The G-Euro, a currency to hit the spot!

Following the unsuccessful negotiations last week between the undemocratic forces of finance (Troika-led Eurogroup) and the will of a democratically elected government, the issue came to a head. The Greek government decided to “leave” the Troika’s “take-it-or-leave-it” offer presented to them on the 25th June. The Greeks have had an offer and they rejected it, something this blog has proposed all along, which will probably lead them to default tomorrow on their Euro 1.6bn IMF loan repayment.

However, there is no talk of Grexit which would not be in the interest of the Greeks. Or in fact in the interest of Greeces’ creditors, to whom it owes 320bn, with an additional 120bn funding the Greek banks, via the ECB (Target2). So, understandably, Grexit is off the table.

Instead we are getting a Greferendum on the 5th July, and, at least until the Greeks have decided, Grapital controls. They follow the ECB’s decision to put a stop on the limit of 89bn that Greek banks can re-finance themselves through the Emergency Liquidity Assistance facility, ELA.

The referendum will ask Greeks to vote ” yes” or “no” on the Troika agreement. That, surely is the only way such an agreement can ever be implemented in Greece, were the Greeks to vote for it. As the Finance Minister Varoufakis pointed out, a democratic decision which would include all citizens. The government’s recommendation is to vote “no”, against the despotic Troika agreement.

So, a spot of bother, indeed, for all concerned, to put it mildly. Witness the furious back-pedalling which has already gone on by the Troika representatives, and watch that grow into a further frenzy as the referendum date approaches.

But let us stand back and have a calm look at the measures introduce.What are the likely effects of these developments, will they help or hinder the Greek government and their battered economy?

Effects of Capital Controls

Until the 7th July Greeks banks will remain closed, no money can be transferred out of the country, the maximum amount of withdrawals from accounts through ATMs is Euro 60 per day. Unless of course you have foreign account, in which case there are no limits on cash withdrawals though. So tourists will not be affected, their holidays are safe.

So will the banks run out of money because of the cap of ELA?

Effect on banks next week

The ECB put a cap on the 89bn Euro ELA which it allowed the Central Bank of Greece to fund itself and therefore its banks through the Euro payment system. The stop of transfers outside the borders of Greece means that the 89bn limit does not need to be extended. Greece will receive money from abroad, but cannot pay any money out, which will reduce the need for ELA.

Effect medium term

However, ultimately money will need to flow abroad for Greece to pay for its vital imports such as food and petrol. It is likely that, were controls to extend in the future, that the Finance Ministry would need to approve payments abroad for appropriate trade transactions. An arrangement like that existed in Cyprus, when it introduced (the now lifted) capital controls two years ago.

Against this, in the next 3 months Greece runs a monthly current account surplus of between 1.5bn to 2 bn a month, as tourists from Europe flock to Greece. This money alone will reduce the 87bn Euro cap, all other things being equal, by approximately 5bn.

Can Greece run out of Euro Notes?

Greek banks cannot run out of notes, as long as the Greek Central Bank will supply notes to the Commercial Banks. It will do so, as long as Greek Banks provide, or pledge, assets to the Central Bank of Greece in return. In effect, commercial banks in Greece buy notes from the issuer, the Central Bank of Greece, to pay them to their customers, if these customers want to withdraw their funds. As long as the banks “remain solvent”, the Greek Central Bank will provice Euro notes to the Greek banks. (The ECB or the ELA limit will not affect the note issuing facility of the Greek Central Bank in any way)

It seems certain that a withdrawal limit of £60 Euro a day will decrease demand for Euro notes significantly, while still providing each account holder with the theoretical possibility (were capital controls to be extended) to withdraw Euro 1,800 of cash a month.

So, the ELA Cap and the 60 Euro cash limit do not effect the economy in a destabilising way. In fact they stabilise the economy, as uncertainty about capital flight is eliminated. Money cannot leave the country, no large cash sums can be withdrawn. However, beyond the one week horizon, the ability to transfer money abroad for real trade transactions has to be re-instated, albeit under state control, should capital controls stay in place.

So, let us come to the bigger picture, why should Greeks vote against the agreement?

Currently Greek public opinion is divided on whether to accept or reject the proposal. The Greek government therefore has to provide a persuasive narrative to its people to follow its recommendation. In short, it has to tell its people why it should vote “no”, and, more importantly, why they would be better off if they did.

The Greek government is rightly against further austerity measures, as are all economist looking at the issue. Instead of further committing to austerity, Greece might now want to tackle unemployment. And now, freed from the shackles of the Troika, it could in effect do something about it. The Greek government could boost aggregate demand, rather than letting it fall further under the Troica doctrine, and therefore provide a Keynesian solution to the unemployment problem.

The Public Works Job Guarantee

The Greek government could propose that it would become the “employer of last resort” of the 25% of the Greek workforce currently unemployed and offer them a limited job guarantee, working in public works projects. Perhaps 30 hours a week for a 400 Euro a month to take 1 million from the 1.3 million unemployment register.
This would need to be financed, and after having fallen out with its international creditors, Greece will need to look for funding for such a scheme at a cost of Euro 5 bn anually.

So where is the money going to come from?

1. Greek Commercial Banks

It could ask the Greek commercial banks to lend the government 5bn Euro. Why would Greek banks provide the funds? Well, for the banks lending to the government is still as safe as it gets. Ultimately, if the Greek government fails, and the Euro fails, all the Greek banks will fail. So the banks, if they want to survive, should lent to the entity which is most likely to ensure its survival.

These new funds to the government could, in theory, be restricted by the ECB ELA limit. But capital controls mean that the ELA ceiling will fall over time, so there should be plenty of capacity for Greek banks to lend to the government.

2. Greek Citizens

It could ask the Greeks, in particular the ones who until now have transferred all the money abroad, to buy Greek government bonds. As they have no outlet for their internally generated funds now, they might want to invest in Greek government bonds.

3. The G-Euro

It could create a parallel currency, to issue in parallel with the Euro. For example, 7% of the government’s expenditure from now on could be paid in G-Euro notes. That would free 5 bn of government expenditure to be used for the public works project.

Ultimately, funding from the banks or its citizen will prove possible, probably at very low interest rates. However, yet more borrowing, for an already heavily indebted government can surely not be the solution.
So the G-Euro looks preferable. The advantage of the G-Euro, issued as currency, is that no interest at all will be paid. The only cost to Greece will be the cost of printing it.

Money can be issued into the economy for the public good, and should be to further the long term aims of society. This is an idea embraced in the UK by the Positive Money movement. Their ideas provide the basis for this thinking.

Will such a public works project pay for itself, even if the money is borrowed? If one assumes that the 5 bn Euro will lead, through the fiscal multiplier of 2 to, perhaps, 10bn of economic growth it will be self financing. The funds spent by the Greeks on  their new job-guarantee will help the economy to recover. A total of 10bn additional economic growth will represent over 5% of Greece’s battered GDP of 180bn. Compare and contrast that to the Troika’s proposed reduction of GDP through tax increases, pension cuts, and loan reduction payments, which would have amounted to perhaps 3-6% reduction in GDP.

Now, all of the above might, at this stage, seem like pie in the sky thinking. But it provides the first signs of hope for Greece, none which would not have been possible through further negotiations with the Troika. Now we have a period of relative calm, perhaps counter-intuitive, as the markets gyrate this Monday trying to come to terms with developments over the week-end. But, peace and quiet will return and it is essential to bring stability into the country, and the rupture with the Troika, the referendum, and the capital controls will prove to be the right choice for Greece.

How could these funding schemes work in detail? And is the G-Euro the best solution? I will explore the details in another post.

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The four henchmen of the Greek disaster

Let us imagine that an agreement will be reached in the current negotiations. Will it end the crisis, will investors be ready to invest in Greece ? Because investments are the only way that sustainable growth can be generated in Greece.

Clearly not, as we have learned over the last 5 years, one unacceptable agreement will lead to another afterwards, with all the drama surrounding the negotiations, the IMF led Troika programme is set up like that. That will continue the uncertainty. That will continue the political instability. And that in turn will continue the dearth of investment.

Unless the factors causing this instability are tackled head-on by the Greek government there will not be any growth. Or any reduction in unemployment.

The four factors which impede investments are:

1. Grexit

Unless there is a firm and credible commitment to Greece in the Eurozone, there will not be any investment. Why should an investor invest now, when, after Grexit and devaluation he could get the same Greek assets at a reduced Euro price, due to devaluation?

2. Economic Collapse

The economy has shrunk due to the policies implemented by the Troika. These policies are still being persued. Continuing along the Troika path will mean further recession and deflation. Nobody will want to invest in such an environment.

3. 180% debt to GDP ratio

This ratio, if it were to paid down by taxes, would base a very high tax burden on the economy. Each 1% reduction would mean an additional 1% tax which would have to be found from the economy each year, roughly. So unless there is a sustainable debt level, perhaps 100% of GDP, there will be no further investment.

4. The Troika Tributes

The insistence of Troika tributes, a.k.a. primary surpluses, of up to 4% has not only a further recessionary effect on the country, but are also seen as illigitimate, as the debt itself is seen by the Greek government as an “odious debt” which does not need to be repaid. The primary surpluses, are as well perceived as reparation payments were in Germany after WW1. And will have a similar effect. The Troika policies stir resentment, political upheaval, and unrest. Nobody invests in a situation of such political uncertainty.

So the solution is simple, Greece should declare a unilateral moratorium on the debts to its European creditors and the IMF and suspend negotiations for one year in an effort to bring calmness, stability and growth back to the economy. Only that will shrink the large unemployment numbers of 26%.

Further, Greece should state that it is fully committed to the Euro, fully committed to export-led growth, and fully committed to repaying its debt, as long as the European partners commit to buying additional goods and services.

Greece should state it will repay debts based on these additional exports, and not follow the diktats of the IMF-led Troika any more.

If that cannot be committed to by the European partners, Greece should insist of cancelling half of the debt to Europe, from 240 bn to 120bn Euro.

Greece should say it is time to end negotiations with the institution making up the Troika, but Greece is happy to talk to the German government as the biggest creditor on behalf of all others after the 1 year cooling down period.

As long as Greece has a balanced primary budget, the creditors will not be able to do anything. It would be suicidal for them to push Greece out of the Eurozone, so they will have to go along with these proposals, ultimately.

Greece is much in the stronger negotiating position, and should now take advantage.

Grexit: Drachma and Devaluation spells Disaster, not Deliverance

Mr Bootle, an economist from Capital Economics writes in a tongue-in-cheek letter to Greek Prime Minister Mr Tsipras published in the Daily Telegraph today. His advice: Exit the Euro and issue a new currency, which will then devalue against the Euro.

As all Grexit advocates, he conveniently forgets two things:

Greece’s debt of 320 bn is in Euro, and the Greek banking system heavily reliant on the ECB. The ECB offer 120 bn of liquidity support for the Greek banks, making a total debt of 440 bn. All denominated in Euro. Greece is barely able to pay for its debts now. A (hypothetical) 20% devaluation increases debt Euro denominated debt by 25%. As the income stream is now 20% lower, it will need even more of its income to service the debt. Greece will definitely be insolvent.

So Before Devaluation : Greek liabilities 440 bn, Greek GDP 180 bn
After 20% Devaluation:   Greek liabilities 440 bn, Greek GDP 144 bn (in Euro)

This insolvency of Euro 440bn would be the largest ever recorded in the world. By a fair way, as Lehman Brothers was only about a quarter of the size. Bootle, by completely ignoring the issue of insolvency, in effect advocates a financial Armageddon on the scale of 2008 or bigger.

So Grexit and a new currency will not happen, as also the ECB, the IMF, and possibly even the German Finance Ministry can see that it does not add up. And the threat of it towards Greece all empty bluster.

However, it is still worthwhile to go through the 10 points he raises to see who would in fact benefit from a devaluation, and who would be the losers.

1. You should not be reluctant to leave the euro. Even if you somehow manage to cobble together a deal with the creditors, this would not solve your country’s crisis. They are obsessed with the financial problem, i.e. with getting their money back. But your fellow Greeks’ plight derives from your economy’s catastrophic loss of output. Even if Greece is granted a significant amount of debt forgiveness, this would do next to nothing to bring an economic recovery.

Bootle is right that the shrinking of the Greek economy is at the heart of the Greek problem. But he is wrong that a significant debt forgiveness, say, 120 bn, would not work for Greece. A 120 bn forgiveness, effectively cutting debts to European Institutions by half, would strengthen bring its debt/GDP ratio from 180% to 110%. All of a sudden Greece would have similar debt levels as Italy or Belgium. And it will lead to a more prosperous Greece.

2.  Don’t fall for the parallel currency idea. It may be tempting to believe that there is some middle way that will allow you to stay in the euro while also enjoying the benefits of devaluation, whether by the Greek government issuing IOUs or allowing the banks to issue certificates of deposit which then circulate as currency. These may be temporary palliatives but they do not square the circle. There isn’t a third way. Greece needs to devalue and that requires a national currency.

Bootle advocates that there is no third way but does not say why it would not work. Why would an additional currency have t devalue against the Euro? It could even strengthen.

3. You must constantly keep in mind how devaluation works. It does so by shifting relative prices. This shift drives a change in people’s behaviour. A lower exchange rate would persuade Greek citizens to spend less on imports and more on things produced in Greece. Moreover, it would persuade foreigners to spend more on Greek things, including visiting your many wonderful tourist attractions. Increased spending by both Greeks and foreigners would call forth increased output.

Not much to say about that, that is the text-book explanation why devaluations work.

4. The rub, though, is that the adverse price change comes at once, while the favourable changes in quantities take time to develop. This means that the devaluation will initially inflict some pain as import prices rise without any obvious immediate offset. Yet, before long, ordinary citizens will benefit from the devaluation. So hold your nerve.

Immediately imports will become more expensive, raising inflation. The real income of the population will suffer straight way. It will be cut. That is a huge draw-back for a population which has already suffered from a devastating fall in incomes over the last 5 years.
Also the wealth of all Greeks will suffer, as expressed in Euro terms. All their Euro deposits in Greek banks would be converted into the new currency and equally devalued. What Bootle is proposing is a de facto expropriation of Greek wealth, in Euro terms, by the Greek government which would go down the devaluation route. No wonder the Greeks like to stay with a 70% majority in the Euro.

Who would benefit, it is of course the rich, who had the means and money to open bank accounts outside Greece, and who now could bring these funds back to Greece. They would get more for their money in Greeks goods and services, so effectively rewarding them for their capital flight. That, of course, brings with it some more moral hazard. If the rich Greeks could increase the real value of their wealth, why should the rich Spanish not try the same and also put all their money into foreign bank accounts?

On a macro-economic level, as imports immediately become more expensive, and export receipts fall in money terms, Greece would all of a sudden have a balance of payment deficit again. It immediately would have to borrow abroad, in foreign currency, to close this gap. That would be difficult after a huge insolvency, which a new currency would entail. Even the IMF might not want to lend any more.
Or Greece introduces import/export controls to ensure that it has sufficient exports to pay for its imports and a balanced current account. That would undoubtedly lead to shortages.

5. Nevertheless, you must not try to shield everyone from the initial ill-effects of the devaluation. That could nullify the benefits and land you back at square one. You will be able to bring relief to some hard-pressed citizens later. The dynamics are very important to the re-establishment of confidence.

So, what Bootle is saying here, do not subsidise petrol or other goods which are imported, if it becomes more expensive, the Greeks will have to bear it. A further reduction in real income for Greece after 5 years of hard-ship. Not sound advice for a government elected to reduce hardship.

6. Don’t be worried by the lack of new Drachma notes and coins. Of course, as soon as you know that you are leaving the euro, you should order these to be printed and minted immediately. But they will not be ready for months. Once you have made the declaration of euro exit, however, bank deposits will be re-denominated in Drachma. Most transactions can take place by transferring these deposits by cheque, debit card or credit card. Meanwhile, you should encourage small transactions to take place using whatever people find most effective, including euro notes and coins, IOUs, bank certificates, cigarettes or whatever.

This is just pure comedy. He says that Euro notes and cigarettes shold circulate in the economy as money. So presumably a loaf of bread will cost 1 Euro, or 1.25 New Drachma, or 5 cigarettes, with all shops displaying all three prices at once?

I think the last time such as system operated relatively successfully like that was in post-war Germany, prior to the introduction of the German mark. I say relatively successfully, because the shops were empty, food was rationed, and there was a thriving black market. No reason to think it would be different this time.

To introduce a currency without being able to give out notes and coins, which will have a value, is just madness.

7. You will need to impose capital controls but these need not last long. Once you have your own currency again, your central bank will be able to support your banks without going cap in hand to those austere chaps in Frankfurt. The Bank of Greece will even be able to buy government debt and hence engage in Quantitative Easing. Don’t think, though, that this is a magic wand. You will still need to act carefully and responsibly. Inflation will rise a bit following the Greek exit. It is important, however, that you don’t allow it to rise uncontrollably.

What is needed first is exchange controls, specifically. If the currency were to float freely, it would  immediately be subject to speculation by the foreign exchange markets. In which case a 20% devaluation could not be guaranteed.

So if the Greek government decided that a 20% devaluation was best for its economy, it would be important to make sure that the currency could only be bought and sold at the Greek Central Bank, the Bank of Greece, at the rate of Drachme 1.25 for each Euro. It would not be freely floating.

To ensure that not too much of the new currency would be exchanged to Euro, and leave the country, fearing further devaluation, capital controls will be introduced, allowing each Greek perhaps to change 300 Euro a day to change into Euro, and not more.

It follows some generic unspecified advice on how Greece should continue to follow the advice of its creditors, run a balanced budget, even with the new currency and not cuddle up to Russia, but stay with its friends UK and US. I will spare you the details. Then the last point.

10. Leaving the euro is not a disaster. If you follow my advice then, before too long, you will be able to tell the Bank of Greece to stop the Drachma from appreciating on the exchanges. What’s more, the investment bankers will be knocking on your door trying to lend you money. (Admittedly, if you don’t follow this advice, you and your countrymen could land up in an even worse mess!) You should think of Grexit as giving you the opportunity to make things better. D-Day approaches: D for Default, Devaluation and the Drachma. As you know, in our recent European history, D also stands for Deliverance. It can do so again for you. Within a year or two the gains may be so extensive that you (and they) will wonder why you didn’t make the move earlier.
Yours sincerely, Roger Bootle

The Drachma appreciating in exchanges? Again, there should not be any exchanges where the Drachma should be traded. It should only traded at the Bank of Greece. That would not be a bad strategy to follow, as those exchange controls helped China to become one of the power-houses of the global economy.

There could initially be import/export controls to ensure a balanced current account, as no foreign currency loans can be secured for a country which just has defaulted. Further, there would need to be foreign exchange capital controls to avoid money being sent abroad again, which would also have an effect on the current account.

“Admittedly, if you don’t follow this advice, you and your countrymen could land up in an even worse mess!”- Bootle thinks continuing to go along the route of Troika advised austerity is disastrous, he is right there. Yet Bootle advocates devaluation, which he himself says will make things worse before they get better. So not really sound advice for a country which has been struggling to get out of recession for the last five years. More pain for gain in two years’ time. The Greeks have heard that from the IMF for 5 years, and each time it turned out to be a lie.

What will the Greek government get out of the devaluation? Bootle says that ” investment bankers will be knocking on your door trying to lend you money”. Bootle is advocating investment bankers as the route to riches, (rather than the highway to hell, presumably), with more loans. Does Greece need more money? Not really, they have a virtually balanced budget in Greece. They have however 26% unemployment. And Bootle says things get worse before they get better.

As import led companies in Greece shed jobs faster (the BMW dealerships will now definitely close) and export industries will only grow slowly to offer more jobs. Try to sell that to the Greek people,Mr. Bootle, who have had one of the longest and deepest recessions ever in the world.

Finally, a general point. Devaluations are advised by the IMF and other experts usually when countries suffer a balance of payment problem. A devaluation induced export recovery might be a good idea in those cases, as more exports and less imports will eventually close the balance of payment gap. But Greece is not at that point, it has a balanced current account. So there is no reason to follow that advice.

And, of course, there is the minor inconvenience of a Euro 440 bn insolvency that is blanked out here, but which would follow a devaluation. Devaluation and Disaster, a D which he forgot to mention, go hand in hand.

So is Bootle completely wrong here?

Well, the Grexit idea and new currency is a non starter. But in one thing he is right, Greece, as Bootle pointed out in the beginning, has a demand problem. Although Bootle advocates an export led recovery through devaluation, it is really domestic demand which has suffered. Greece already had record tourist numbers last year, its main export earnings, why pile on more exports?

So that is the other Ds in his long list of alliterations which he does not mention. Domestic Demand. Surely, there must be other ways to boost internal demand in Greece other than through a devaluation which leads to a catastrophic insolvency. I will write about that in another post.

How to get repaid

Greece has to agree with its creditors a long-term repayment schedule. However, the benefits of the loans have long since been invested and consumed. Only some remain, in better infrastructure, for example, such as the Athens metro. But for the majority of Greeks now suffering under the weight of these loans, it must feel more like transfer payments, payments by governments to other countries for which you receive nothing.

Success of reparation payments, or not

Here is a quick outline of the story of German reparation payments, a previous set of transfer payments, all known to us, following its defeat to the victorious Allied Powers in WWI (1914-1918)

1919 Treaty of Versaille, imposing principle of reparations on Germany
1921 London Payment Schedule sets out reparation
1923 Occupation of industrial Ruhr area by French Troops as Germans did not pay up
1923 Hyperinflation – New currency in Germany
1924 Dawes Plan
1929 Young Plan
1933 Hitler comes to power

Altogether a disaster from start to finish, a right shambles, continued restructuring with ultimately a very nasty outcome. Although, it has to be said, financially there was some success, despite lowering previously agreed payments continually during restructuring: Germany paid in total approximately 25% of one year’s GDP in reparation payments. In 13 years, with much huffing and puffing.

Surely that could have been expected from the beginning? Keynes warned us at the time. But what was the previous experience with reparations?

Indeed, there was another country which paid reparation payments of 23% of its annual GDP. France paid the French Indemnity, following its defeat in the Franco-Prussian war (1870-1871). These payments were received in two years, two years EARLIER than they needed to be paid. The timeline here is short:

1871 Treaty of Versailles (Franco-Prussian War)
1873 Last payment of reparations received

What was the effect on France? Surely disastrous, as they paid in two years what Germany paid over 13 some fifty years later. Here Michael Pettis from his excellent blog post about the situation

One might at first think that France’s indemnity, at nearly 23% of GDP over three years, might have been devastating to the economy. It certainly left France with a heavy debt burden, but its immediate economic impact was not nearly as bad as might have been expected. Wikipedia’s assessment is pretty close to the consensus among historians:

It was generally assumed at the time that the indemnity would cripple France for thirty or fifty years. However the Third Republic that emerged after the war embarked on an ambitious programme of reforms, introduced banks, built schools (reducing illiteracy), improved roads, spreading railways into rural areas, encouraged industry and promoted French national identity rather than regional identities. France also reformed the army, adopting conscription.

How to extract money from another country, successfully

The political context of the payments from one country to the next, in this case reparation payments, will have a substantial influence on their ability to meet the goals for which they were set. Swift negotiations and financings agreements lead to success, drawn out discussions and negotiations to failure.

After WW1, Germans felt humiliated, the same as the French did some 50 years earlier. Hence the French got the Germans to sign the Versaille treaty at the same spot where Bismarck had accepted a French surrender earlier. So why was it different?

French reparations to Germany were successful at the end of the 19th century, because the French had other things to get on with, an infrastructure building programme, reforms to start one of its many republics (this one was the 3rd after the abdication of Napoleon III). There was an initial uproar, but quick financing of loan bonds (one-third of the money came from Germany – the Rothschilds opened their French bank in those days, following their success in Frankfurt) allowed France to raise the money quickly, and pay it over to Germany. Only then did German troops leave France, leaving Germany in turn with the problem of how to invest that flood of money wisely.

In contrast, in Germany’s case in the early 1920s, the reparations they had to shoulder became the bug-bear for the nation on which all ills could be hung, a constant reminder of the humiliation of Versailles. Protracted negotiations and continous restructuring reminded everyone of that failure.

Clearly there were also different macroeconomic circumstances during each period, but the reparations in Germany were never accepted as legitimate and fought at every level. In France they were more easily forgotten.

The current situation in Greece, of course, is similar to Germany in the 1920s. The problem then, as now, were the little niggly issues which hampered the development of good-will during continued negotiations. Then it was the number of wooden telegraph poles Germans were expected to deliver as part of the reparation deals. Currently it is the issue of Greek pensions, micro managed at every level, from the IMF chief economist’s blog to the comments sections of German tabloids. All with the implied connotations, are the Germans (then) or Greeks (now) cheating to get out of their obligations?

What is the lesson which all negotiators should draw from the above?

  • Clearly, the repayments have to be agreed as acceptable by debtor and creditor alike.
  • The speed with which a sustainable repayment schedule is reached is important. Out of sight, out of mind.
  • Loans should amortise slowly like a mortgage, or have long maturity dates, and not subject to constant refinancing, over a multitude of countries and institutions.
  • Then, once an agreement is reached it is worthwhile to get on with some other task, like building railways, or investing in education, as the French did in the 1870s. In other words, have some economic growth.

Troika: designed to fail

The Troika, often bickering amongst itself, has obviously failed to reach any of these minimum conditions in Greece. Now it is too late, of course.

But in any case, this is an IMF led programme. Troika policies demand ever-increasing austerity. A tightening of thumb-screws. Even if, having succeeded in its deflationary policy to bring things into equilibrium, it is NOW not necessary any longer. The Greek budget is balanced, more or less, so is the current account and unit labour cost are back to year 2000 level. Greece is competitive again, it needs some investment. It needs to do something for its unemployed. The callous disregard of the plight of the unemployed in Greece has undermined the legitimacy of the EU institutions. The Troika’s imposition on rules – the putting of pressure on Greece to deflate and repay is not the Europe which people thought they sign up for.

The Troika’s constant meddling in the situation, setting up Greece at each stage for new uncertainty is poisonous. Dictating, like some Roman pro-consul, tax rates in this and that, in a nose-diving economy due to the Troika-prescribed austerity measures, is disastrous. What do they know? Why follow them? The Troika’s estimated growth measures have always been missed. By a massive margin. Why follow their prescription? In fact, the Troika programme would only make sense if one wanted to devalue the assets of Greece on purpose, to make them more attractive to outside investors.

Of course, that is the IMF adjustment program, and that might well be the intent. But even the efficiencies which can be garnered from deflation and any supply side measure agreed and implemented are quickly destroyed by the continuous circus which has accompanied these adjustments. Add the minor inconvenience of having to do this in a democracy, which is bound to throw up a government against these measures, and the legitimacy of the Troika to do anything has now come to an end.

Who would invest in Greece condemned to deflation by Troika?

As far as the Greek economy is concerned, it needs investment. Stability and prospects for growth are the minimum which each investor expects in any country. Unless that can be delivered, and a five-year Troika track record says it cannot, Greece should loosen its ties and find a way to guarantee that stability. It is time to leave the circus, because it will not stop. And is has no chance to grow or repay the debt.

Thanks to the internet one can now  follow the main protagonists in this drama. Not the digested news which the media presents to you. The press conferences are streamed. Negotiation documents can be downloaded. There is always one side that strikes me as reasonable, the other obsessed with bureaucratic rules and an interest in the financial sector above all else. First it was save Deutsche Bank, who cares about tripling unemployment in Greece. But now, even worse, it is save the German pensioner, who cares about the Greek pensioner. This surely is not a Europe which we want.

Time to leave the Troika behind

The Troika programme, equivalent to the failed German reparation saga, should make way for Greece to emulate the relative “French indemnity success” in paying its creditors. Investing in its own country, in peace and quiet, generating employment and growth. Without any Schaeubles or Lagardes heckling at the sidelines. If Greece can only do that through a unilateral moratorium, so be it.

What that moratorium should look like, and how it could put Greece’s creditors on the spot, I have outlined in previously posts here.

How to turn the table

Greece ows Euro 240 billion to its European creditors. Yesterday, talking about the Endgame, I suggested Greece should declare a moratorium on its debt. And incidentally, Jeffrey Sachs, in an article for Project Syndicate with the same name, also said that the Greek government should not give in.

How to repay when declaring a moratorium:

So let us assume Greece declares a moratorium on its debt to Europe, what should it say?

Greece could commit itself to repay the 240 bn it owes over the next 12 years, at 20 bn each year. That would, of course, hardly be a moratorium, the current loans stretch much further into the future. But this offer of the Greeks should come with a catch: only if the Europeans buy additional goods and services, or provide foreign direct investment, of 20 bn a year. That is 20bn over and above the current level of exports to these countries.

So Tsipras and Varoufakis should say to the Europeans, you buy the additional goods, and we will pay. If you do not, we will not. It is as simple as that. So European governments, if they were serious about wanting their money back, could set incentives for their citizens to buy Greek goods or come on holiday in Greece. It would hardly cost them anything to set these incentives.

Such an offer to repay the debt should be made. So nobody could claim that the Greeks are not serious, in fact it would offer the Eurozone a rapid debt reduction strategy.

Can 240bn be repaid in 12 years?

What if the Eurozone countries took the Greek government at its word, could this be delivered?

Currently GDP in Greece is 180 bn. If 20bn additional exports were added, the GDP would stand at 200bn.
This would increase its currently balanced current account to a surplus of 20bn. It would lead to a massive reduction in unemployment, perhaps 0.5 million from over 1 million at the moment. The tax base would grow, and government expenditure (unemployment, pensions subsidies) would fall. Clearly, taxes would still be increased to deliver a 20bn loan repayment, but that would be considerably easier in a rapidly growing economy.

At the moment the Greek government raises taxes of 80 bn. It would have to raise taxes of 100 bn, to repay the 20bn of debt. The tax rate of GDP would be raised from 44% to 50%. But because the pie is bigger, these taxes should be easier to raise. When the Greeks had previously 3.5 million working, now it would be 4 million. So there would be a lot more money in the economy to pay these taxes.

An additional 20bn in the Greek economy would mean a direct one-off rise of GDP of 11%, a nice change after 4 years of the economy contracting. It would probably be bigger, because of fiscal multipliers. The current account surplus would be 10% of GDP. That is even more than the export champions of the world Germany.

The GDP would not grow further in the following years, if this 20bn additional export over current levels were repeated every year. However, employment would still be substantially higher, and government finances a lot more sound.

How realistic is it?

In practice, it is unlikely that the Greek economy could deliver such a rapid rise in one-off GDP growth, so it could be tapered over 2 – 4 years. But then it is equally unlikely that the Europeans actually wanted to help the Greeks and enter into such an agreement. It is a shame, because, as this example illustrates, increasing exports is actually the only way to repay the debt.

And Greeks would provide these goods and services, the additional olives and holidays, to the Europeans effectively for free. Well, the citizens pay for them, enjoy them, and their governments get the money.

The extreme alternative is always that Greece defaults on its debts completely. In this case the citizens of Europe do not get anything from Greece, no free olives or holidays, but have to pay off the debts of their governments nevertheless.

Endgame

The final stages of the battle have begun. Merkel and the Troika against Tsipras and Varoufakis. How will it end?

We assume here that the budget for Greece is balanced now, and likely to be balanced in the future.

Can they agree on anything?

So far they have agreed:

1) It is best to stay in the Eurozone for all concerned, there won’t be a Grexit.
2) A 1% primary surplus this year, and 2% next, effectively paying part of the interest which is due on the 320bn debt.

What they cannot agree upon is:

3) Troika wants cut in Pensions of 1% of GDP.
4) Troika wants increase in VAT of 1% of GDP.
5) Greece wants some further help to boost the economy, allowing some infrastructure spending.
6) Greece wants a restructuring of the Euro 240 bn debt to other European countries, the EU and the IMF.

Strength of the Eurogroup negotiating position:

Very weak, if the budget position of Greece is in primary surplus, as it probably is, if only slightly. That would mean that internally, Greek’s government income from taxes matched its outgoing.

Ultimately, there is no sanction for Greece other than a moral condemnation if it unilaterally decides to stop payments to its creditors.

That ECB would stop financing Greeks banks via ELA is very unlikely. There is no way Greece can be pushed out of the Eurozone

Strength of Greek negotiating position:

Extremely good. If they think they have a balanced budget. They could just leave all creditors and walk away from debt. Or they could choose to pay some creditors (private bond holders) and declare moratorium on public debt to EU.

Greeks know that they economically in the right – and have broad support of economists. Greek government has won the propaganda battle, which explained their situation in European press as well as they can.

However, Greek government probably does not know that cutting themselves off from the EU-Troika mandates by unilaterally declaring a moratorium would bring calm and stability into the Greek economy. Sounds counterintuitive, but think about it. The moratorium loan would quickly be out of sight/out of mind.

Initially bilateral lenders would be furious, especially Spain, Finland, Slovakia, so a mutually agreed settlement will now be high priority, which will probably link repayments to GDP growth rate. So, once all the debt is in a moratorium situation, it is up to the creditors to restructure it quickly in a mutually acceptable way, if they want Greece to pay anything – and avoid contagion, while making sure that all countries get back what they put in. Only the ECB can help here with QE.

However, international credibility would be lost, as defaulting only 5 months after election victory tricky. Against that, credibility will be regained if moratorium works and Greek GDP growth can be restarted quickly and unemployment falls.

What is the likely outcome of negotiations?

Some fudge on the outstanding issues, with implementation dates put into the future.

3) A cut in pensions of, say, 0.2% of GDP (300m) next year (rather than 1.8 bn proposed by Troika), and a cap of pension spending (pensions of 2016 + half GDP growth) for the following two years.

4) VAT increases something similar. Perhaps a 0.4% increase of VAT this year, followed by VAT increase of 0.8% of GDP for the next – this has already been proposed by Greek government.
Further taxes, as proposed by Tsipras government, make up some of the shortfall

5) Early access to the 330 bn Juncker growth fund 1 – 2 bn to kick start economy in growth.

6) Cutting interest rates further on EU debt to Greece, all the way to 0%. (ECB uses QE for all of Greek debts to its institutions and to the EU countries). This could be subject to further review if GDP growth rates based repayments are appropriate. So no restructuring, but prospect of restructuring.

Here all parties save face, and nobody looses out. None of the creditors will be disadvantaged. Some investment from Juncker fund, which will come through anyway soon. No cut of the debt, yet, but restructuring promised.

However, is that the best solution?

No. The Greek government should reject it, once it is sure what the best deal possible could be. It should default anyway. And declare a moratorium on its debt to EU institutions and countries.

Why a moratorium? Just to get out of the destructive negotiation circle, which undermines any confidence in the economy. And to have more growth, as economically senseless cuts will not have to be implemented.

Greece government also has to be seen to

a) not borrow any more money
b) stand on its own feet and show that they can govern.

Only through a moratorium can this be achieved. Only then will confidence in the economy return.

So my prediction is that the above outlined deal is probably as good a deal as they can get.

Whether Greek government will accept will depend whether it values its own destiny and a moratorium more than the destiny prescribed under the Troika.

I think Greece will choose its own destiny.