Ativo Capital

Rigorous Thinking

Financial and economic commentary reflecting Ativo’s world view:

A Catechism on the Greek Tragedy

Friday, July 10, 2015


Q: What do Bernie Madoff and Alexis Tsipras have in common?

A: Both have been involved in Ponzi finance. But there is a difference, the Government of Greece has been involved in Ponzi finance since Greece joined the Euro in 2002. A variant on the Willie Sutton line, “If the money is there, take it.”

Q: What do you mean when you say “Greece has been involved in Ponzi finance?’

A: Sure, for most of the last thirteen years until 2014, the purchases of the IOUs of the Government of Greece by various banks and government agencies in Northern Europe have been larger than the debt service payments of the Government of Greece. All the chatter in Athens about the need for debt relief is intended to delay the date at which the Greeks make the transition from living on other people’s money to living on their own money.

Q: Why does Tsipras continually chatter about the need for debt relief?

A: Probably because he believes that if there were a third write-down in the debt of the Greek government, the government would be able to finance larger deficits in the future.

Q: Does this mean that Greece hasn’t adjusted to the demands of the creditors?

A: No, Greece has adjusted, public employment has declined, pension payments and salaries have been cut, and the private sector has been badly squeezed.

Q: Does this mean that austerity has not worked?

A: Yes and no. Yes, austerity has squeezed some of the bloat out of government expenditures. But no in that Greece is far from an internationally competitive economy. The two families that have dominated Greek politics have patronage machines like those in Chicago and Boston; they spent public sector money to build money to build political support. After Greece joined the Euro, Government employment increased. The price level rose. James Angelos, in his new book, The Full Catastrophe, mentions that government salaries doubled after Greece joined the European Monetary Union.

Q: Why has Iceland adjusted while Greece remains in austerity?

A: Iceland had a private sector consumption boom. When the investment inflows suddenly stopped, the price of the Icelandic krona declined by fifty percent, the unemployment rate increased to eight or nine percent, and foreign investors that owned Icelandic securities were subject to exchange controls. In contrast, the surge in investment inflows in Greece financed a sharp increase in the government payroll and construction spending associated with the 2004 Olympics. If the government of Greece had defaulted on its debt service payments, the banks in France and Germany would have incurred large losses, and Greece would have left the monetary union because the government would not have had the money to pay its workers and the pensioners. (And the ratio of pensioners to population is higher in Greece than in any other EU country.)

Q: How in the “best of all possible worlds” could the government of Greece make the transition from living on other people’s money to living on its own money?

A: Greece has a “Twin Deficits” problem. Greece has had a trade deficit and a fiscal deficit. Its trade deficit contributed to its fiscal deficit; because costs and prices in Greece are too high, there is a high level of unemployment, and the government has been involved in a make-work activities to provide employment. The fiscal deficit contributed to the trade deficit; if the fiscal deficit had been smaller, GDP would be lower and the demand for imports would be smaller and the trade deficit would be smaller.

Austerity has “solved” both deficits. In 2014, Greece developed a primary fiscal surplus-its fiscal revenues were slightly larger than its expenditures exclusive of interest payments; the decline in government payments had led to the 25 percent unemployment rate. And there was a primary surplus in its international payments because import demand had declined sharply as GDP fell.

Q: Anything else?

A: Yes, my guess is that if the Greek economy were at a reasonably high level of employment, the trade deficit would be ten percent of GDP–Greece imports much of its energy, foodstuffs, and lots of durables. Excess capacity in the export sector is modest. Hence a massive decline in costs will be necessary for Greece to develop a trade surplus.

Q: Why do you keep harping on the trade deficit?

A: Look, if the debts of the Greek government are to be worth more than a nickel, Greece must develop a trade surplus (for convenience, the trade surplus includes net receipts from tourism, shipping, and other services). Some or all of the net receipts from the trade surplus will be used to pay interest on the Greek IOUs owned by foreigners. No trade surplus, no money for interest payments–and if interest isn’t paid, the debt is worthless.

Q: What about the impact of the Tsipras government?

A: GDP growth has become negative, and the taxpayers are on strike, and slowing their payments. My guess is that the government has been involved in a lot of deferred maintenance and has delayed paying its bills, and so the government expenditures are on the low side

Q: Okay, what about the impact of fiscal austerity?

A: Sure, declines in government payments have led to a decline in GDP, and in the demand for imports, and there is a small trade surplus. Assume a miracle, Zorba becomes the tax czar, “pay now or rot in prison”, the citizens would pay and the fiscal deficit would decline; because more of their incomes would go for tax payments, their spending on goods and services would decline, AND unemployment would increase. The trade surplus might increase.

Q: What about the first page banner headline in the Financial Times, “Martin Wolf– The Eurozone faces only bad choices on Greece.”

A: Sorry, Martin has it wrong. The bad choice for the Eurozone is to continue to “throw good money after bad” and to believe that a “Lourdes miracle” would lead to a surge in export earnings that in turn would lead to a higher GDP and an increase in tax collections. Greece needs a decline in domestic costs of 35 to 45 percent to achieve a sustainable balance in its international payments at a high level of employment. Greece won’t solve its basic problem until it become more competitive. And it won’t become more competitive until it takes a holiday from the Euro.

Q: Does this mean that Greece leaves the Euro?

A: A holiday, a separation. Greece remains in the European Union, and when it achieves a fiscal deficit of 3 percent of GDP, the creditor countries write down the value of its indebtedness to 60 percent of its GDP.

Q: What about the “bad choice” if Greece leaves the Euro?

A: Sure. The market value of Greek government debt depends on whether–and when– Greece can develop a trade surplus. If Greece stays in the Euro, the government will be on the dole until the end of time. For all practical purposes, Greece has defaulted; the major issue is how large is the haircut. And the haircut is smaller if Greece leaves the Euro than if it stays.

The argument that a Greek holiday from the Euro is a bad precedent is hollow. But if other countries allow themselves to become non-competitive they clearly do not want to be humiliated as the Greeks have. The Germans, the Finns, and the IMF thought that austerity would lead to a decline in costs; they got it wrong.

There will be turmoil in the markets in Greece for several months while the price of the new currency declines and the price level increases.

Q: Would you comment on the “trade” that the Government of Greece has been making, hoping for more credit.

A: Greece has used the threat that if new money wasn’t available from the creditors, it would not make its debt service payments, and the banks and others that owned its IOUs would have had to recognize their losses. In effect there has been “regulatory forbearance”, the creditor countries wanted time for this debt to move from the private banks to the public lenders before the losses would be recognized. So the Greek government did as little as it could by way of adjustment to get as much new money from the creditors. The creditors used the promise of new money to get as much adjustment as possible. But most of the new money was of the “kick the can” variety and was used to re-finance maturing debt.

Q: Are there other significant differences between Greece and other countries that were bushwhacked by the 2008 financial crisis?

A: Yes, the big puzzle is that Greece has not become more competitive as prices have declined. One contributing explanation is that the imbalances in Greece were much larger than in these other countries. Another is that the imbalances had financed government spending in Greece rather than real estate and consumption booms. Greece has a narrow range of exports. And there has been very little cash to finance new exports and ventures.

Q: How big a “haircut” is needed on Greek government debt?

A: You don’t want to know. In 2009, when the crisis first appeared, the debt of the Greek government was $430 billion, or about 180 percent of its then GDP. There have been two debt restructurings, otherwise known as writedowns, totaling $120 billion. Today, the government debt is $450 billion. GDP is $220 billion, and full employment GDP is $275 billion. 60 percent of GDP is $165 billion–the sixty percent is one of the Maastrict convergence criteriA: $450 billion minus $165 billion is $285 billion. (Estimates are ballpark, need to be confirmed.)