority of pensioners were either private employees such as bank tellers where the state is acting as their collective insurer, or they were relatively uncontroversial state employees such as teachers and bus drivers.

Why are Greek pensions organised this way? Why aren’t they stock market investments like in the Anglo-Saxon world. For a start, the Anglo-Saxon model is a lousy deal for all income groups except the very wealthy. If you assume continuity of a sovereign state, a tax-and-transfer scheme limits downside better than market investments. The Euro ended monetary sovereignty for Greece, so for pensioners that was a miscalculation.

Secondly Greek capitalism (the portion of the economy in publicly traded companies) is too small to support pensions. Greek pension funds would have had to invest internationally. That would have been quite a leap of faith, and the pension funds did not. Another miscalculation, but understandable, I think. You have to remember people who are now pensioners put their trust on the continuity of the Greek state decades ago.

Alright, so if Greece doesn’t have the money to pay the pensions why doesn’t it cut anyway? What other outcome could one hope for? Well, if Greece left the Euro it could once again print money to partly fund pension obligations. This generates inflation, as was common before the Euro, and inflation acts as an indirect tax. It also causes currency devaluation, which makes imports expensive relative to domestic goods. Guess what: Greek pensioners consume more food and services (domestic goods) than iPhones.

A much better outcome would be for Europe to shoulder some of the social burden of these pensions. Why should they? For the same reason the US has federal food stamps that people disproportionately consume in Detroit. The “unruly” Greek government would much more readily agree to fiscal conditionality in the Euro if it wasn’t solely responsible for the welfare of its citizens. Remember these are people who bet on national sovereignty decades ago, then it was taken away with the Euro and the Europe that transpired is now unwilling to honor their benefits.

European integration would have gone much more smoothly if harmonisation of social welfare across states had been part of the project sooner (or at all). This doesn’t mean giving Swedish benefits to Greek pensioners – you get what you pay for. But it is at least arguable that Europe as a whole should not cut a nation’s pensioners out of their own modest level of benefits.

Greece and its creditors: What has been happening

Since March The Institutions have been refusing to roll over Greece’s debt, claiming that Greece is failing to comply with a program. As long as a deal is not struck they demand that Greece pays off maturing loans as they come due. No country can do that. If Greece doesn’t run out of money in a week or two, it’ll run out later. Every time Greece submits a plan, the creditors reply “No, do as we said originally”.

I feel it’s a mistake to continue this false negotiation and make significant concessions or distressed asset sales, only to postpone a forced bankruptcy by a few days or weeks.

Instead, Greece must send to The Institutions a bankruptcy plan now rather than layer. Since the creditors are not cooperating, in a few days Greece will go bankrupt like so. If the institutions still don’t cooperate, Greece could maybe agree to go bankrupt another way. Tsipras must say this and mean it. In a negotiation you must be clear what you’ll do if the other side doesn’t cooperate. You must have accepted that outcome. To go into a negotiation otherwise is to surrender.

I think a reasonable bankruptcy plan is that which SRIZA set out in its electoral program, removing the concessions that were agreed later and are now seen to be pointless. It’s not clear if bankruptcy will push Greece out of the Euro or whether the Greek State can go bankrupt in the Eurozone like a corporation, leaving the banks in the care of the ECB (like Detroit). I think SYRIZA needs to figure out what the post-bankruptcy recovery plan is, and act accordingly.

Τι συμβαίνει με την Ελλάδα και τους Θεσμούς?

Απο το Μαρτιο, Οι Θεσμοί με το επιχείρημα οτι η Ελλάδα δεν έχει συμμορφωθεί σε πρόγραμμα αρνούνται να ανανεώσουν (roll over) τα δάνεια. Ζητούν λοιπόν όσο δεν επιτυγχάνεται συμφωνία η Ελλάδα να τα εξωφλεί. Καμμιά χώρα δεν είναι σε θέση να κάνει μια τέτοια εξώφληση. Για την Ελλάδα αν δεν εξαντληθούν τα χρήματα σε μια βδομάδα θα εξαντληθούν αργότερα. Σε κάθε πρότασή μας οι Θεσμοί απαντούν “Όχι, κάντε όπως σα; είπαμε απ την αρχή”.

Βρίσκω λάθος να συνεχίζεται αυτή η δήθεν διαπραγμάτευση και γίνουν μεγάλες παραχωρήσεις και ξεπουλήματα για να πάει μια διαδικασία βεβιασμένς πτώχευσης λίγο πιο μακρυά.

Αντίθετα θα πρέπει ο Τσίπρας, πρίν την καταληκτική ημερομηνία, να στείλει στους Θεσμούς ένα σχέδιο πτώχευσης. Αφού δεν συνεργάζεστε, το Ελληνικό κράτος σε λίγες μέρες θα πτωχέυσει έτσι. Αν εξακολουθείτε να μη συνεργάζεστε τότε ίσως μπορούμε να συμφωνήσουμε να πτωχεύσουμε αλλοιώς. Και αυτό πρέπει να το εννούμε. Οταν μπαίνει κανείς σε μια συμφωνία πρέπει να είναι συμφιλιωμένος με το τι θα κάνει αν η άλλη πλευρά δε συνεργάζεται. Αλλοιώς παραδίδεται.

Νομίζω οτι ένα ικανό σχέδιο πτώχευσης είναι αυτό που ο ΣΥΡΙΖΑ ήδη προτείνει στο λαό και στους θεσμούς, ίσως αφαιρώντας τα σημεία παραχώρησς προς τους θεσμούς αν αυτό είναι πια άσκοπο. Ασαφές είναι αν αυτό μας βγάζει εκτός Ευρώ ή το Ελληνικό κράτος χεωκοπεί μέσα στο Ευρώ, σα να ήταν εταιρεία, ενώ οι τράπεζες μένουν μέλλημα της ΕΚΤ. Ο σύρζα πρέπει να εκτιμήσει ποιό απ τα δύο σενάρια προτιμά ανάλογα με το πώς σχεδιάζουμε να κινηθούμε για να συνέλθουμε μετά.

Greece and Europe are in a confrontation over democracy

You wouldn’t think so given a week of awkward handshakes, public contradictions, sternly worded demands to fall into line, and galling bankers’ ultimatums to destroy an economy, but Greece and Europe agree on most things:

Europe: You must reform your economy.
Greece: We plan to reform and modernise our economy even more than has been already accomplished. However we want growth oriented changes, not ones that are just destructive.

Europe: You must reduce graft and waste.
Greece: Our finance minister travels economy. He fired the ministry “consultants” and re-hired the outsourced cleaning ladies. Down to earth is the new normal.

Europe: You must collect taxes properly.
Greece: We’re the first Greek government determined to do that, including going after the big fish. Intrnational help would be appreciated. But sending German in tax inspectors at this time would be unwise.

Europe: You must pay your debts.
Greece: We have the interest of all European taxpayers in mind so please hear our case. During the bubble years your banks lent recklessly to Greece while our government committed financial fraud. We’re sorry. Then your governments transferred private investment losses onto the shoulders of European taxpayers. At the same time the Troika imposed austerity that crushed our economy by 25% and raised debt to GDP from 115% to 170%. European governments mismanaged the crisis and lied to you that you were helping Greece.

Right now we need to end the most damaging aspects of austerity so that we can have growth, and then agree a debt service schedule that this small economy can sustain. Greece is already making a surplus and paying back money to Europe. You are not “financing Greece”, we’re paying you back. We want to make that repayment slower, 1.5% of GDP instead of 4.5%, so that it’s possible to have an economic recovery.

Your central banks won’t get back the full value of the debt at commercial rates. You’ll get less in total or less interest or over a much longer time. However these are by now paper losses in the books of central banks. We’re trying to bury a loss of around €150 billion at a time when the ECB is crating €1.1 trillion of new money on the books of the same banks. That means there’s no need for Europeans to lose money or pay higher taxes over this, and if your politicians make you take this loss it’s their choice.

Europe: You must privatise everything.
Greece: If that’s not letting go of a profitable asset at fire sale prices, sure. Right now the income stream from public enterprises is worth more than the sale price.

Europe: You must stay in the Euro.
Greece: We want to stay in the Euro but the ECB is kicking us out.

Why then all the bluster? Greece’s new government is a popular government. The good kind. We don’t want to see the other one. With the exception of Merkel, the people they face are mostly technocrats. I don’t understand German politics, but from outside it seems clear that capital rules politics and is spinning a morality tale for the people.

Where Greece and Europe don’t agree is where people (in Greece and elsewhere, even Germany) want one thing and narrow capital interests want another:

Europe: You must continue with Austerity.
Greece: We won’t continue with this policy that destroys wealth and evidently doesn’t work.

Europe: You must take this money from our taxpayers.
Greece: We have no right to take any more money from your taxpayers.

Europe: You must do as the previous governments.
Greece: Have you heard of democracy? We have a strong popular mandate for change.

Europe: We have agreements with Greece, not a government.
Greece: It’s like marriage. If you offer solidarity we’ll do the same, and by coercion no.

Europe: You must comply with the Troika inspectors.
Greece: We were elected to end this humiliation. We’re committed to reforms but we’re not a debt colony.

Europe: We have rules here.
Greece: We’re bankrupt, party as a result of bad rules. We’ll follow the rules we can, and if we can’t you may throw us out.

Europe: You’re one country versus 18.
Greece: Have you noticed that the Eurozone is increasingly a club people want to leave? How much democratic opposition to these failed policies will it take to change them?

And that’s really the the point of disagreement this past week, and probably next week or until Greece’s democratic flare is resolved. Greece is arguing for a democratic Europe that works for its people. The establishment is arguing for a largely undemocratic status quo that doesn’t work, or works only for large industrial capital.

It’s been a while since Greece had a government that actually represents the interests of the people. Maybe more than two thousand years. If the other governments in Europe were similar, or Europe could be jolted into reviving democracy, we would find many more parallels than differences and the crisis would be quickly over.

How to understand Greece’s negotiations with its creditors, part 1

Greece: We can’t pay the interest on our debt because the principal is high, the rate of interest is high, and our income is much too low thanks to the income-reducing austerity measures imposed by our creditors.

Creditors line so far: Prioritize paying creditors above anything else. We don’t care about the cumulative damage it does to your economy.

Greece with Syriza: We refuse to do that any more. Besides, can’t you see it’s pointless? We have less and less income to possibly pay you with.

Creditors after election: Well we can’t remove the debt principal from the books because debt is money and European nations’ money would have to disappear.

OK, these are good opening positions for negotiation. Greece is asserting you can’t collect from a business you’re running into the ground. Central bankers are asserting that “Europe’s money is our balance sheet” and you can’t remove debt from the assets side of the balance sheet without something bad happening to the liabilities (money) side.

What next? Compromise I expect. Either central bankers accept that balance sheets with liabilities exceeding assets are OK for central banks, or they’ll figure out a way to make old debt a token asset that generates little or no current account obligations. The first would be easiest, but the economic Zeitgeist is against it so I expect the latter. Some sort of indefinite near-zero real interest rollover as is the case with US or Japanese debt.

To clarify for the concerns of northern European folk:
No-one really expects a nation to pay back its debt. It’s not a project to build a highway, or little of national debt is like that. Nations borrow more or less indefinitely and the amount of debt may rise and fall but that’s an investment concern like the stock market rising and falling in valuation. Generally debt is supposed to rise slowly, and to pay it all back is a bad thing because it removes bonds from the investment market. Neither is Greece expected to pay back northern Europe nor are northern European taxpayers on the hook to pay Greece’s bill to someone. Sovereign debts are not like auto loans.

Rather, sovereign debts are like stocks or mortgages. They’re assets in the banking system. Greece essentially borrowed into a bubble and in 2010 was revealed to be a bad asset. Greece’s economy is worth less than it’s mortgage, so to speak. Bad call, maybe reckless, but it’s the truth. Since then the bad asset that’s Greece’s debt has been passed around until it ended up in Europe’s central banks, the way bad assets in the US ended un in the Fed. That’s OK, it’s partly what central banks are for. No one is going to liquidate a central bank because its liabilities exceed its assets. Except the ECB, if they decide to. But that would be dumb.

So what the negotiation is about is seeking one of two outcomes: Either agree in banking circles that having big holes in the balance sheets of central banks is OK, in which case they can write off a big chunk of debt and put the remaining amount back on the investment market on a sound footing, or figure out a clever way to keep the debt on the books so the books look neat but the debt generates no real interest or pressure on the real economy. The first is emotionally cleaner and revives the economy, and it’s what Syriza wants. The latter buries the problem until it dies of old age and is the Japanese approach. I like Japan…

Here’s why I’m voting SYRIZA

I’m in Greece, partly so I can vote in the upcoming Greek elections where the leftist euro-reform party SYRIZA is expected to win. SYRIZA would probably win without me, but I felt it was important to come and vote for this important event. From the tone of the media inside or outside Greece you get the impression that a SYRIZA victory represents some kind of Euro disaster. On the contrary, I feel a SYRIZA government in Greece (or another one like it in Spain or Italy, this is about policy not people) is a bold step towards the solution. I regard it with optimism, even jubilation. Let me tell you why.

Disclaimer: I’m close to some SYRIZA candidates, policy thinkers, or MPs so I may be biased.

First why am I voting in Greece? I don’t live there. It would make more sense for me to vote in the UK where I live and pay taxes, but I don’t get the privilege. I guess native Britons are afraid I might vote for someone worse than David Cameron. Our concept of EU citizenship is still half-baked compared to America so we vote for national elections in our country of origin. We’ll fix it, but until then we have EasyJet democracy. In any case, I don’t feel strongly about voting on Greek affairs. I feel it’s important to vote, via Greece since that’s where I have a vote, for changes in Europe.

At a basic level I feel a duty to avert a bad outcome and push for a good one. If you recall, two elections ago the extreme right scored well in parliamentary elections in Greece. A surprising result that showed rising intolerance, fear, and naive insularity in Greek society. I find it abhorrent. At the same time you saw the Front National in France and Britain’s UKIP, which I see as equally negative but better at hiding behind a veil of respectability, gaining ground. SYRIZA is the polar opposite of these parties. In a climate of extreme right-wing euroskepticism, I feel it’s imperative to vote for leftist euro reform in Greece, Spain, or elsewhere. So that’s a defensive reason to turn up and vote.

The other reason, and the main one, is I don’t want an EU president and finance minister elected only by Germans, running the EU in a way that only suits Germany. Ms Merkel is our de-facto EU president. It’s clearly not Mr Hollande or Mr Juncker. Mr Schäuble is Europe’s finance minister. Whether German citizens like it or not, these officers set policy for the Eurozone, not just for Germany. They run the Eurozone in a way that serves the interests of narrow or short-sighted mostly German capital while driving real economies especially in the south into depression. This is wrong, and we need to use the democratic process to change it. Because of institutional inertia we non-Germans can’t vote for the Eurozone’s de-facto president and finance minister. Eventually these will be elected EU-wide but now, urgently, we must force our German-elected EU leaders to change their policies.

The way to do this is for the governments of peripheral countries to confront Ms Merkel and Mr Schäuble with the failure of their policies. This is what SYRIZA intends to do. It’s not an anti-Europe or anti-Euro party but it has to say, realistically, that current EU policy towards the periphery is not working. Greece’s economy is in depression and it’s debt is unsustainable, as it has been since 2010. Debt restructuring and expansionary monetary policy are needed to end the crisis. A growing consensus of economists agree, so we witness establishment papers like the FT urging the same policies that SYRIZA favors, for pragmatic economic reasons.

What will happen if SYRIZA is elected and starts renegotiating debt and austerity measures with Berlin? I think mainly compromise. EU institutions will have to accept balance sheet losses, which can easily be covered by monetary expansion. Greece will have to live within its means day to day, which given the big drop in incomes since 2010 is now possible. SYRIZA is new so it can enact better tax policy, touching previously untouchable classes, and in return can reasonably ask the EU for welfare assistance towards the poorest citizens. On election night the markets will jitter and possibly overreact, but forcing a Grexit is in nobody’s interest. In the long run markets agree with SYRIZA’s program and EU-wide policies such as quantitative easing that it aligns with.

A win for SYRIZA will be an important event for Europe, not because Greece is important but because some peripheral country needs to stand up for a change in EU policy. It could be Spain or Ireland, but looks like it’ll be Greece. Far from that being a disaster or some new chapter in the Euro crisis, I think it’ll be a triumph of the democratic process and post-crisis Europe’s finest hour.

The Eurozone crisis is about taxation vs. inflation

This formidable crisis that we’re having is, still, about taxation vs. inflation as a means of surplus recycling. A handful of countries including Germany have managed to make taxation work sufficiently well for surplus recycling (sort of, given high surpluses and still rising inequality). The Germans have foolishly written that into the constitution. All other countries, including the US and Japan, find taxation politically or practically insufficient as a means of surplus recycling and make up with a measure of monetary expansion. We’ll call that inflation although it’s not the same thing.

Monetary expansion taxes all assets denominated in a currency and is thus a form of recycling. In the US the market rises when easing is expected. Why? Because investors know that firms will have an opportunity to capture the surplus that is so recycled. Otherwise surplus will be more and more concentrated in retained profits, it won’t return to the market, and investments will have diminishing yield.

Southern Europe and the so-called lazy Greeks have been especially bad at taxation and especially reliant on inflation, devaluation, and the like. All countries pay their way if inflation is allowed. Fiscal obligations are covered in nominal terms and purchasing power for imports diminishes. The Eurozone was created, foolishly, with a German-inspired “there shall be no inflation” clause, and foolishly Greece applied and was admitted knowing that making taxation work in the timescale was unrealistic (and it’s a tall order for any country ever). The Eurozone then persisted, foolishly, in denial. The Greeks will endure anything but make taxation work, and the Germans will contemplate any measure but admit that taxation is insufficient and monetary expansion is a necessary pillar.

So please, let’s not moralise about lazy this and cruel that. Let’s see how we can back out of past decisions that were foolish, and that means talking about the role of both taxation and inflation (monetary expansion) in the Eurozone.

Inspired from Yanis Varoufakis’s blog here

Είναι επικίνδυνος ή αναγκαίος ο ΣΥΡΙΖΑ?

An unusual blog post in Greek about the suitability or otherwise of the socialist SYRIZA party for governance. I think it’s what Greece needs. Translate this badly with Google.

Το παρακάτω ακολουθέι απο μια συζήτηση με τον πατέρα μου, που λέει περίπου τα παρακάτω (συνοπτικά):

Ο ΣΥΡΙΖΑ είναι επικίνδυνος γιατί διακατέχεται απο αριστερές επαναστατικές ή λαικίστικες ιδέες που δεν ταιριάζουν στην εποχή μας ή δεν είναι δυνατόν να τις εφαρμόσει η Ελλάδα όταν περιβαλλόμαστε απο μια άκρως καπιταλιστική Ευρώπη που απαραίτητα μας στηρίζει. Αν βγεί λοιπόν θα κάνει κινήσεις τύπου Αντρέα ή τίποτα ή χειρότερες τυχοδιωκτικές ζημιές.

Η απάντησή μου:

Οι δυο παραμετροι που προσδιορίζουν την κίνηση της Ελλάδας ειναι το πρωτογενές έλλειμα/πλεόνασμα, αν δηλαδή μπορούμε να ζήσουμε τον εαυτό μας, και οι προσδοκίες των Ελλήνων για το πώς θέλουν και φαντάζονται τη χώρα αυτή και το μέλλον.

Οσον αφορα το πρωτογενές έλλειμα:

Όλη τη σύγχρονη περίοδο το Ελληνικό κράτος δε μπορούσε να συλλέξει αρκετά χρήματα για τα έξοδα του και κάλυπτε το κενό με κάποιου είδους πληθωρισμό: Έκδοση χρημάτων, υποτίμηση της δραχμής, ή δανεισμό (έκδοση ομολόγων) χωρίς να υπάρχει πρόθεση ή προοπτική αυτο το “χρέος” να επιστραφεί ποτέ. Έτσι κάνει και η Αμερική. Τα ομόλογα των χωρών κατα κανόνα ανακυκλώνονται και αυξάνονται αενάως. Οι πρώτες δυο μέθοδοι έκλεισαν με το ευρώ, και τα ομόλογα δούλευαν μέχρι το 2008 οπότε τα χτύπησαν οι επενδυτές και τα επιτόκια εκτινάχτηκαν.

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On Debt

In the aftermath of the financial crisis, and with a raging sovereign debt crisis in Europe, notably Greece, it’s worth stopping to consider what debt is. Even as so much is written on the subject, when I read journalistic or even some economists’ accounts of the debt crisis I’m left feeling that they don’t understand what debt is, or rather that they bring a moral frame to the concept that is unhelpful and out of touch with reality.

There are only three formulations of debt, as an economic transaction between strangers, that are moral and advisable:

  • An investment future: If you have a pile of cash, the net present value of keeping it as cash for a year is a few percent below face value, because of inflation and the risk it might be stolen or destroyed. You can give it to someone who can realize a better NPV and share some of that with you, so you both win. You could give it to Facebook in exchange of stock, or to a bank that invests in sub-prime mortgages. You could give it to the government of Germany, or of Greece. These differ in risk and return, and the market does a rough job of pricing them, but it’s always your investment decision. You can ask politically for an investment to be insured, or bailed out, and that simply means socializing losses by inflation or other means. Often, this is the right thing to do.
  • An option to sell: A secured debt, such as a mortgage, is really an option to sell the collateral to the bank at some future date, for some variable amount that’s equal to your then outstanding obligation. Again, it’s a business decision. The lenders should plan according to the possibility that they may get the full payment schedule or the collateral, presumably whatever is worth less in the ensuing economic conditions. If they forecast that poorly, well, too bad. There’s nothing moral or otherwise beholding of the borrower in a secured debt arrangement.
  • Due payment: Invoices for goods or services are a short term loan from the supplier to the client, granted as part of the cost of doing business. This debt does carry moral weight because it affects the cash flow of both parties a great deal and because only the value of the relationship, and a firm’s reputation, really compel a firm to pay it.

These are acceptable, modern forms of debt. Notice that, apart from the case of honorable business debt, there’s no moral angle to it. If you have surplus you give it to someone in the hope of achieving a better NPV, and maybe you get that or you don’t. There are no reckless borrowers or predatory lenders, and debt is not some kind of crushing moral obligation in this world. Continue reading

Three options for Europe, three options for Greece

The countries in Europe have different productivity. Germany is large and near the top, Greece has a lot of debt and is near the bottom in productivity. With an open market and easy credit, the mismatch in productivity produces a trade imbalance within the EU, and that accumulates as debt. Poor Europe buys goods from rich Europe partly on credit.

Assuming things remain constant, this credit is nominal only – it’s to keep trade flowing and will never be repaid. This is usually OK. Sovereign debt is usually permanent, and it’s really a monetary instrument (bonds are a kind of slow money) rather than a cashflow debt that’s expected to be repaid. The market will sustain the debt if it matches the pace of growth, so that the debt to GDP ratio is roughly constant. If debt grows much faster than GDP the market gets jumpy and starts perceiving sovereign debt as ordinary cashflow debt, and we get the current mess.

What, then, is to be done? Europe as a whole has three options:

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Greek debt crisis, as of summer 2011

Here’s an update as to what is happening with Greece. First, some numbers from the 2011 Greek budget:

  • Total revenue: €128 billion
    • Real revenues from taxes etc. €55 billion
    • Aid from the EU €3 billion
    • Borrowing from the market, including rollover €70 billion
  • Total expenses: €128 billion
    • Real expenses such as pensions, health etc. €63 billion
    • Debt rollover and interest payments €65 billion

And another pair of interesting numbers

  • Interest rate charged by the market for German bonds, 2 year maturity: 2%
  • And for Greek bonds: Around 25%, rising

So, what does all this mean?

Real deficit

In summary the Greek state is like a business that takes in €55 bn in sales but pays €63 bn in salaries and what have you, so it makes a real loss of €8 bn, or 14%. To recover, the state needs to increase revenue by extracting more taxes or running profitable businesses, or it must cut the amount that it pays to the Greek people, or some combination thereof. If it doesn’t the Greek state will run bankrupt anyway, abruptly cut expenses to €55 bn, and go on living in a hand-to-mouth way.

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What’s up with the Greeks?

You may have heard that there were huge protests in Greece over the financial measures, basically pay cuts, that the government put in place to get its finances under control. A minority of the protesters were violent. Someone set fire to a bank, there were staff inside, and three people died.

This must seem like tragic madness to outsiders, and even to many who live in Greece. When societies fail, it’s easy to conclude that people are irrational, that therefore there’s no prospect for improvement, and that imposing a basic plan or order upon them might be a good idea. Let me try and allay these notions.

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The Greek financial crisis

Pavlos’s Thoughts – Episode 2 – The Greek financial crisis

Talking post (podcast). Click to open as MP3.

Key points:

  • The core problem is that the Greek economy is unproductive in structure and ethos.
  • Greece will probably have to default against the debt market, if not now then later.
  • It would be better if the EU dealt with the issue instead, by taking over and restructuring some debt.
  • The EU should probably create a framework to deal with national solvency in a consolidated way.
  • Fortunately the Greek economy has poor coupling, and could be protected temporarily by price controls.
  • In the long run the solution is to make Greece more productive by fixing exactly that – creating high coupling of innovative firms with the international economy. The best way to do that is probably to create international economic zones, which work in English by Western rules.

Feedback:

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