Sunday, May 9, 2010

How to turn a minor crisis into a Greek tragedy

In the last four months the Greek economy has escalated from a minor national crisis to a near-catastrophe spreading to the whole of Europe, due to a combination of:

genuinely worrying Greek macroeconomic trends - in terms of government deficit, public and private debt and its maturity structure, trade competitiveness, current account imbalances - made worse by a recent and past record of national accounts falsification and cosmetic manipulations (both the responsibility of past right wing governments);

plus European chauvinism in wanting to keep the IMF out of it in spite of the fact that only the IMF Board can mobilise substantial resources more cheaply and quickly (in half an hour or so) and smoothly than anybody else, and Greece is actually entitled to those funds. The very proposal of setting up a European Monetary Fund was unnecessary (why have a regional agency when there is a global one, should we also have a European Trade Organisation, a European Health Organisation, a Bank for European Settlements?). It was also a waste of time or, worse, a costly dilatory tactic;

plus German populism in delaying and opposing EMU assistance against the interests of the German governent and public (German banks have at least €32bn exposure to a Greek default, higher than the current German cost of a rescue package over three years, of €22.2bn), just to please the North-Rhine Westphalia electors voting today; Angela Merkel deserves to be duly punished for that;

plus the EU'S unbelievable vagueness about the scale, form and terms of a bail-out: "the EU will provide as much as it will be needed if and when it will be needed" does not tell investors what they want to know: how much, whether they will be guarantees or loans, by the Union or bilaterally by member states, EU or EMU. And there is still uncertainty about the very legality of a bail-out, with the German constitutional court examining various appeals against the rescue package. Jean-Claude Trichet and Angela Merkel insisted on "no subsidy" on interest to be charged to Greece, thus effectively casting serious doubts about the effectiveness and success of their own package. The compromise 5% interest eventually charged on EU states' bilateral loans is higher than both the interest charged by the IMF (just over 3%) and the cost of borrowing by the German government;

plus the adverse effects of silly pronouncements by a number of EU high officials and economic commentators, i.e. talks of possible expulsion of Greece from the eurozone (for which there is no legal instrument), or voluntary withdrawal by Greece returning to the drachma (this would require its withdrawal from the EU, which is not in anybody's interest, and just imagine the level to which drachma interest rates would rise) or the introduction of a currency parallel with the euro; or German withdrawal from the Eurozone for the reverse of those reasons, or a two-euro zone, one Southern and weak and the other strong and Nordic ...

plus Greek failure to apply in good time for even the little finance they had secured in April (€45bn), allegedly not to signal distress, yet thus precipitating a much greater distress.

plus delays and quarrels leading to interest spreads over Bundes and to CDS prices rising to the point that Greece could no longer afford to access international financial markets, for at such high market rates Greek debt would have been unsustainable and demonstrably ended in default in the near future.

At that point the scale of the package required rose to €110bn (€80bn from EMU member states, €30 from the IMF) but, by the time this was granted, "markets" wanted even more.

And the burden of adjustment will fall on Greek public sector employees and on pensioners. Some of them benefited from large public deficits, for instance through the hiring by the previous rightwing government of thousands of their supporters, and through an earlier retirement age than most (including Germans). But they were not the main beneficiaries of rising public debt, or of rising inequality at large. When Romano Prodi squeezed Italians hard in order to meet the Maastricht conditions to join the euro, at least he made some symbolic gestures of taxing interest revenues and putting some extra tax on real estate. The people on whom the burden of Greek adjustment unfairly falls today have every reason to show their dissent on the streets of Athens - especially since the party now in opposition, responsible for the debacle, will not face up to their responsibilities. Popular protest, of course, objectively strengthens the expectation and the likelihood of default. In 1988 Ceaucescu implemented a brutal deflation in order to pay off all of Romania's foreign debt at a stroke, but fortunately Greece 2010 is not Romania 1988: creditors, bailers-out and the Greek government should recognise that there are limits to the political feasibility even of otherwise sound economic policies.

The coup de grace to Greece and perhaps to the euro was given by rating agencies unreasonably downgrading government bonds in the Eurozone even after the large scale rescue package had been approved. The "three sisters" should have been utterly discredited by their past failures in predicting performance, from Enron to Lehman Brothers, and by their past record of frequent conflicts of interest, yet they still mould and guide expectations, and are taken seriously even by the ECB (until Trichet fortunately decided to keep accepting Greek bonds as collateral regardless of their credit rating, and initiated a long-required re-assessment of the rating agencies' status. Nevertheless, talk of setting up a European (public?) "independent" rating agency is laughable, for nobody would take seriously its ratings of European bonds.

The attack on the euro must have been - at least partly - encouraged by the Americans and the British in order to deflect public attention away from their own economic and political troubles. Not necessarily through a conspiracy, as it has been suggested by some commentators, more by following a natural and self-serving inclination. In the end - during the night of Friday 7 May - Europe delivered, but delivered so much later than they should have that the tragedy is not over by any stretch of the imagination. And the deal made even the usually clownesque Berlusconi - compared to Trichet and Merkel and Sarkozy - look like a born statesman.


Jack said...

So, how far will the dollar/euro exchange rate fall by the end of the year? 1.20? 1.10? 1? below 1?

D. Mario Nuti said...

It was devalued by 5% last week, it touched 1.25 on Thursday before recovering slightly. Nouriel Roubini predicts a new equilibrium exchange rate at 1.10: being one of the few economists who correctly predicted the latest big crisis, he should be taken seriously.

A euro devaluation is more likely than eurozone dis-integration; it might stimulate exports and employment and growth in the Eurozone, though Germans usually benefit more than the average.

People tend to forget that the vast amount of global liquid assets must be parked somewhere at any time, and it is wiser to keep them parked in different currencies, including the euro no matter how shaky.

Demo said...

Are rating agencies really that powerful and obnoxious? surely these days the information they use is fairly widely and freely available?

D. Mario Nuti said...

Yes, they are. Here are some instances.

First, the European Central Bank normally uses credit ratings to decide the minimum standard of the bonds it accepts, e.g. A- before the crisis, BBB- until recently when it suspended this requirement for Greece.

Second, on last Friday Paul de Grauwe notes how credit rating agencies - and financial markets in general - do not take into account the fact that an increase in government debt may be the result of its taking over an equivalent amount of private debt, without an overall deterioration of a country's position.

Third, last Thursday Moody's made damaging statements while markets were open, they now have been asked to issue such statements only in the (rare) spells when markets are closed.

chilosi said...

"A euro devaluation is more likely than eurozone dis-integration; it might stimulate exports and employment and growth in the Eurozone, though Germans usually benefit more than the average."

How can you tell? After all the Germans, unlike the others, are able to engineer a huge trade surplus even when the Euro (or the Dmark before) is very strong.

As to the delay in acting there is a benevolent explanation: they wanted to be sure that the Greeks were serious. After all the action came just after the Greek parliament had approved the measures, if I well recall. And there was some good reason based on past experience to be distrustful of the seriousness of the Greeks...

thedmaster said...

Professore, dato che sono stati fatte, a quale logica di fondo corrisponderebbero le proposte di una possibile espulsione della Grecia deall'Eurozona, del ritorno alla Dracma o dell'adozione id una moneta parallela ? (Non cito le altre perchè mi sembrano sinceramente più assurde)

D. Mario Nuti said...

Alberto, "a benevolent explanation" for German reluctance to assist Greece? Clearly you are a very nice person, unfit for our wicked world.

the dmaster: the logic of other nice economists who do not have their feet on the ground and do not follow through their conjectures to their ultimate conclusions...