The terrible twins

The terrible twins were in action over the last few days, first Juncker, saying that Greece should “not choose suicide for fear of death”. Not really sure what he means here, but as metaphors go, you probably could not choose worse. I think he is saying do not choose “NO” in the referendum that would be suicide. Vote “YES” instead, and you will certainly die, he seems to say. So to choose murder by the Troika, vote “YES” . That is Juncker’s message.

Yesterday then a further intervention by the other half of the comedy act, Merkel. She will not negotiate until after the referendum, she said. Anybody Greek who is not sure whether to vote “YES” or “NO” will now know. It is now certainly better to vote “NO”, as a “YES” vote would not bring further negotiations, and Greece would be stuck with an unacceptable agreement.

So, as the Troika twins do their unintentional work for the “NO” vote, the Tsipras and Varoufakis twins can sit back and relax. They cannow contemplate what to do with the Euro 1.6bn which is still in the Greek Treasury, rather than at the IMF, having failed to meet their loan repayment last night.

But neither of these twins will be the subject of this blog post, a more pressing issue of economic concern are surely the twin deficits of Greece, the budget deficit and the current account deficit. Because they tell you something about the sustainability of the state of finances in a country.

Let us take a step back and look at some identities of national income accounting (for more look here).

It is a fact that the budget deficit G – T (Government spending minus Taxes), must equal S – I the amount of Savings minus the amount of investment in an economy.


G-T = S-I

Now if countries did not trade, that equation would always be correct, but as they do, we have adjust the equation for the current account surplus (Exports – Imports, or X-M).

G-T = S-I – (X – M)

So the higher the current account surplus, the smaller the budget deficit.
And the higher the current account deficit, the higher the budget deficit.

In an ideal situation, Government spending covers Taxes, Savings cover Investments and EXports cover IMports. That would be a well balanced economy.

But, it never is like that:

So for the UK for 2014 we saw the following: The UK ran a 6% deficit in its budget and a 6% deficit in the current account. Puttiing these numbers in the equation we get the following numbers: (All expressed as percentage of GDP)

-6% = S-I – (-6%)
-12% = S-I

In other words, after taking account of investments, the UK was dis-saving (running down savings) or borrowing up to 12% of its national output in 2014

Not all countries are as bad. For Greece, for example, we get the following equation, based on a 4% budget deficit and a 1% current account surplus in 2014

-4% = S-I – (1%)
-3% = S-I

So Greece was dis-saving or borrowing only 3% of its output. Almost in balance.

And here the mighty Germans, who ran a current account surplus of 8% in 2014 and a budget surplus of 1%:

1% = S-I – (8%)
9% = S-I

The Germans saved more than 9% of their GDP in 2014 after investments!

So Greece is actually a pretty solid country in 2014, better by far than the UK, based on these twin deficits. So the UK lives well beyond its means (it is as bad as Greece in 2005, see below). The Greeks who had to tighten their belts considerably, are now almost in balance. But the Germans live well below their potential.

Now what is the point of this post. Well, Mr Krugman mentioned yesterday  that he did not understand why the position of Greece was so bad as it only ran a budget deficit of 7% of GDP in 2007, something it surely should have been able to control.

Well, lets try to explain it to Mr Krugman and look at the twin deficits for Greece in the years around 2007:

-5%= S-I – (-8%)
-13% = S-I

-6% = S-I -(-11%)

-7% = S-I -(-15%)

-10% = S-I -(-15%)

-16% = S-I -(-11%)

-11% = S-I -(-10%)

So, the Greek twin deficits went from 13% in 2005 to a whopping 27% in 2009. These are enormous numbers. A quarter of its GDP was financed just through increased borrowing from 2007 to 2009. Year after year Greece had to borrow more and more to maintain its GDP and its GDP growth rate. So Krugman, just looking at the budget deficit in one year and ignoring the current account deficit in 2007, or the long term trend, is clearly not looking at the whole picture.

Greece had a hell of a party, and needed a hell of an adjustment.

Should somebody have noticed at the time, the authority in charge of financial stability in the eurozone, the European Central Bank, perhaps? Instead of only having a blinkered look at the inflation rate for the whole of the Eurozone, and not doing anything else, the ECB failed massively in its job af supervising the financial system. It should have raised some alarm bells around the middle of the last decade about Greece. These twin deficits could clearly be seen at the time and their unsustainability would have become clear.

So, clearly the Greeks borrowed too much, but the Greeks were lent the money in an environment where market forces ruled, and nobody, ECB or local bank regulators, thought there would be a problem. So the regulatory environment was inadequate to protect the financial system from these huge imbalances which, sooner or later, had to be brought under control.

Or to say it more succinctly, the idea of free flow of capital in the EU is clearly rubbish. Whoever thought that free flow of capital was a good idea is responsible for the Greek predicament. Without it the huge Greek current account deficits could not have been financed. So the EU will have to pay for its mistakes. The Greeks borrowing the funds are not too blame here, for them it looked like there was real economic growth at the time, and their individual loans justified.

The overall macro-economic supervision was lacking, and the ECB will have to pay. The ECB, I suggest, will pay on the 20th July when Greece has to repay 27bn Euro of government bonds, which the ECB currently holds. Greece cannot repay these sums, and these will have to be written off by the ECB. As any other lender who acts imprudently will have to write off loans which are not repayable and were not justified at the time.

It is time that the the EU and its financial supervisor ECB take some responsibility for this disaster and shoulder the losses.


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