Protesilaos Stavrou

Analysis: Capital adequacy, LTRO and artificial demand

2012-03-13T15:54:00.000+02:00

Flames from a Frankfurt Occupy protesters' fire outside the European Central Bank. Image Source: WSJ

On the October 26 European Council Summit, the heads of state or government of the EU agreed on the capital adequacy criteria that European banks had to comply with by June 30, 2012. They asked from banks to raise their capital adequacy ratio from the threshold of 8% to 9%. Though a 1% increase might sound marginal, it is not when speaking of billions of euro, especially after considering that banks were struggling to meet the previous target, while to raise fresh capital amid the ongoing crisis is tantamount to a Herculean Task.

The Capital Adequacy Ratio (CAR) is measured by the following formula, which will allow us to better understand how a bank was expected to behave and how it actually did.

Regulators were actually asking from banks to increase their capital - the numerator, most probably by issuing shares. This however would have meant that the status of shareholders would be diluted, with bankers ultimately losing control of their banks, something that obviously no banker would like to do by force. So in practice the only course of action banks had was to reduce their risk, the denominator. There are many ways to do so, yet the goal is to replace risky assets, with less-risky ones.

Towards that end sovereign bonds are the ideal tool to achieve a higher capital adequacy ratio, since according to the criteria of the Basel committee (all three perverse packages) they are considered risk-free, provided the country is credit-worthy (!!!). Hence bankers would fight tooth and nail to buy sovereign bonds and hold on to cash to shrink their risk, thus raising their capital ratio. The effect of this on the real economy was a significant reduction in lending and in overall liquidity.

Working out the logic of this leads to the conclusion that the above policy of the capital requirements, no matter how adverse its effects might have been for the real economy, could only ask from banks to buy sovereign bonds. Yet there was a "small" drawback, since banks actually lacked the funds to buy such bonds en masse. This is where the LTRO (Long Term Refinancing Operation) came into play and that is why I consider it together with the capital requirements as parts of the same policy framework.

The two tranches of loans from the LTRO injected a total of nearly €1.02 trillion in the European banking system, at 1% interest for a 3-year term. These transfusions of funds were supposedly conducted on the expectation that banks would use their newly acquired funds to provide liquidity to the real economy, thus easing the transition of the now-stagnant market, back to recovery. However it was more than obvious that banks had absolutely no incentive to pass these funds on to the real economy for three reasons:

They were practically forced to buy sovereign bonds by the capital requirements programme as outlined above,
The spread between the yields on sovereign bonds and the 1% interest of the LTRO loans, meant an easy profit for bankers, especially when compared to the highly risky venture of lending money to the real economy in the midst of the ongoing recession,
The policy of the ECB to accept sovereign bonds as collateral for further loans, means that banks must get their hands on sovereign bonds if they are to cling on to cheap funding.

These conditions -all set by regulators, not market forces- have created what I see as artificial demand for sovereign bonds, especially for Italian and Spanish bonds. The political reasoning behind all this is crystal clear: To bring down the borrowing costs of the 3rd and 4th largest economies of the eurozone, in order to buy additional time for the European leadership to implement the fiscal compact and carry out other incremental policy steps towards tighter fiscal control, with the hope of appeasing the markets and restoring confidence in the capacity of the EU to deal with its own problems in an effective way. However this is something that the markets are also aware of, hence leading me to the assumption that once the artificial money bonanza is over we will witness renewed stress in the ill-designed Euro architecture, for as long as its structural flaws, both national and supranational are not addressed with determmination.

Yet the profoundest of problems I identify in this creation of artificial demand, which by the way is only a short-term "painkiller", is that policy-makers are channeling resources into unproductive areas, on a large scale. This is disastrous over the longer term for four reasons:

The real economy is deprived of much needed funds, implying that failures of SMEs will increase, suggesting that the backbone of the economy will be weakened. Real competitiveness, which is the ability of the European single market to produce goods and services, diminishes as much of the "economic growth" is now taking place within the complex network of capital markets, which are nonetheless detached from the real economy.
Systemic risk is in fact exacerbated, not mitigated, since banks become even more exposed to sovereigns who would normally not be able to sell such amounts of bonds at the current interest rates - this means that the balance sheets of banks, private and central, are being filled up with potentially toxic assets and there is no exit whatsoever out of a renewed feedback loop between stressed sovereigns and quasi-bankrupt banks.
The moral hazard of this artificial demand is huge as states and banks are provided with the incentive to delay or even avoid necessary structural reforms, thus preserving the root of the problem, i.e. bad policies and reckless practices,
The capital structure is distorted, the rules of fair competition and trade are perverted, as bankrupt entities remain operational to the detriment of those who really deserved staying in business. Somebody pays for the preservation of the bankrupt and that is understanably the portion of the economy that is not bankrupt (yet).

With all the above in mind I uphold that we are only reallocating problems without solving them, either that is geographically, as debts or claims are transferred or mutualized among states and their banks (see analyses on TARGET 2), or over time by rolling and compounding our problems on to the future.

If all this is viewed over a short time horizon it might indeed seem rational and many might applaud policy-makers for presumably bringing the situation under control. However once the after-effects of this large-scale malinvestment are seen over a longer period of time, then I am afraid there will be nothing to be happy about, since we are indeed preparing the grounds for new crises, erratic business cycles and renewed uncertainty and frustration, as the underlying malignancies of the system remain untouched.

The point is to eliminate all this policies that brought us here, not perpetuate them.

Structural reforms in Greece can only be done within the EU and the Euro

2012-03-12T11:40:00.000+02:00

The fortunes of Greece and the EU are intertwined. Image credit: AP

Those who support an exit from the euro and the reconstitution of the drachma, argue that Greece is trapped in a "downward spiral" whereby costs remain fixed and cuts only push the economy deeper in the abyss. As such, they advocate that the only way to break this vicious cycle is to repatriate monetary policy powers, depreciate the currency to reduce costs, regain competitiveness and inflate your way out of the crisis. In an abstract world, in laboratory conditions so to speak, this view could have been correct, yet in the real world, under the given conditions in which Greece finds itself, such a theory is pure fallacy from beginning to end, since it asserts that the main problem is in relative prices, not in absolute productive capacity, implying that no real reforms are needed once the depreciation occurs - something that is dangerously misleading as it gives the impression that nearly painless solutions exist, but for some "inexplicable" reason they are not taken into serious consideration (for more also see "On the fundamental fallacies of Euro-exit advocates").

Let me be precise: A currency depreciation would only prove beneficial if the country had much idle capital that could not operate under the high costs, but would be prepared at any given moment in time to restart operations, once relative prices had fallen thanks to the depreciation. However this does not hold true in Greece, since the country does not have any industrial capacities who have been under-performing due to the recession, nor does its commercial navy reside within its numerous ports, nor do hotels have many empty rooms during the summer season. In short the impact of reducing relative prices would be relatively small, since the productive capacity of the economy will not expand as much as necessary, while any marginal benefits will be annulled by the increased costs in the import side - and there we have much to worry about since Greece imports even basic goods. As such even with massive depreciation Greece will still require deep structural reforms, to broaden its productive capacities by attracting new investments and reallocating resources from non-tradable to tradable areas (from consumption-oriented, to export-oriented areas).

About the issue in question: Greece has a very narrow productive base, upon which a very broad consumption culture was established, something that is reflected in the chronic current account deficit of the country. This is clearly unsustainable, since it requires constant foreign funding that increases the stock of national debt. For Greece the only path back to recovery, under the given conditions of the debt crisis that deprive the government from implementing expansionary fiscal policy, is deep structural reforms that will aim at reversing the current account deficit, by means of increasing the productive base.

For that to be achieved four conditions need to be met:

Abolition of all bureaucratic obstacles and other protectionist policies
Dismantling of the rigidities in the labor market
Confidence and liquidity in the banking sector
Institutional stability and confidence in the political system

Firstly, by abolishing bureaucracy and by eradicating all barriers to trade and obstacles to economic activity, the government will have established a policy framework that will favor the reallocation of capital from non-tradable to tradable areas, since it will become much simpler, faster and less expensive to put together whatever available resources to set up an extroversive enterprise.

Secondly, by dismantling the rigidities in the labor market, structural unemployment will be addressed in its source, while the reposition of workers to the export sector will be facilitated. Here of course it needs to be said that horizontal wage cuts are detrimental to the economy as is the support to the privileges of special interest groups.

Thirdly, by ensuring stability and liquidity in the banking system, capital flight will be reduced, the silent bank runs will be minimized, while the looming financial panic will disappear, allowing for renewed economic activity.

Fourthly and perhaps most importantly, the policy-makers need to make sure that institutional stability is preserved. This means two things: (1) the political order will not change every few months, (2) the policies affecting the economy will have a long-term horizon, instead of being altered every few weeks the troika thinks that more austerity is needed.

By meeting these four conditions the country will have established the necessary framework, within which the productive capacities can be expanded, ultimately reversing the current account deficit, bringing about recovery over the longer run.

With respect to the above four conditions, a currency depreciation would:

have failed to eliminate bureaucracy, but would instead require more state mechanisms in place to control prices, capital movement, exchange rates, fight the parallel economy, combat increased tax evasion etc.,
conceal the need for real reforms in the labor market (and beyond), since politicians will have the incentive to postpone "unpopular" measures, by means of printing money,
exacerbate the stress in the banking sector, by increasing uncertainty, encouraging withdrawal of deposits, producing financial panic, lead to large scale bank failures because of euro-denominated debts becoming much higher in relative prices and so on,
increase political and institutional instability since the ramifications of the exit from the euro both in terms of politics and economics would be far-reaching, thus increasing uncertainty about the future - and without confidence in the future prospects of a country there simply is no investment.

Greece requires structural reforms as far as its interior is concerned. The key is to increase the productive base of the country which at the moment is very narrow. As such all efforts need to focus on the reallocation of resources from non-tradable into tradable areas, since the option of expansionary fiscal policy is not available, due to the sovereign debt crisis. Towards that end it is clear that an exit from the euro would do much more harm than good, by producing perverse incentives, exacerbating uncertainty in the economy, the banks and the political system and by failing to deliver the much-vaunted "competitiveness" the Greek businesses need to regain.

The future of Greece is within the Euro and the EU, so if we want to speak along realistic lines we need to see how to make this work. If it can be done by Greece alone it's good. If it can be accomplished within the context of a coherent, reformist European strategy that will systematically address all the asymmetries of the Eurozone and the EU, then it will be even better.

On the fundamental fallacies of Euro-exit advocates

2012-03-09T10:35:00.001+02:00

The costs of exiting the euro are significantly higher than the benefits. Image credit: Reuters

Regular readers of my articles are well aware of my opposition to the argument that considers orderly exits from the Eurozone and reconstitution of national currencies as the best course of action for countries mired in economic depression, such as Greece or even the rest of the GIIPS. My opposition is established, first and foremost on my fundamentally different approach to economics; one that deviates from the economic mainstream and especially from the field of standard macroeconomics. Next my counter-arguments are based on three pillars that are often neglected by many:

a revision of the very notion of "competitiveness", where I uphold that countries do not compete with one another - only businesses do, thus a macroeconomic aggregation cannot see which sectors of the economy really need a boost of competitiveness and most importantly against whom. The assertion that exports in general will be boosted, is inherently flawed and misleading.
no real correlation exists between exports and currency depreciation, since such claims are not consistent with the facts. The productive capacity of an industry cannot increase by means of depreciation, nor can the rooms of hotels be expanded in a similar way, nor will the fields become more fertile to increase agricultural production. Even with depreciation of the currency deep reforms are still necessary to boost real competitiveness and productivity. As such the effects of currency depreciation are at best largely overstated.
there is a profound difference between a currency union and a fixed exchange rate. More so there is an even greater distinction between a currency union and a monetary union. Those laboring under the assumption that exits from the euro are good, confuse a monetary union such as the eurozone, with either a currency union or even worst with a fixed exchange rate. The eurozone is a monetary union (or Economic and Monetary Union), established upon a complex system of central banks - the Eurosystem, which then coordinates its policy with the European System of Central Banks - encompassing 17 sovereign nation-states, within the context of a single market. In addition it lacks a genuine fiscal union backing it, while its political dimension, the EU, is even more complex, resembling a "political UFO" that is neither a federation, nor a confederation, nor a super-nation, nor inter-governmental cooperation.

Anyone willing to argue persuasively in favor of an exit from the euro needs to establish the following:

the gains in competitiveness of certain export industries will be greater than the losses from all other sectors of the economy that will not benefit from the massive depreciation of the currency,
the purchasing power of individuals will indeed be higher than before - something that I am afraid will be almost impossible to do, given that massive inflation will quickly kick in, the financial system will be obliterated, the black market will run rampant, the state will have to increase tis supervising mechanisms to control capital, prices and collect taxes, while the (imported) standard of living of will fall dramatically,
the myriads of interconnections that exist between the member-states of the eurozone, either those are measured through the payments between central banks (see analyses on the TARGET 2 payment system), or the exposure of banks to each other or to sovereigns, or even the businesses that operate across borders and finally the citizens themselves; will all not be hindered from an exit from the euro, or if they are indeed affected, the effect will be marginal and ancillary. Here I may say that any exit from the euro will simply trigger a series of cascading effects that will see full scale bank failures, massive loss of capital, great uncertainty and confusion between officials and citizens; ultimately doing much more harm than good to everyone involved, thus annulling any benefits that could have existed from an orderly exit from the single currency.
the government that will have the audacity to exit the euro, creating all that smoldering mess in the process, will be perfectly prepared for political isolation or even covert diplomatic embargo, at all European centers of power. The political cost will be significant, hence those who argue in favor of an exit need to convince us that this will not be the case and still the benefits are more than the loses.

The above-mentioned list is of course non-exhaustive, as there are several other issues that one could raise to challenge the arguments that are in favor of an orderly exit from the Eurozone. However I believe that these are enough for the time being.

As a concluding remark I would first like to remind my readers that I am in favor of deep reforms at local, national and supranational level, not just in the economy but also in the political level and these can only be materialized within the context of the Euro and the European Union. A united Europe has many benefits, the point is to make it beneficial for the individuals and this will be done when we abolish all delusions pertaining to the "cornucopia" of the welfare system, the scandalous protectionist policies at EU and national level, the stunning democratic deficit at all levels of governance, especially the European; and the collusion between big governments and big corporate interests against the average consumer, worker, entrepreneur and citizen.

Exits from the euro that will supposedly produce more good than harm, are wild delusions at best and unbridled speculation at worst.

TARGET 2 is essential - German objections are groundless

2012-03-08T11:33:00.001+02:00

Following my previous article titled "What Bundesbank and Target 2 tell us about the fate of euro countries", in which I describe the implicit dimensions of the objections that were recently raised by the chairperson of the Bundesbank, Mr. Weidmann, I shall now elaborate on the reasons that make the TARGET 2 payment system essential to the existence of the European monetary union (the Eurozone), proving that the objections of the German economic elite are nothing more than demagogy that serves political ends.

One of the many features of a monetary union is that its currency, the euro in our case, has the exact same value all across its area either that is Greece or Germany (these two countries are only used as an example, the same rules apply to all 17 member-states of the eurozone). So a "Greek" euro - a euro residing in a Greek bank account - will have the exact same value with a "German" euro - a euro residing in a German bank account - meaning that payments between the two states can be made using that same euro. Though this might sound obvious and mentioning it might seem bizarre, in truth there is a very complex system in place that allows for this constant equation between the "Greek" and the "German" euro. It is the payment system underpinning the monetary union that creates this effect, by allowing for the smooth operation of the credit line between all private banks, the 17 National Central Banks (NCBs) of member-states and the ECB. Note that the central banks of all 17 member states together with the ECB form the so-called Eurosystem.

Why credit is fundamentally important in the capitalist system

Image Source: ECB

Under the capitalist system, all economic activity is established on the basis of credit. This is especially true in modern banking, whereby all banks function under the Fractional Reserve Banking System, which means that by law they are obligated to keep in their vaults only a fraction of their reserves, say 10%, while the rest is lent out to the economy. In practice this means that if all depositors of a single bank went at the same time to draw their money, the bank would simply not be able to satisfy them all, but would rather give the money back only to the percentage of those equal to the legal reserve ratio - for example to 10%.

In order to avoid such extreme instances or indeed in order to insure that banks never run out of cash to trigger any sort of financial panic, which is detrimental to everyone, private banks are eager to extend credit between them (with profit of course). However just in case no private bank would be willing to issue credit to another bank, thus leading the entire system into jeopardy, there are central banks in place to act as a "bank of banks", effectively filling in the gap if necessary. So in a nutshell the entire credit system - capitalism - works smoothly as credit flows without obstructions all across the banking system.

In the eurozone the above process is facilitated through the TARGET 2 payment system, thus always allowing for a euro in a Greek bank to have the exact same value with a euro deposited in a German bank, since the Greek bank will never run out of cash thanks to the credit line in place. The euros in separate banks would be priced differently only if their value was determined by their scarcity and market forces, which however is not the case as outlined above. If that was the case then most probably each bank would have its own currency, while even the concept of a currency union would never be conceivable.

TARGET 2 in the context of European political economy

Image Source: ECB

Prior to the economic crisis in the eurozone, private banks were more than happy to extend credit to one another, hence the indices on the balance sheets of central banks measuring claims made through the TARGET 2 payment system were always very low or near-zero. Towards that end the Bundesbank, just like all other NCBs experienced something quite normal since all the clearing process was done by private banks themselves, thus not burdening its balance sheet.

So when the crisis finally hit the eurozone, practically breaking the credit line and crippling, among others, the financial system, all payments made between private banks stopped or were drastically reduced. At that very moment the entire monetary union would have collapsed had it not been for the intervention of the National Central Banks that provided their balance sheets to allow for the continuation of payments through TARGET 2. In other words central banks had to facilitate all payments by replacing private banks in issuing and accepting credit. Henceforth a German product purchased in Greece would ultimately be recorder by the Bundesbank as a claim against the eurosystem, thus increasing the index measuring TARGET 2, which is today the subject of the debate.

The process would go as follows: the Greek bank would ask for credit from the Central Bank of Greece, since no other private bank is willing to supply it under these tough economic conditions >> the Central Bank of Greece would create the money necessary for the transaction and would send a claim, through TARGET 2, to the Bundesbank with the exact same amount >> the Bundesbank would then record the amount of the transaction as a claim against the eurosystem. So the bigger the exports of Germany, the higher the number of claims to the Bundesbank will be, something which is clearly shown in the significant increase in the index that measures these claims, which has gone from near-zero in 2007, when the credit line between banks was still fine, to some €500 billion today, where the banking system is in serious trouble.

If this whole process did not occur then two would have been the immediate effects: (1) German products would stop being imported by Greece due to lack of money, (2) a euro in a bank account in Greece would no longer have the same value with a euro in a bank account in Germany. These two, when extended to all member-states, over all banks, including on transactions of imported goods, would have effectively meant a disruption of such proportions that the whole Eurozone would have to be dismantled straight away.

The demagogy of the German economic elite

Given that the eurozone is already characterized by current account imbalances with some countries running persistent deficits and others persistent surpluses, the ultimate burden of the broken credit line will eventually fall on the surplus countries like Germany. Why? Because a person willing to buy a Volkswagen in Greece, will have to do so through a local bank - yet since the (nearly bankrupt) Greek bank does not have the money to finance this transaction, the chain of events will ultimately bring the total amount, or more realistically, a large part of it, to the Bundesbank - which is absolutely normal in a monetary union, as described above.

The reason I speak of demagogy, of propaganda from the side of the German economic elite, is that the only way to reverse this dynamic is either for Germany to stop all exports in the eurozone, or for the eurozone to cease existing - both of which would prove to the great detriment of German interests.

So why are they raising such an issue? The goal is clearly political and is two-fold: on one hand it puts extra political pressure on deficit countries, by maintaining a "hard line" against them, even though this is harmless rhetoric that will never gain flesh and bone; on the other hand the Bundesbank is indirectly asking from the ECB to intervene in the TARGET 2 system by providing its own limitless balance sheet for all these transactions, so that the Bundesbank is no longer burdened by the effects of German exports (by the way this is a separate issue that deserves an article of its own).

No matter which of the two is most important to the Bundesbank at this point in time (in truth none), the gist is that the spirits are already against a particular group of countries (like Greece) that supposedly add a greater risk to the balance sheet of the German Central Bank and consequently the German economy. In truth the notional risk on the German economy is predetermined, since Germany is the largest net contributor to all funds (and the ECB), meaning that its exposure is from the outset the largest; while in addition Germany is an export-oriented economy, which means that if nobody buys their exports they will run into serious trouble.

What the German economic elite is doing is dead wrong as they intentionally distort an otherwise normal function of the monetary union to put forward their own political agenda, ultimately victimizing a particular group of states. To me this clearly is propaganda.

Demagogy is never good, especially when it is exercised by people who should stick to their job and make sure they do it well, for the sake of all of us Europeans.

Does nuclear energy have a future?

2012-03-07T14:01:00.000+02:00

Several events are taking place these days, in the memory of the tragedy that hit Japan a year ago, when a tsunami triggered uncontrollable reactions to a nuclear plant in Fukushima, leading to a nuclear crisis, with far-reaching effects on the environment, the society and the economy.

The compelling catastrophe, has ever-since given birth to a rather controversial debate over how should our societies satisfy their energy needs.

Should the limits of the planet be respected and should environmental responsibility be given priority in policy-making, or should human needs be met by the most cost-efficient way possible, regardless of the potential collateral damage?

Moreover is an environmentally-oriented transformation of the economic model of our societies, a task that we must urgently materialize, or the time is not yet right to proceed in such deep reforms in the way we allocate our resources?

Is there place for nuclear energy in our era, given that the ramifications of such programmes can be far-reaching as the tragedy of Fukushima has demonstrated? Or can nuclear energy be a safe choice for current and future generations, who realize its potential benefits that greatly outnumber its costs?

These and many others are the questions that people and policymakers have been called to answer over the years and especially ever since the disaster at Fukushima.

Within this context the European platform for political debates, Debating Europe, holds today a live discussion on the fate of nuclear energy in the European Union with Patrick Moore, Co-founder of Greenpeace, Chair and Chief Scientist of Greenspirit Strategies in Vancouver, and Jo Leinen MEP, Member and former Chairman of the European Parliament Committee on the Environment.

You can watch the debate LIVE today between 18h00 and 19h00 CET by visiting the website of Debating Europe - click here to be directed to the video stream.

Given that the issue is very important for our present and future and after taking into account the high quality of the work done by the people at Debating Europe, I highly recommended this debate to everyone who is interested in the issue.

What Bundesbank and Target 2 tell us about the fate of Euro countries

2012-03-06T12:14:00.003+02:00

The Bundesbank has always been producing a lot of noise regarding the way in which policy makers are dealing with the ongoing economic crisis. At times their objections are legitimate and well-grounded, at others they exaggerate by stubbornly maintaining a disproportionately hard line on rather insignificant issues. The last in the series of such over-emphasized concerns is the "discovery" that intra-eurozone current account imbalances are a risk to the Bundesbank that could presently cost it some €500 billion. This was found through the amount of claims made by the Bundesbank on the inter-central-bank payment system known as Target 2, which measures payments made within the Eurosystem (ECB + national central banks of EU17) - a quite technical issue that should only concern central bankers and mostly their statistical bureaus. The alarms started ringing when they realized that the claims through Target 2 were close to zero prior to the crisis, whereas now they have climbed to about half a trillion euro. What the economic intelligentsia of Germany had just realized was how problematic current account imbalances are, but it did so in a rather peculiar way. To explain why allow me to first outline the issue.

The Target 2 is a payment system between the central banks of the Eurosystem that allows for the smooth operation of the monetary union, by facilitating transactions between banks and/or national central banks. It serves as a platform that allows for the creation of money that are needed for local transactions that involve imported goods. This is necessary in modern economies, since due to the Fractional Reserve Banking System, private banks only keep a fraction of their reserves, while the rest is lent out to the economy. Thus private banks do not actually have in their vaults the money needed to carry out a transaction, but have to make a claim to the Central Bank to create that money. This process is normal under the current monetary system. When the transactions involve payments to other eurozone countries, in other words when they concern imported products, then the process will also involve the central bank of the state that exported the product. As such a German product bought in Greece would create the following chain of events in the eurosystem (Germany and Greece are just used as an example):

The local bank would bring a claim to the Greek central bank (Bank of Greece) asking for the amount of money necessary to carry out the transaction,
Since the issue concerns a German product the Greek central bank would create the necessary money, but would send the claim to the central bank of Germany (Bundesbank),
The Bundesbank, would then record the amount of the transaction as a claim against the eurosystem.

*the picture below depicts what was just described above, under normal economic conditions (click to enlarge).

Target 2 payment System. Image Source: ECB

All the above are done through the Target 2 payment system, which of course is monitored by the statistical offices of central banks. The reason that suddenly the Bundsbank reacted to this, through its chairman Mr. Weidmann, is because before the crisis the figure measuring Target 2 claims of the Bundesbank, was close to zero, whereas now it shows around €500 bn worth of claims against the eurosystem. Given that the crisis has practically disrupted the credit line and after considering how deep in the hole European banks are, it is quite normal to witness such a rise, since central banks step in to avoid a credit crunch and an eventual collapse of the monetary system (and consequently the monetary union). The noise that the Bundesbank has produced around the issue and the collateral they now ask for to cover this exposure, is worth observing since it implies a few things about the countries within the eurozone.

First of all the rise of the Target 2 index shows to the German economic intelligentsia that current account imbalances are problematic even for (or perhaps more for) the country that runs a surplus. The increase in the amount of Target 2 claims, shows how exposed Germany and the Bundesbank are to a disruption of trade with other eurozone countries. This exposure would ultimately prove to be disastrous, if the eurozone collapsed, or even if the countries that produce the largest amount of claims via Target 2 - the countries that have the largest current account deficit vis a vis Germany - were to exit, or be forced out of the eurozone. In short the interconnections that are created through Target 2, are such that no part of the eurozone can be severed without immense pain for all the rest, especially for Germany that is a surplus country and thus its exposure is greater.

What does this tell us? The obvious: That no country will ever be forced out of the eurozone for as long as it affects the overall current account balance - even Greece -, thus I am again proven correct when insisting that such "threats" were groundless and could only be used rhetorically. The cost of forcing a country out of the eurozone would mostly be felt by Germany, therefore the German government that pretty much shapes the European agenda, will never allow that to happen, ultimately for their own good.

Moreover the Bundesbank has brought to the surface a debate that only makes sense if there is a high chance that the eurozone will disintegrate in the near future. At least that is what it directly implies since collaterals would only make sense in such an event. But there really is no chance of a eurozone collapse within the next few months (maybe there is over the medium-term), so why does Mr. Weidmann maintain such a hard line on this issue? But of course to satisfy the conservative German economic elite that still wants to believe that the crisis is all about the fiscal finances of certain (irresponsible) states. Well Target 2 itself should open their eyes to make them see that the crisis might be more intense in Greece or Portugal or elsewhere, but Germany and other surplus countries are equally involved in it - again a proof that the crisis is systemic and not a series of "sovereign debt crises".

By posing objections to the increase in the claims made through Target 2, the Bundesbank has actually fell into a trap of its own making, as it has unwillingly undermined its own interpretation of the ongoing crisis and its overall view of the political economy. By saying that Target 2 is a risk to the Bundesbank, its chairman Mr. Weidmann, has indirectly admitted that (a) current account imbalances are also problematic for Germany, not just the deficit countries, (b) the cost of forcing a country out of the eurozone will be immense for Germany - thus it will not be allowed to happen, (c) the interconnections measured through Target 2 alone are enough to prove that the crisis in the eurozone is systemic and is not only about the unsustainable finances of certain states.

It finally becomes crystal clear that being tough in your decisions is good, but having a sense of proportion and realism is better.

Analysis - LTRO will not help the real economy but prolong speculation

2012-03-04T10:10:00.000+02:00

A few days ago the European Central Bank launched its second round of three year loans to private banks at 1% interest rate, under the so-called Long Term Refinancing Operation (LTRO). This second round of LTRO loans attracted funding requests from 800 banks, bringing the total supplied amount to €529.5 billion. Combined with the first round of the programme, the amount of funds loaned by the ECB are around €1.02 trillion. The fact is that this massive injection of liquidity in Europe's quasi bankrupt banking system, has prevented an immediate financial crisis and has bought enough time for policy-makers to bring their houses in order and push for concrete solutions to the ongoing crisis.

Several analysts believe, or want to believe, that the LTRO will ultimately provide much-needed liquidity to the real economy, allowing for increased business activity that will stimulate demand and thus kill off the recession, leading back to recovery. Having followed the eurocrisis for months now (I was speaking about Europe's bankrupt banks since almost a year ago) I may say that the LTRO will not help the real economy, since the given conditions provide no incentive to banks to issue loans to firms and individuals. Instead banks have a series of very good reasons to invest in sovereign bonds, thus prolonging the stress in the real economy.

The reasons banks will not be willing to issue loans are three. Namely the bank recapitalization programme, the criteria of the ECB for new loans, the high risk that loans have contrary to sovereign bond purchases. Analyzing each of these will make my point clear and will allow the reader to understand that this new bank bailout (LTRO is a euphemism) will only buy time for politicians at the cost of more speculation from bankers.

First, the bank recapitalization programme. In the October 26-27, 2011 European Council Summit, the heads of state or government of the European Union agreed to formulate a programme under which banks are asked to raise their capital ratio from 8% to 9% until June 30, 2012. A one percent increase might indeed sound marginal and ancillary, yet when speaking of billions it is not; let alone the fact that few banks were at the 8% target.

For banks to meet these conditions there are three possible courses of action: (1) bring down total risky assets while keeping the available Core Tier 1 capital constant, so that the denominator decreases, while the numerator stays the same, thus increasing the ratio, (2) issue shares, offering the opportunity to new investors to come in, at the potential cost for the banker of losing control of his/her bank, (3) buy sovereign bonds that comply with the criteria set by regulators to count as Core Tier 1 capital, in order to directly increase their capital.

If the ECB had not provided any support to the region's banks, they would be forced to cut expenses and reduce their openings (deleverage), while keeping their core capital constant, and/or they would issue shares to attract fresh capital, always at the risk of losing control of the bank to the new investors. The option of buying sovereign bonds would have been extremely hard to reach, given that most banks were short on funds, therefore not allowing them to make such investments ("investments"). By launching the LTRO the ECB has offered the chance to banks to avoid the tough choice of reducing their activity and/or issuing shares, by providing them with the funds they need to buy sovereign bonds. By acquiring the sovereign bonds of countries like Italy and Spain (or other like Germany), banks increase their Core Tier 1 capital, since these bonds meet the criteria set by regulators in October, 2011. In a nutshell the bank recapitalization programme, in conjunction with the LTRO provide the incentive to banks to buy sovereign bonds of particular countries, instead of issuing loans to the real economy.

Second, the criteria of the ECB for new loans. The ECB maintains a policy of accepting as collateral for the issuance of new loans, sovereign bonds that again comply to a given set of conditions. In practice a bank that has Italian bonds can offer them to the ECB in exchange for a new loan. Taking into account the fact that most sovereigns are in desperate need of loans (sell their bonds), to cope with the mounting pressures of the debt crisis; while also considering the sufficient profit margin that exists between the 1% loans of the ECB and the 5% or 6% (or more) rates of certain sovereign bonds, banks have every reason to buy these bonds, enjoy the profits and then offer the bond back to the ECB in order to restart the speculative process.

Again the point is that there will be an interplay between states and banks, whereby banks will be the ultimate winners as they will make considerable profits, while the real economy will remain short of liquidity; as again there is no real incentive for banks to issue loans, amid such uncertain conditions, especially when the secure option of sovereign bonds exists. After all buying such bonds also serves the banks needs with respect to the recapitalization programme, as explained above.

Third, the risk in issuing loans is much higher than in buying sovereign bonds. The actions of policy-makers all these crisis years have manifested an unprecedented determination to prevent sovereign defaults - and even bank failures - at all costs. All know about the massive bailouts to banks at the beginning of the crisis, followed by bailouts to bankrupt states, again for the sake of preventing a financial meltdown (the talk about "solidarity" is nonsense). Considering that politicians will go to any length in setting up "safety mechanisms", it is safe to conclude that a banker will have good reason to bet on this, by speculating on sovereign bonds. The perverse incentives that bailouts produce are indeed numerous, yet the gist is that the underlying malignancies are not addressed, while speculation is in fact encouraged and reinforced.

While sovereign bonds are indeed protected by all sorts of mechanisms and interventions, ultimately making the investment quite safe, the loans to the real economy are not - and cannot - be guaranteed by any authority. Given that the real economy is still in a recession and after taking into account the fact that many loans might not be paid back, why would a bank get in such a trouble, when it has the safe (and profitable) option of purchasing sovereign bonds thus accomplishing three things in one: comply with the recapitalization criteria, have the chance to get more ECB loans, minimize risk. So again it becomes evident that there is no real incentive for banks to provide liquidity to the real economy, but instead speculate on sovereign bonds.

After taking all the aforementioned into account, it becomes crystal clear, to me at least, that the LTRO funds will not reach out the real economy, or if some of them do, the total effect will be negligible, since the vast majority of the funds will be directed to sovereign bond purchases. And of course states will use those funds to cover their immediate expenses and most importantly pay back their older debts (to these same banks). Banks have very strong incentives to buy such bonds, while there is nothing really that would make them provide much needed liquidity to the real economy. I myself am convinced that regulators were fully aware of all the above and everything has been planned from beginning to end for one single reason: to bring down the yields on Spanish and Italian bonds, in order to show that the new governments' efforts are effective, with the hope of restoring confidence in the markets, about the capacity of Europe to deal with its crisis. Though this could indeed be a rational plan (a trick) to get out of the crisis without making real reforms in the institutional framework of the euro and the EU and without addressing the flaws of the single market; I am afraid to say that the markets are also aware of what is happening and will abuse all the loopholes with impunity. For the months ahead we will see the spreads on Italian and Spanish bonds falling and we will hear the well known rhetoric of European leaders over how successful their strategy has been. However once the artificial money bonanza is over, expect to see a repetition of the shadow play we have been witnessing all these years.

Oh and needless to remind you that when money was given to states, harsh austerity and loss of sovereignty were among the preconditions...

The reelection of Herman Van Rompuy and the need for democracy

2012-03-03T09:46:00.000+02:00

On March 2, 2012 the European Council appointed for a second two-and-a-half year term, Mr. Herman Van Rompuy as its President after receiving the unanimous approval of its members.

I have no doubt whatsoever that Mr. Van Rompuy has all the necessary skills to be President of the European Council, however this alone is not enough to justify his presence there. For such an important position there should be more criteria apart from the consent of the heads of state or government.

The President of the European Council plays a decisive role in shaping the agenda of internal and external policies, while he also represents the EU on international organizations, institutions or other fora. In other words his actions heavily influence the lives of European citizens and others. As such it is natural to expect a far more democratic process than what we now have: a decision taken behind closed doors, without any accountability to any democratic institution or directly to the citizens.

This stunning lack of democratic legitimacy and transparency need to be addressed immediately, to ultimately improve the EU and strengthen the relationship between its institutions and the citizens. Given that drastic changes in the institutional order require numerous Treaty amendments that will take several years to materialize, the European leaders should show good faith in exercising practices that derive from political custom instead of statutes.

For instance there is no clause in the Treaty that forbids a mini presidential campaign, six months before the day of the appointment, whereby the candidates would at least present their agenda, goals and priorities in front of the European Parliament in search for its consent. The decision of the Parliament need not be a binding one, yet it should be taken into serious consideration by the members of the European Council, given that the European Parliament is the only institution that enjoys democratic legitimacy, as its members are directly elected by the citizens. As such the opinion of the Parliament should be included in the final appointment, to show that democracy is respected, at least in form.

Following the same train of thought, one could also expect a duplication of the phenomenon we see in the US, with the presidential caucuses. Right now the candidates of the Republican party, for the Presidential elections of November 2012 tour around all states to win the approval of the local electorates. The individual with the most wins becomes the de facto candidate of the Republican party. This is not included in the US constitution yet it is a custom that definitely contributes to democracy. I therefore see no real obstacle for this happening in Europe, with candidates for the presidency of the European Council touring around all member-states in an attempt to convince electorates about their plans.

There are of course many other steps that could be made to circumvent the rigidities of the Treaties and allow for more democracy and transparency in the office of the President of the European Council. Given the nature of European politics, these incremental steps might indeed be the only realistic option that will of course pave the road for a truly democratic process where the positions of the President of the Commission and the European Council, will be merged and the person filling the office will be directly elected by the citizens.

What we now have, a President who is appointed by heads of state or government to actually act as the puppet - the assignee - of certain influential states, is suboptimal. The EU needs to decisively address its growing democratic deficit even if that means circumventing the Treaties, without however breaching any of their provisions.

The European Union, that cares so much about the values of democracy, cannot possibly afford to be as undemocratic and opaque as it is. Failing to strengthen the democratic mandate of European institutions implies an inability to comply with the principles that the EU ostensibly protects.

The real problem of the Fiscal Compact

2012-03-01T11:24:00.001+02:00

The Irish people will be asked to vote on the fiscal compact, a treaty that does nothing to address the real problems that stem out of the economic crisis.

There currently are discussions in all political groups of the European Parliament on the Fiscal Compact, the new international treaty that will soon be brought in front of the national parliaments or electorates of all signatory member-states for ratification. The idea underpinning this new treaty is that fiscal rules need to be tightened and their provisions implemented in full, either by compliance of national governments or by enforcement from the supervising mechanisms.

The arguments that are heard against the fiscal compact, mostly stress the legal dimension of the issue, namely that European institutions cannot operate outside EU law and since the fiscal compact is not part of that legal corpus, as it is considered international law, its legality will be dubious if not contradicting the community's acqui. Hence several of the provisions of this new treaty can practically have no force within the EU, since community law is superior to international law.

This argument is indeed correct and in fact I pointed that out in an article of mine short after the December 9, 2011 European Council summit, when the foundations of the fiscal compact were put in place (see Think twice before saying that the UK is isolated). Yet no matter how strong that argument may be, skilled lawyers can always find loopholes to push for the implementation of this treaty's provisions. Hence I myself do not see the legal side of the matter as the real problem here.

The real problem of the fiscal compact is the approach it maintains vis a vis two things: (1) the root of the crisis in the eurozone, (2) the remedy to it. In both issues the spirit of the new treaty is problematic, as on one hand it does not see the crisis as a deeply systemic issue, that encompasses the real and financial economies, the welfare state, the national and supranational institutional framework; but only as a "debt crisis" whose source is the indeed imbalanced public finances of certain states.

The fiscal compact follows the rhetoric of the established powers of the EU. It is that one-sided, monolithic approach that only sees one facet of the crisis, namely public finances, while intentionally omitting the malignancies of the European banking system, the structural flaws of the single European market and the institutional gaps of the Eurozone.

In short it is the approach that deals with the symptoms of the broader systemic crisis not the causes, without even making mention to the need for real reform in (1) the monetary system, in which we identify a symbiosis between states and private banks, (2) the protectionist and perverse policies of the EU and its constituent member-states that only hinder real economic growth and are to the detriment of the average consumer, worker, entrepreneur and to the favor of big corporations, (3) the democratic deficit of the EU - which starts from the regional, national level - that is gradually increasing, with all the negative ramifications this can have on the lives of all European citizens and people residing in the EU.

Note that the above are not the feature of any particular political group, say "the right". Here I am speaking of ideas, not micro-political disputes; and the ideas that led to the creation of the fiscal compact together with all the other policies that preceded it and will follow it, are the real problem that European citizens are called to cope with. What is really bankrupt in the EU, what really is the problem, is the established ideological framework that has so far dictated political life. For as long as we do not think outside the box, beyond our prejudices and "acquired rights" we will always remain in this position and Europe will be the patient of the planet in the decades ahead.

Growth in Europe - The key is to reallocate resources

2012-02-29T10:52:00.000+02:00

After several years in recession, stagnation or anemic expansion, characterized by massive cuts in public and private spending, the issue of "growth" has naturally perhaps been brought to the foreground. The question that every political group seeks to answer is how do we recover from this crisis? The views on the issue are of course vastly diverse, reflecting the ideological differences between politicians; yet there is a common belief shared by all parties, which is that fiscal consolidation (austerity) is not a solution per se - everybody knows that, even if they are not wiling to accept it at this stage for political or tactical reasons.

When it comes to growth, my view is that we first need to clarify our framework of ideas, before proceeding into the actual discussion. The reason I say that is because we often attach too much attention to the macroeconomic figures that show economic growth, without however looking into the quality of that economic drive. In the eurozone this has over the last ten years led to large scale malinvestment, perverse incentives and undesirable outcomes as the bubbles in the European periphery demonstrated (Greece, Ireland, Spain etc.) and as the persistently high levels of unemployment always point out.

This experience must teach us a lesson: that we can no longer afford to exercise inflationist practices that exacerbate economic instability. Growth must derive from a self sustainable, endogenous engine, not from political alchemy. This can only be achieved by reforming the state (from local to supranational) while facilitating the reallocation of resources from non-tradable to tradable sectors.

Take Greece as an example to grasp my point: the country experienced an unprecedented capital flow bonanza when it gained accession to the eurozone. This tsunami of capital allowed Greek banks to issue relatively cheap credit and the Greek state to borrow at low interest rates. As such the economic growth in Greece was driven by a sharp increase in consumption and several investments in infrastructure (many in projects for the Olympic Games, that are now useless). Greece experienced growth rates that were significantly higher than other core European economies like Germany. Yet all that growth was purely artificial and was definitely going to lead to a sharp downturn one way or other. The reason is that the structural malignancies of the Greek economy remained in place. Namely the persistently negative balance of payments, the cumbersome bureaucracy, the ridiculously ineffective tax collection mechanisms, the shaky banking system, the problematic real economy. These were all magnified by inflation, which was the natural outcome of the credit hog ever since the early 2000's.

Today we all know where those dynamics brought us to. If we are prudent enough we will simply not repeat such policies and instead look for real reform and sustainable growth. This is now what Greece needs (and Greece is used as an example for most eurozone countries). To correct all the structural flaws of the economy, eliminate bad government failures (interventions), allowing for sustainable investments and growth in the production and consumption of real goods and services. The key to growth in Europe is to reallocate resources and live within our means.

Are bailouts acts of solidarity?

2012-02-27T19:12:00.001+02:00

The word "solidarity" has been widely used all these crisis years, ever since oodles of taxpayer money were put to bail out unsustainable entities, like over-leveraged banks and reckless sovereigns. The rise to prominence of this particular word is not at all coincidental since politicians always use euphemisms to present in a positive way, actions or policies that are otherwise hard to accept and digest.

As such "solidarity" serves pretty well the needs of all political sides involved. The EU likes it because it reasserts the important role it has to play, in "fighting the speculators of the markets"; the conservatives love it because they can put sugar to their otherwise poisonous remedy; the socialists adore it as they reconfirm their belief in the existence of an interventionist state/superstate to help the needy and alleviate inequalities. In short every political party confirms its own biases and dogmas, by using the word "solidarity" to refer to the series of bailouts that have been issued in the eurozone these last few years.

Regardless of what politicians might be saying, the persistent question the citizens have is: are bailouts acts of solidarity? The answer is a straightforward "No" for two main reasons:

Bailouts are issued to contain contagion. They are administered on the basis of preventing a complete meltdown of the system, by halting the crisis either within a section/sector of the economy or within a given geographic area (locally/nationally). Hence we often hear about the need to build a "firewall" around states like Italy and Spain who could potentially become insolvent should their position deteriorate further. At any rate the rationale of a bailout is to stop the crisis from spreading in other sectors of the economy or over other countries - whether that is sound politically and theoretically and whether it does indeed bring the desired results, is another issue.
Bailouts are issued to avoid sovereign defaults. When a state defaults (when it goes bankrupt) it seizes paying back its creditors and instead engages in negotiations with them in order to restructure and reschedule any debt payments - either the creditors like it or not. Though there is a significant cost on society when such a process materializes, the ultimate cost falls on the creditors of the state (usually banks). Preventing a sovereign from defaulting ultimately implies an indirect support to its creditors, not to the people of the state, since they will be called to pay both the original debt and the amount of the bailout (the new debt).

The above two lead to the conclusion that bailouts are a means of conserving the established system - they are not charity, nor is there any altruistic morality behind them. And by "system" we of course refer to the powers that be and the institutional/political entities that support them either directly or indirectly. We mean the collusion between our big states and big corporate interests. We refer to the cozy relationship between politicians and financiers and so on. Therefore the word "solidarity", as it is used by the European elite can only mean "support to our own vital interests".

I understand that politicians need to keep a balance in their approach to everything and so they need to use positive language. That's absolutely fine with me. After all my point here was not to ask from politicians to change their discourse, but to state my objection to hypocrisy and naivety wherever those may exist in the actions that have led to all these ineffective bailouts.

What the free-thinking citizen realizes by working out the mechanics of these issues, is that first things are not as depicted; second, altruism or other idealist virtues are not the driving forces of any policy. Solidarity to the needy is good and welcome. But we have not seen any of this and there is no sign that things will change in the years ahead. Saving those who brought us into this crisis is never going to be a genuine act of solidarity no matter how they are willing to present it.

Second Greek bailout - another perverse short term fix

2012-02-26T15:42:00.000+02:00

For several months now we have all been witnesses of the political shadow play between the Greek government and its trio of lenders (EU,ECB,IMF). Anyone aware of the circumstances was already convinced that a new bailout to Greece would eventually be agreed upon, given that all parties had no better alternative. At the same time we all knew that European politics would still have to respect its gradualist character, i.e. the small, cowardly steps towards the truth. This has after all been the history of the "Greek" and broader crisis - a story of prior denial of everything that was rational, as it was deemed "politically impossible"; only to be embraced as inevitable when the damage was done and the cost was higher.

A bailout was considered unacceptable in the first place, yet we have seen massive bailouts over the last years and there is much evidence suggesting that we might well have more in the near future. So was the idea of restructuring the public debt of Greece or of offering loans with low interest rates, in order to keep the debt dynamics in check. Time and again EU politics have not been able to get rid of their chronic sclerosis and self-defeating austere conservatism. They undoubtedly failed to do so again with this second package to Greece worth €130 billion.

The new bailout has violated all the initial "no" of the troika, but has done so in a manner that further perplexes things instead of offering a way out of this smoldering mess. The conditions that were set as prerequisites to the new programme are so complex that may in the end allow the shrewd (speculators) to abuse the loopholes that exist, thus canceling all efforts to make the debt sustainable in a way that does not harm other member-states.

The numbers of the new bailout simply do not add up. One has to resort to fantasy and unrealistic assumptions about the actual situation and the way the economy functions, in order to conclude that this latest package will be a long-term solution to the Greek facet of the systemic crisis. To be precise, it is wildly optimistic, if not utopian to believe that Greece will run primary surpluses for almost a decade only to reduce its debt level to some 120.5% of GDP by 2020 - note that this is the most optimistic figure, yet it still is an unsustainable debt ratio. For that to happen there must first be some magic fairy that will contribute to robust economic growth for several years in a row, in an economy that still suffers from the internal and external malignancies that brought it in this position. In addition the monolithic austerity regime must ultimately lead to recovery, even though it is crystal-clear that it has so far made the real economy even less competitive, because of higher taxes, increased political uncertainty and critical banking stress. In other words austerity, which deals only with the symptoms rather than the causes, must somehow fix all the structural flaws of a collapsing edifice, ironically by putting more pressure on it, thus accelerating its destruction.

Policy-makers have clearly been elaborating under false assumptions or dangerous delusions. Characteristic is the process of the restructuring of the public debt of Greece. The so-called PSI (private sector involvement) programme whose purpose was to impose loses on the sovereign bonds held by private creditors, had as a precondition the notion of voluntarism, in order to avoid an anticipated "calamitous" activation of the CDS contracts resulting from a coercive debt restructuring that would surely classify as a credit event. This practically deprived Greece of its sovereign right to proceed with a coercive debt restructuring. Having lost its bargaining power, Greece could not push for a deal that would likely ensure the sustainability of its debt.

This offered the opportunity, though it never had such intention, to hedge funds to step into the play, by buying up large quantities of Greek sovereign bonds, with the purpose of exerting magnificent pressure on Greece for more profits on their side. Indeed only a small percentage of the banks that are supposedly involved in the restructuring deal, do actually participate, since most of them have been replaced by hedge funds who will make profit out of this either by blackmailing Greece into accepting odious conditions or by gripping on to their CDS contracts, which will yield them exorbitant profits in case of a credit event. Regardless of what might be the end to this story, its impact both on Greece and the future borrowing prospects of countries mired in crisis will be significant, since it will make things much more difficult and complex than they ought to be.

The perverse effects of the new package can also be seen on the creditor status. In the bond swap that leads to a "voluntarily" writedown (the PSI programme), the ECB and the Eurosystem were exempted. Though it might sound reasonable not to impose loses on central banks or other official creditors, in truth it is not. By giving a preferential status to the ECB and the Eurosystem, policy makers have created two classes of creditors, while they have also killed off the market's checks and balances, by greatly reducing the effectiveness of the CDS.

With the bad precedent of the Greek debt restructuring, the crucial question that is raised, is who will from now on invest in eurozone sovereign bonds, when he/she will either be forced to give seniority status to the ECB or other institutions and when he/she cannot effectively hedge the investment with the acquisition of CDS contracts in parallel? Three are the most likely answers:

no serious investor will do that, thus expect increased difficulty in accessing the markets for those countries that need it the most,
only those who can abuse the loopholes to engage in unbridled speculation, just like the hedge funds with Greece - which again makes the situation worse for the state and its partners/official creditors, or
only those banks that benefit from the money-printing bonanza of the ECB, under its latest LTRO programme - but of course this practice clearly is large scale malinvestment that distorts the capital structure, ultimately paving the road for more bubbles, crises and bailouts.

The second bailout to Greece is nothing more but an ill thought short-term fix, that was agreed upon only for the purpose of pretending that the situation is under control. The unintended ramifications of this deal will be far-reaching and unpleasant. The pressure will be taken off Greece for the next few months or years at best, only to be reallocated in other parts of the eurozone. The sure thing is that we are very far away from a sustainable solution to the problem. There definitely are many issues that cause concerns, skepticism and a general uncertainty about the future of Greece and the eurozone - and needless to say that the Greek interior will simply not comply with the troika's diktats, with whatever impact that may have on the viability and effectiveness of the new package. All this shall become clear when Greece comes asking a third bailout to finance its debt obligations from 2015-2020.

And who knows what else awaits the poor taxpayers who see their money being wasted in futile policies...

The problem with Greek austerity

2012-02-21T18:48:00.001+02:00

Austerity policies deal with the symptoms rather than the causes of the crisis. For as long as the underlying malignancies of the Greek economy stay in place, austerity will remain a largely self-defeating approach towards to the crisis. Image Source: Daily Mail

The second bailout to Greece was approved by the last Eurogroup summit, effectively bringing this marathon of negotiations (ever since October 26) to its end, even though a few formal steps are still required. The new deal, is not at all "new" as far as its policy orientation is concerned, since it will follow the same economic regime of the first bailout, i.e. draconian austerity or "fiscal consolidation" as it is officially known. I have repeatedly expressed my opposition to the policies of the troika, not because I wish to defend the frivolous spending of the Greek state - but because these monolithic policies do little to arrest the crisis, since they do not deal with the causes, but the symptoms.

The problem with Greek austerity is that the underlying malignancies and structural flaws of the Greek economy/state/society are not addressed. This can be wrapped up in the following three observations:

Austerity implies tax hikes, without however making real, deep reforms in the tax regime and the tax collection mechanisms. In other words, the chronic inability of the Greek state to tax in a fair and efficient way persists, which means that those who were previously burdened with taxes will pay ever more, while those who were systematically evading their obligations are now evading even more. As such there is a growing chasm between those who pay taxes and those who don't, which is not a good thing both for the economy and the social order. Given that revenues are falling, while inflation remains relatively high, increased taxes which in effect are levied only on a portion of the Greek society, put more pressure on the real economy and raise less revenue for the state. Hence more are the businesses that are threatened with bankruptcy and more are the people that are led to the margins of unemployment - all this while the actual revenues of the state do not really increase, at least not as much as they should. Meanwhile those who evade taxation have a relatively good time.
The trade balance of Greece remains negative. The Greek economy imports much more than it exports, thus more money is leaving Greece, than entering. Given that Greece does not attract foreign direct investment, primarily due to its cumbersome and counter-productive bureaucracy, this negative trade balance proves to be an obstacle towards the road to recovery. For the country to be relieved from the pressures, the exports need to become more than the imports. This does not happen with currency depreciations (return to the drachma) for several reasons that would prove catastrophic for the economy, but only with modernization and rationalization of the public administration; simplification of all official procedures; and stabilization of all economic policies that affect investment, in order to minimize policy uncertainty. So far little to nothing is done towards these directions, to the contrary we see more of the same sort of malpractices and more political uncertainty.
The banking sector is quasi bankrupt and will continue to remain in a highly stressed position for as long as no decisive action is being made to restore faith in it and put an end to the silent bank runs that have been taking place for some years now. Indeed large amounts of money have left the Greek banking system in fear of a financial meltdown, sovereign default and reconstitution of the drachma. This is a very big problem, yet is also not being dealt with under the current set of measures. To the contrary austerity reinforces the uncertainty that permeates the Greek public (this is also sustained by the loose talk of Greek and other European politicians).

The gist is that fiscal consolidation might be necessary to control the finances of the state but definitely is self-defeating in addressing the sources of the problem. For as long as the structural flaws of the national and supranational economies remain in place; austerity can at best go as far as producing some "fine" macroeconomic aggregates which are necessary to please the troika, at the expense of eating in to the muscle of the real economy. A new strategy is needed, not just for Greece, but for the whole EU; one that will see robust growth especially in the European periphery, deriving from the real economy, not some credit bonanza that will ultimately lead to the same bubbles that brought us here. As such one-sided austerity is clearly not working.

Great Recession and the mechanics of a Euro Breakup (wonkish)

2012-02-19T17:23:00.004+02:00

Yesterday, Saturday February 18, 2012, I received an email from the chief editor of Variant Perception, a global macroeconomic research group, informing me on their latest research paper titled "A Primer on the Euro Breakup". I was kindly asked to redistribute their work, so I thought the best way to do so would be, by publishing this article in which I will expand on issues related to a potential breakup of the Eurozone, the mechanics of deflation and the origins of the Great Recession.

The people at Variant Perception consider "default, exit and devaluation" as the optimal strategy for countries currently mired in a deep recession and seen as insolvent, like Greece and Portugal; as well as for countries that are hardly pressed, yet are considered to be illiquid rather than insolvent, like Italy and Spain. In short the drafters of the "A Primer on the Euro Breakup" argue that exiting the euro would not have the cataclysmic implications many economists across the globe argue it would. They provide historical data of other breakups of currency unions, arguing that the macroeconomic indicators show that these can occur with little short-term pain and considerable long-term gain.

After reading their paper I may say that I disagree both with their diagnosis and their conclusions. However I am perfectly willing to republish their work, as I consider it very important to elaborate on alternative solutions to the crisis or to other versions of the broader "truth". In addition I am always in favor of a healthy dialogue, even when the participating views are diametrically opposed.

What follow is the report of Variant Perception titled "A Primer on the Euro Breakup" and then my article, in which I shall lay down my views on the broader issue, without however engaging in a direct commentary of the paper of Variant Perception. Their work has offered me the incentive to bring together my views on issues that I have already explained in previous articles of mine.

VP - February 2012 - Eurozone Breakup - Summary

What follows are my views, which are separated into sections to facilitate the reader.

Sections:

Intro and methodology: Approaching a complex issue
The origins of the Great Recession and the Eurocrisis
Deflation and the "debt-deflationary spiral"
Redesigning instead of breakup
The mechanics of a Eurozone breakup and concluding remarks

I. Intro and methodology: Approaching a complex issue

In approaching a complex issue, such as the systemic crisis of the euro, one needs to bear in mind that no easy answers exist. Using methods that shed light only on one facet of the matter, might be correct in terms of scientific approach, but can easily lead to false conclusions when policy is concerned. In particular one always needs to be skeptical about the researches of any single discipline on the matter in question, given two fundamental problems that exist:

The general: Social sciences, such as political science, sociology, economics (yes it's a social science) are profoundly different from positive sciences. In positive sciences natural laws might be discovered and constants may be identified, through empirical research. As such, we know that water will always evaporate once it has reached a particular temperature, or an apple will always fall in a given way when there is gravity and so on. In social sciences this is not the case, since the subject of study is the human being, which is far more complex than natural phenomena, as it is unpredictable. This should not imply that social sciences are not "sciences", nor that there is nothing we can learn from studying human behavior. To the contrary social sciences have helped us immensely to further develop our civilization. Yet it is important to comprehend the difference between the two branches of science, in order to realize that prediction is much harder, when the subject in question is the human being - more so when we are dealing with collections of humans (societies, economy etc.).
The particular: The science of economics has not yet developed effective tools that allow for pinpoint estimates, nor does it possess a coherent framework that allows for a deep understanding of the actions of human beings, their interconnections and their (co)relations. This is especially true when speaking of macroeconomics, i.e. the field that studies economic aggregates such as GDP. The indices that are widely used by macroeconomics are more than imperfect and must always be used with caution. In addition they are aggregates which tell us little about the dynamics of the forces that compose them (the individuals), while they can easily mislead us a lot. Policies that have relied on macroeconomic indices have time and again proven to be problematic and largely ineffective in reaching their goals. The European Union and the Eurozone in particular provides one such example: The Stability and Growth Pact. It is the set of macroeconomic criteria that need to be met for a state to be part of the eurozone. Such criteria are the debt ratio, the budget deficit, inflation and long-term interest rates. The failure of the SGP to prevent the current systemic crisis of the euro is a clear sign of its flawed scope and method (instead of revising their original idea, European policy-makers are now planning to repeat the same mistake by implementing the new treaty, the fiscal compact, which is more of the same).

With the above two in mind, I may say that in approaching a highly complex issue such as the systemic crisis of the Euro, we need to be aware that we can easily reach wrong conclusion if we focus on one side of the matter, especially if that is done with the use of imperfect tools, such as macroeconomics. I am not saying that the conclusions will necessarily be wrong, nor am I suggesting the abolition of specialized studies in facets of a given issue. I am only stressing the need for a different approach in making policy proposals, one that views the subject from many perspectives.

This is perhaps the main reason why many policy papers that have been published in the past by prolific academics or think tanks have failed to take material form - they are one-sided, thus apolitical. As such I personally am very skeptical in using macroeconomic indices to see how the world works, while I am also hesitant to rely on historical data of other currency unions, since the conditions are profoundly different, as each case is in fact unique - and the eurozone is seen by the vast majority (if not all) of experts as a sui generis entity, thus things become even more complex, favoring a case-by-case approach.

To elaborate on the prospect of a Eurozone breakup, we must first identify the problem in question. The eurozone is not an abstract currency union, existing in laboratory conditions, whereby academics and policy-makers would have the power to shape the world according to their intentions. There are particular dynamics that have existed prior to the actual crisis, which are fundamentally important in evaluating the so called "debt-deflationary spiral" and the mechanics that influence the real economy, the financial system and the fiscal finances.

II. The origins of the Great Recession and the Eurocrisis

The purpose here is not to provide a definite account of the causes of the Great Recession. It is just to outline the forces that led to it, which will be of use to us as we evaluate the issues that are directly related to the ongoing crisis in the eurozone. The origins of the crisis are identified, in my view, mainly in two areas:

The artificially low interest rate policy of the Federal Reserve Bank in the United States, which encouraged large-scale malinvestment and caused the housing bubble
The increase in the "investments" in financial derivatives thanks to the perverse incentives provided by states and central banks.

Concerning the first parameter, economist Paul Murphy argues the following in his article titled "Did the Fed cause the Housing Bubble?" (Apr. 14, 2008):

The case against the Fed is straightforward: In an attempt to jumpstart the economy out of recession, Greenspan slashed the federal funds target from 6.5% in January 2001 down to a ridiculous 1% by June 2003. After holding rates at 1% for a year, the Fed then steadily ratcheted them back up to 5.25% by June 2006. The connection between these moves by the central bank, versus the pumping up and popping of the housing bubble, seemed to be more than just a coincidence. On the contrary, it looked like a classic example of the Misesian theory of the business cycle, in which artificially low interest rates lead to malinvestments, which then require a recession to correct.

To support his point Murphy provides the two following figures, which clearly indicate how the Fed followed an inflationary policy in the early 2000's:

Chart 1. Source: Mises.org

Chart 1 shows that the real interest rates were at very low levels, comparable only to the rates in the 1970's. This clearly is an indicator of easy monetary policy.

Chart 2. Source: Mises.org

For chart 2 Murphy himself argues the following:

There are a few interesting features of the above graph. First, note that the growth rate in 2002 (8.7%) was higher than in 2001 (5.6%). (Henderson and Hummel may have given the opposite impression, because of the units involved. The base bounced around like crazy because of huge injections and then drainages because of Y2K and 9/11.) Second, note that the base growth in 2002 was about as high as any year from the 1970s, except 1979 (when base growth was 9.2%).[2] Everybody in this debate agrees that the 1970s were characterized by excessively loose monetary policy. It is hard to see then how Greenspan's behavior during the serious onset of the housing boom can be described as moderate.

In parallel to the perverse, inflationist monetary policy of the Fed, we were witnessing an unprecedented growth of the financial sector and in particular the rise of "private money", i.e. financial derivatives that were used as if they were money (store of value, means of exchange etc.).

The account of Yanis Varoufakis on the matter is simply brilliant:

Wall Street was attracting $5 billion of fresh capital from abroad every working day. On top of that, it was attracting another $5 billion daily from two domestic sources: Corporate profits (which were soaring as a result of accelerating productivity in an era of zero real wage rises) and the interest on debts incurred by middle and lower income groups in the US (the debts of Americans who borrowed on credit cards and against their homes to keep up with the Joneses, banking on ever increasing house prices).

Now, I have a question for you. One that does not require a push of your button: When every day of the week, for twenty years in a row, a banker has $10 billion more to play with than she had the previous day, what do you expect her to do? Nothing? Of course not! Even if she holds it in her hands for a few minutes before passing it on, she will find ways of making it work for her. It is the nature of the beast. That is what bankers do. Expecting them to do otherwise is like expecting a bird not to fly or a crocodile not to ambush.

Well, ladies and gentlemen, bankers did what bankers do. It came to be known as financial engineering and the new mode of business was labelled financialisation. Securitised derivatives, CDOs, CDSs and the like were the tools. And by golly did they work for them. Every one of the dollars that passed through their sticky fingers was pumped up using the new tools of the trade and yielded between $30 and $100 for them.

Was that the result of Out of Control Greed? No, Out of Control Greed was the effect. The cause was the tsunami of capital that went through their hands. And, if my analysis holds water, that tsunami was an integral part of the Grand Hoover that kept global capitalism going on the basis of the constant feeding of the US twin deficits; a feeding frenzy that kept Germany, Japan and China in business, and able to find markets for their increasing trade surpluses.

The above two combined with the creation of the Euro led to the following artificial conversion in interest rates between Core and Peripheral Eurozone economies, as depicted in the chart below (click on image to enlarge).

Eurozone interest rate convergence. Source: BBC

All these combined led to the creation of all sorts of bubbles. In the eurozone in particular it allowed for the massive borrowing of the Greek state, the bubbles in Ireland, Spain and so on. As such much of the growth we were experiencing all these years was unreal, since it was boosted by cheap credit rather than an expansion of the capacity of our economies to produce real goods and services and accrue wealth.

This naturally brings us to the second section of this analysis, which concerns deflation and the arguments that many stress about the so-called debt-deflationary spiral in which the Eurozone supposedly finds itself.

III. Deflation and the "debt-deflationary spiral"

In mainstream economics, deflation is depicted as the black hole of the economy. Economists generally fear deflation, since they argue that if prices keep falling then investment will be averted. In addition this diminishes profits for the businesses, thus leading to bankruptcies, foreclosures and layoffs, which in turn lead to further bankruptcies and the process continues until the economy is reduced into rabble. This logic could hold true when the economy is growing, though again that is debatable. The point though which matters to us the most is the mechanics of deflation in the midst of a recession, since that is what we are now supposedly experiencing. Deflation in the midst of a recession is first and foremost a natural part of the business cycle. There is a boom followed by a bust, there simply is no other way. Second, deflation is actually good for the economy, especially in the midst of a recession since it functions as a shock absorber.

But first the general view as expressed by Murray Rothbard:

Rather than a problem to be dreaded and combatted, falling prices through increased production is a wonderful long-run tendency of untrammelled capitalism. The trend of the Industrial Revolution in the West was falling prices, which spread an increased standard of living to every person; falling costs, which maintained general profitability of business; and stable monetary wage rates—which reflected steadily increasing real wages in terms of purchasing power. This is a process to be hailed and welcomed rather than to be stamped out.

Then the particular view about the mechanics of deflation in the midst of a recession. The following is a quote taken from the article of Mark Thornton, titled "The Lehman Brothers Plan":

First, under deflation, the prices of capital goods fall dramatically. This initially happens with stock prices plunging, but eventually the prices of office buildings, warehouses, retail stores, etc., also fall.

Second, the price of labor will fall as the unemployment rate rises. Wage rates are somewhat "sticky" compared to stock prices and leasing rates for commercial space, but they do tend to fall in real terms if they are not propped up by government intervention and unemployment insurance.

Third, the prices of consumer goods will also fall — but not as much. The demand for "nondiscretionary" consumer goods is not elastic. Things like milk, flour, tobacco, electricity, daycare, and iPhone apps have what economists call "income-inelastic demand" because we don't change the amount we buy either when our incomes increase or decrease. In the past, for example, the quantity demanded of margarine has actually increased when our incomes go down.

This means that in the deflationary-corrective process, the prices of land, capital goods, commodities, and labor are falling relative to consumer goods. This provides potential profit opportunities for entrepreneurs to purchase these greatly depreciated resources in order to make products to sell to the consumer. In other words, the deflationary process is more like a shock absorber than the black hole imagined by mainstream economists.

Not only do profit opportunities emerge, but wage-labor opportunities are scarcer and less attractive. Both influences encourage entrepreneurial behavior, and this is a key factor in any corrective recovery process.

From the above, we may argue that deflation leads to a reallocation of capital, which is ultimately good for the economy as it will lead to robust growth, deriving from the production and consumption of real goods and services, on a new solid basis.

Bringing this to the systemic crisis of the Euro allow me to say that there is no such thing as a "debt-deflationary spiral" that has ostensibly gripped the area. The latest reports from Eurostat show that inflation in the euro area averages around 2.7~3% and there is no sign whatsoever, that there is a tendency for prices to fall sharply.

In addition the comprehensive set of welfare subsidies at national and supranational level, suggest that labor costs will not decrease, or their decrease will be ancillary. Similar narrative for all other sectors of the economy that depend on state subsidies.

One of the reasons unemployment is rising while the crisis deepens, is exactly because the authorities have not allowed deflation to kick in and correct the distortions in the capital structure. The real downward spiral that we are experiencing in the Eurozone is largely due to relatively high inflation in an environment of diminishing real incomes and little to no growth (stagflation).

IV. Redesigning instead of breakup

Bringing all the afore-mentioned to the paper that provided me with the opportunity to compose this article, I shall now look into the potential breakup of the eurozone, whether that is desirable and whether there are alternative paths.

What we need to keep in mind when speaking of the Eurozone is that even though we are referring to a currency union, in truth we are dealing with a political project. To understand this, one needs to be familiar with the European Integration process, which is characterized by gradualism. Incremental steps are made towards the direction of an ever-closer union, ultimately leading to a political union, which is still not clear how will it operate (federation? confederation? etc.)

The European integration process has a particular pattern that starts from step-by-step economic integration, which then brings about the need for further integration as the half-built edifice cannot possibly be sustainable. In short economic integration brings the need for political integration. Within this context the euro was seen as a tool in the hands of policy-makers willing to accelerate this process. Hence even though the euro never satisfied the criteria of an Optimal Currency Area, it was established, with the hope/conviction that over the medium-term/long-term further integration would cover the gaps of the system and produce a true currency union, backed by a genuine fiscal union - a process that would be facilitated by the even more intense economic integration. As such one cannot omit the political dimension of the matter when speaking about the breakup or the redesign of the Eurozone.

The euro is a very big political investment for the European Union and thus cannot be abandoned with a light heart, since its breakup can easily affect the overall balance in the EU and halt the momentum of integration. Therefore even if the euro as a currency was not sustainable (which is not the case), European leaders would still have a very strong incentive to fight tooth and nail for its preservation. Yet the euro is not insolvent nor unsustainable in the long-run for two rather simple reasons:

Even in the extreme case of a series of defaults in the European periphery, the currency itself will not receive any mortally wounding hit, since it is a fiat currency that several states will still be willing to use. As such the euro itself cannot collapse because of economic pressures - this can only be done if its constituent states agree on its breakup in favor of national currencies, which however is still unlikely.
As the crisis continues, many policies that were once considered unthinkable are ultimately being implemented. We have seen the violation of the no-bailout clause (there have been bailouts), the no-intervention by the ECB (ECB is intervening like crazy), the no-debt restructuring (Greece will restructure its debt, by imposing a "haircut" on its private creditors) etc. This suggests that over the medium-term more "taboos" will be broken, implying that what is needed to save the currency will eventually be done. And this is something admitted by myself, who am not at all optimistic.

Hence once facing a dilemma of the sort "breakup or redesign" the European policy-makers will clearly vote for the latter. The euro will be redesigned and this will start from the ratification of the fiscal compact, which will have to be followed by a legal framework that will establish a uniform tax base (not tax rates), a unified banking sector and a genuine fiscal union, with a common treasury capable of raising revenue and issuing bonds of its own.

I am not saying that there is no chance for a currency breakup. To the contrary, such prospect is quite likely if policy-makers continue their "extend and pretend" practices. I am only arguing that for as long as Europeans can stick to the euro, they will do so.

This also provides the political answer to whether unilateral exits from the euro would be beneficial - they would clearly be to the detriment of the state in question, as far as politics are concerned (for an economic approach on the issue matter see "Exit of Greece from the Euro is collective suicide" and "Currency union vs fixed exchange rate - Greek Euro Exit").

V. The mechanics of a Eurozone breakup and concluding remarks

To me if the euro should ever be broken up, for whatever reason that may be, it must be done in an orderly way, since the interconnections that it has created over these years are such, that if not taken into prior account will definitely lead to a sub-optimal level for all parties involved, while it will definitely have a negative impact on the world economy. I do not share the view that a potential collapse of the euro would be "cataclysmic", I am only saying that better make the transition as smooth as possible - this is a matter of common sense.

Coming to the conclusion of this article, I may say that there are several remarks in the report of Variant Perception which are worth examining and which definitely hold true. I recommend you have a view at their report, since I repeat I always am in favor of a healthy dialogue, even if there are contrasting views, as is currently the case since I so not agree with their thesis.

Finally I would say that the above definitely do not exhaust any of the subjects in question. They only provide a framework of thinking, that can facilitate us in (a) understanding the crisis, (b) evaluating policies and/or policy proposals. Much more needs to be said and in fact much more has actually been said in previous articles of mine. The point is to always remain open to alternative ideas, never be dogmatic, never take anything for granted; while also never exclude scenaria that might be politically or economically or socially undesirable; since everything is possible under the conditions we now find ourselves in.

Solidarity is good - But a new Greek state is Better

2012-02-18T09:25:00.001+02:00

People in Europe and across the world are mobilizing to show solidarity to the Greeks who have been hardly hit by the greatest economic depression in the history of their country. Being a Greek myself I can only express my gratitude to those who understand the difficult position the Greek people find their selves in. As such solidarity, either practical or rhetorical is more than welcome as it is noble and humane. However being above all a cynic who wants to see real change in Greece and the EU, I may say that solidarity alone is not what we are in need of.

Greece is in desperate need of deep reforms in the structure of the public administration, the economy, the education system, the health system, regional policy, social policy and the political system itself. In short Greece needs a new beginning; one that will put aside the profligate, irrational, unfair and counter-productive past; one that will abolish and condemn all these malpractices and ill attitudes that brought the country to its knees and caused untold suffering to its people.

This will be done by the Greek people themselves who must finally realize that the root of the problem is their apathy and their guilty tolerance of the parasitocracy that was established ever since the fall of the dictatorship of the military junta in 1974. The Metapolitefsi (the democratic era after the dictatorship) gave birth to a political system that specialized in charlatanry, corruption and deceit.

A political establishment which once promised the lofty ideals of "bread-education-liberty", appeared as corrupt as its predecessors, effectively eating in the foundations of the Greek society. The practices that were exercised all these decades - these corrupt policies - are what led to the destruction of the productive capacities of the country, the creation of perverse incentives, the distortion of the capital structure, the formation of a highly unproductive and costly bureaucracy and in the end the magnification of inequality and the rule of injustice.

For Greece to be part of the modern world; a country that will make its citizens proud; all these policies that destroyed the country must be abolished. This will start from the individual citizen. The Greeks need to realize two things if they are to move forward:

Freedom is not free. You fight for it on an everyday basis and you win it by remaining vigilant and by demanding a better life (the Aristotelian eudaimonia),
In a democracy the responsibility is always collective. Thus they should stop pretending being innocent, since they were well aware of the corrupt practices of the political elite, since they too benefited from them. Also they should stop cultivating "foreign enemies" and other "ghosts of the past", since the problem starts and ends internally - it is a matter of political culture.

When the Greek people realize that, they will then be better equipped to demand change in the roots not the leaves; in the institutions not the figures. In other words they will ask for stable rules, transparent public administration, lesser government intervention in their everyday life (thus fewer government failures), a fair tax regime, a truly secular state and above all, meritocracy.

What we now see as problems of the Greek society, namely the growing numbers of the homeless and the people in need; is only a fraction of the deeply political, cultural and existential crisis that the Greeks face.

Having said that, I am more than happy to see our friends across Europe and the world, showing their support. Philhellenism ("the love of Greek culture") has always been important for the Greek people across their history and as such it is more than welcome. However we must never forget that the Greek people themselves have the responsibility and the duty to demand and push for real change and deep reforms in virtually everything that is Greek. Progress comes from the actions of the individuals, from the subjects of history, the individual citizens. This is what we ultimately need to ask for.

Stop this anti-German madness!!!

2012-02-17T09:12:00.000+02:00

Anyone who has studied history, even on the surface, knows that the Hobesian dictum "bellum omnium contra omnes" - "war of all against all" holds true, especially when crises hit humanity. It is during such times that reason and rationality give their way to hatred and prejudices. The current systemic crisis of the euro could not possibly be an exception to this historical "rule". Ever since the crisis first hit Europe several interest groups tried to put the blame on a particular party for the misery that hit us. We all remember how the people of Southern Europe were depicted as "PIGS" and how certain purely racist and stereotypical beliefs gained popularity, such as the completely groundless assertion that the Greek people are "lazy", contrary to others who are industrious - even though the data is showing the exact opposite (see Common misconceptions about bankrupt Greece).

In countries mired in economic crisis, like Greece, there are similar beliefs gaining popularity currently. Europhobic and Germanophobic sentiments are spreading really fast. [ I highly recommend listening to this podcast of mine titled "Greek crisis and Greek pseudo-nationalism" to learn more on the broader issue. ] For some months now this hatred speech has given birth to equally racist rhetoric from the Southerners and others. Time and again the German people are depicted as "Nazis" and German Chancellor Merkel as "Hitler". A few days ago "The Greek Reporter" published the following provocative picture, claiming that it was originally published on "The Independent" (I could not find the original one), which speaks of itself, showing how racist sentiments are gaining momentum at a worryingly fast pace all across the EU.

This hideous picture is inspired by the work of Spanish painter Fransisco Goya "Saturn Devouring His Son"

My point here is not to search for the original publisher of the above or other similar pictures. Regardless of the origins of such images, the fact remains the same: Racism and counter-racism are making their way to the forefront of political talk. In my view this needs to stop immediately as it is a time-bomb seated in the foundations of the European Union and the common principles that now characterize our European societies. In our recent history we were led to bloodshed, mass killings, excruciating pain and untold suffering exactly because we were thinking of "the others" as purely evil, while "we" were the victims of their voracious appetite. No well-meaning human being wants to relive those dark moments of history, hence every single one of us who put reason above hatred, must stand up and say "NO" to this preposterous racism that threatens our societies.

Yes the troika might indeed be harsh on Greece, yes austerity alone is not a solution but a problem. But it is one thing to argue against bad policies and against the inanity of policy-makers; and it is another to dehumanize peoples, to use hatred speech, to put the blame on individuals or particular parties.

We as Greeks have nothing against the German people, just as the German people should have nothing against the Greek people. Same applies for all the other European nations. The crisis that we are facing in Europe is common. We are dealing with the same problem and the only way to get out of it without destroying ourselves and obliterating whatever we have constructed all these years, is to stand united and propose a coherent system-wide strategy to deal with the systemic crisis that we are facing.

As such STOP THIS RACIST MADNESS before it is too late!!!

Is the troika punishing Greece? Why?

2012-02-15T21:32:00.000+02:00

Ever since September 2011 or even earlier, we have all been experiencing a crazy rollercoaster ride, regarding the situation in Greece. Every day there is information made public about the "increased" chances of Greece defaulting on its debt obligations, or about a statement of an EU official or other top-ranked politicians which disturbs the overall balance by asking for greater efforts from the Greek government as far as the implementation of its bailout programme is concerned and so on. In short Greece (and we) have been living in an environment of high political and economic uncertainty, which has had all sorts of negative implications on the Greek economy and the prospects of the Eurozone as a whole to recover from its systemic crisis.

Characteristic of this uncertainty - this dithering to be more precise - is that the decisions of the October 26 European Council summit concerning the restructuring of the Greek debt (the so-called PSI programme) and the second bailout to Greece have still not been implemented, even though they were first expected to be completed many weeks ago. To anyone familiar with EU politics, these delays are more than expected, given that the EU is a very complex, lumbering entity that has very poor reflexes, since it is neither a confederation, nor a federation, nor a union of sovereign states; thus lacking a coherent way of acting. Yet there is more to the delay than just the "natural" way things are done in Europe. It has to do with a tough bargaining process that is being held directly between Greece and the troika of international supporters (EU, ECB, IMF) and indirectly between Greece, the troika and the rest of the EU, with extra focus on other countries mired in recession or under bailout programmes.

To begin with: Greece agreed to implement a harsh set of austerity measures back in May 2010, in exchange for the 1st bailout worth €110 billion, that would be given in several installments. The government undertook the responsibility to diminish its deficit, in order to stop producing new debts, while it also committed itself to privatize several entities that belonged (belong) to the public, or even close them down. Whether the Greek government should have signed such a deal is another issue, the point is that it took certain responsibilities towards the troika who provided funding for whatever reason that may be (to save their skins of course, any talk about EU "solidarity" and "partnership" is unreal). For reasons that relate to political culture, incompetence and opportunism, those governing Greece did not stand up to their signatures, failing to implement whatever the agreement included (listen to podcast Greek crisis and Greek pseudo-nationalism). As such the Greek government is no longer considered a reliable partner, hence much stricter conditions need to be envisaged for the ends to be met. In other words, the unreliability of the Greek government has exhausted the patience of other European partners and has made them much less tolerant on all issues concerned. The result is a much harsher treatment than necessary from the side of the troika.

In addition here is what I wrote in a previous article of mine about the factors leading to the Greek failure, which describes the indirect bargaining between Greece, the troika and the rest of the EU:

Greece was the first country to fall in the domino effect that commenced in 2008 and is still underway. For that the country has received most of the attention all these years, as it is (correctly) considered the weakest link in the euro chain. As such the treatment of Greece should "necessarily" have the following features:

The European Union needs to show that it does not violate its own rules - the no-bailout clause for instance, or the "prohibition" of debt monetization or eurobonds by the ECB.

Any support to Greece must be done in such a way so as to avoid moral hazard. In other words Greece must not be given away money which might seem like a "reward". Instead it has to be "punished" (though such a word will never be used officially) for not complying with the rules governing the Euro architecture.

The European Union needs to handle the situation in such a way that markets do not lose faith in its capacity to deal with its own issues. Therefore even if the situation in Greece deteriorates, it will be because of the "special" circumstances that apply to Greece - not due to the narrow-sighted troika policies.

For as long as the broader eurozone is facing its systemic crisis (listen to 30-minute podcast) Greece must not be allowed to default on its creditors as that would (a) trigger a payment of the CDS contracts, with negative implications for the financial system, (b) would mortally wound several European banks that are directly or indirectly exposed to Greek debt, (c) it would create uncertainty about the prospects of other countries mired in recession or under bailout programmes.

In a nutshell the troika is being quite harsh on Greece and there are some good reasons justifying its behavior, while others are completely ridiculous and unfair. The Greek people are suffering firstly because of the irresponsibility and incompetence of their governors, secondly due to the political interests that are involved in the handling of the Greek crisis, which extend well beyond the borders of Greece itself.

Regardless of what will be the outcome of this preposterous shadow play, two things are certain. First the Greek people will continue to experience the worst economic depression in the history of Greece. Second the eurozone will continue to disintegrate. In both cases responsibility falls on all sides and there is no point to put the blame on any particular party. What is now needed the most is collective action and a coherent strategy to deal with our common crisis, something which I am afraid is completely off the table, as policy-makers cling on to their inane policies that have done much more harm than good these last years.

A new Greece must emerge from the current existential crisis

2012-02-14T12:19:00.000+02:00

Greece has been at the focal point of international media, because of the ongoing economic crisis that has severely hit the country the last few years. Though the analyses of several experts and "experts" are centered around the economic aspect of the matter, I uphold that at the root of the crisis, as far its internal dimension is concerned, Greece faces an existential crisis - a crisis of identity. The Greek people were caught completely unprepared when the crisis hit them. They saw their world changing dramatically overnight, as the practices, mentalities and attitudes of the past had no application to the present. The Greek populace has still not recovered from this shock and has not yet realized that it needs to change as the world around it changes as well, something which is depicted in the inane general strikes and the "scorched earth" practices of some gangsters who think they will do harm to "the system" by burning the property of their neighbors; by ultimately harming those who suffer the most from the current crisis.

To understand why the Greeks face an existential crisis, one needs to grasp the macroeconomic dynamics that were initiated in the mid 1990's, before the introduction of the euro. The following can be helpful in providing the context (click to enlarge image):

In the years prior to the establishment of the currency union, the Greek sovereign could get loans from international markets at exorbitant interest rates, significantly higher rates than the perceived barrier of 6% or 7%. In comparison Germany enjoyed much lower rates that have remained stable over the long-run. This interest rate spread, this difference between the borrowing cost of Germany and Greece reflected two things (1) the difference in the competitiveness and productive capacities of these two countries, (2) the lack of real convergence between two countries that would soon form a single currency block. When the euro was introduced, the interest rates of Greece fell considerably, eventually converging with the German ones that had remained unaltered. In short the euro ensured cheap funding for the Greek government. And here is where it all starts.

The Greek state transformed from a semi-peripheral European economy into a core economy, by means of becoming a member-state of the eurozone. The convergence in interest rates was purely artificial since it was not the end result of reforms in the real economy, it was not the product of intensive efforts to modernize, minimize, rationalize the Greek state; it was not an accurate representation of any change in the productive capacities of the economy or its competitiveness. It only was a perceived convergence, resulting from the ill-thought policies of the European policymakers and the fraudulent accounting of Greek authorities.

To cut the long story short and without willing to explain the forces that led to this convergence, I say that this brought Greece into a new era; an era of cheap credit. All of a sudden oceans of liquidity were reaching the Greek shores on a daily basis, eventually propping up the consumption bubble that burst some years ago and led to the economic crisis we all know of. The cheap loans facilitated malinvestment, encouraged frivolous entertainment and provided perverse incentives to conniving plutocrats and unscrupulous politicians who realized that they could profit immensely from this perceived cornucopia, this infinite source of wealth, called the "eurozone". As such an ill-thought welfare state was built on sand which gave excessive benefits to several groups of people, while at the same time the public sector expanded both in terms of costs and powers; all this was happening in parallel to inflation in the real economy and problematic real growth that was eating in the muscle of the productive core of the country.

Protests in Athens. Image Credit (Yiorgos Karahalis, Reuters)

This was unsustainable and was naturally brought to an abrupt end, when the crisis hit Greece. It is here where the Greek people first experienced the shock, it is then when the identity crisis was realized. Instead of accepting that their life over the last years was nothing more than a fleeting dream, the Greek people reacted disproportionately asking basically for more of the same malpractices that led the country on the verge of bankruptcy. Time and again the once-privileged pressure groups went on the streets to demonstrate their opposition to the "machinations of the troika"; while Athens has often resembled a battlefield rather than a modern European capital, thanks to the Molotov cocktails and tear gas, of which Greece seems to have plenty of.

Greece must change bottoms-up. But this cannot be done in the offices of Greek bureaucrats or in the bowels of European institutions. For the country to enter the modern epoch on a very solid basis, the Greek people themselves need to realize that their world has ended. The catharsis must commerce from the lowest possible level all the way upwards, since it is the responsibility of every single citizen to make the country better-off. Instead of putting the blame on the troika or the Germans or the bankers or some other external forces that "conspire against the nation", the Greeks should look into the mirror and have the courage to criticize their own attitudes, practices and choices that brought them into this position.

A new Greece needs to emerge out of this crisis and this will be done when a populace, permeated by new ideas will demand change in the roots not the leaves; in the institutions not the figures; in the ideas not the words. The crisis will be killed off when Greeks decide or accept who they are and what they want, first and foremost from their selves.

The difference between economic and political fiscal discipline

2012-02-12T10:19:00.000+02:00

The European leadership considers fiscal discipline as the only realistic remedy to the systemic crisis of the euro. I have repeatedly stated my objection to the inflexible set of policies that are being forwarded by the EU elite. I have done so because I understand the profound difference between the political and economic forms of fiscal discipline. By analyzing the two distinct types of this concept I shall elaborate further on my objection to the plans of European decision-makers.

On the economic level, the phrase "fiscal discipline" sounds like a call for lesser government intervention, through the tightening of government spending, the control of budget deficits and the restriction of sovereign debt. It gives the impression that the set of measures, policies and principles that are enshrined in the new fiscal compact will "rationalize", "modernize" and "harmonize" the fiscal policies of all signatory states. In short the concept of fiscal discipline seems to fall within a free-market context, in its various emanations. As such my fellow Europeans, both those who believe in free-market capitalism and those who believe in a mixed economy, tend to consider the new package as "neo-liberal". I myself strongly disagree with such a conclusion, since there is nothing libertarian about the issue in question and this will become clear by expanding on the political (real) dimension of the matter.

The political side of fiscal discipline is very precise and specific. It has three features:

The fiscal compact will be the first step towards an ever-closer EU that will see a further erosion of national sovereignties for the sake of granting more powers to the EU's supranational institutions/bodies/agencies.
It imposes stricter rules on national governments, not for the sake of reducing state intervention in general; but of reducing only national government intervention, while increasing supranational intervention and control.
It follows the same Procrustean (mal)practices of the Maastricht Treaty that set the foundations of the Euro. In short the rationale of one-size-fits-all continues to dominate policy-makers, despite the lack of reforms in the real economy and the financial system; and regardless of the absence of real economic convergence that would allow for viable (de facto) harmonization.

In addition to the above three characteristics of the political (actual) fiscal discipline, the whole concept is the natural extension of the one-eyed approach certain powers have held vis a vis the crisis. It fleshes out the theory which advocated that the crisis in the eurozone is the end-result of excessive public spending, while completely omitting the situation in the real and financial economies, as well as the broader (flawed) institutional framework. Those who share such views neglect several aspects of the actual crisis in the eurozone, while they misread the facts and data available. In a nutshell they are dogmatic, rather than objective; and dogmatism is always harmful even if it seems prudent on the surface (see Monolithic fiscal discipline is not a solution but a problem).

Had fiscal discipline in the EU been about a reduction of state intervention in favor of genuine supply-side economics my approach would have been fundamentally different. Yet exactly because this proposal exists within a given political context and after taking into account the fact that no real reforms are being proposed on (a) the real economy, (b) the financial system, (c) the EU trade barriers and perverse policies, (d) the EU democratic deficit; I hereby restate my objection to the orientations of the European leadership.

EU elites are seeing the hole in the barn door and they are not looking at the barn door itself...

External and internal factors of the Greek failure

2012-02-07T18:52:00.000+02:00

Greece will have to be built anew otherwise more of the same malpractices
will continue to hinder the country's prospects. Image source: The Guardian

Greece has been missing one "critical deadline" after the other, without achieving any real progress on its troika programme. Ever since the European Council summit of July 21, 2011, when the first debt restructuring plan was agreed upon --- the so-called Private Sector Involvement (PSI) --- the Greek people have been the recipients of an unprecedented psychological war that sows the fear of bankruptcy/default every few weeks. The reasons Greece has been failing to cope with its troika programme can be divided into internal and external.

External factors:

Greece was the first country to fall in the domino effect that commenced in 2008 and is still underway. For that the country has received most of the attention all these years, as it is (correctly) considered the weakest link in the euro chain. As such the treatment of Greece should "necessarily" have the following features:

The European Union needs to show that it does not violate its own rules - the no-bailout clause for instance, or the "prohibition" of debt monetization or eurobonds by the ECB.
Any support to Greece must be done in such a way so as to avoid moral hazard. In other words Greece must not be given away money which might seem like a "reward". Instead it has to be "punished" (though such a word will never be used officially) for not complying with the rules governing the Euro architecture.
The European Union needs to handle the situation in such a way that markets do not lose faith in its capacity to deal with its own issues. Therefore even if the situation in Greece deteriorates, it will be because of the "special" circumstances that apply to Greece - not due to the narrow-sighted troika policies.
For as long as the broader eurozone is facing its systemic crisis (listen to 30-minute podcast) Greece must not be allowed to default on its creditors as that would (a) trigger a payment of the CDS contracts, with negative implications for the financial system, (b) would mortally wound several European banks that are directly or indirectly exposed to Greek debt, (c) it would create uncertainty about the prospects of other countries mired in recession or under bailout programmes.

The troika officials are focusing only on the fiscal finances of the state without any real concern about the effects of their policies on the real economy. For instance they only ask for the reduction of the budget deficit even if that requires unprecedented tax hikes that increase costs, decrease demand and create uncertainty about the tax regime, hence new investments are held back.
European politicians who will soon be running for elections, have found an easy victim in Greece that they can attack in order to raise their "popularity". As such many have "threatened" to kick the Greeks out of the euro in case they do not comply with what "leaders" say, even though that will never happen (see Greece will not exit the Euro - Groundless threats and speculation).

To conclude on the section of the external factors, Greece is trapped in --- or is part of --- a highly complex political system, namely the EU. For as long as this system lacks all those mechanisms/institutions/tools that would allow it to function as a unified entity, instead of the now-sectarianated patchwork of squabbling states; the situation will remain extremely difficult and more failures will definitely follow.

Internal factors:

For reasons that go far beyond the scope of this article, the Greek state has always been ill-designed. The public administration of the country is very big and highly inefficient, while the resulting bureaucracy creates several problems:

It retards economic activity as even routine procedures require considerable time to materialize.
"Fakelaki" and "miza" (Greek words for corruption payments) become the only way for citizens to get their job done. As such corruption becomes a "vital part" of the broader political system.
Because political parties and the main body of the state's public administration operate in Athens, the Greek state has gradually become Atheno-centric, since exponentially more powers are brought to the capital, leaving the periphery underdeveloped and thus the country less competitive and productive on aggregate.

Decades of ill advised policies have created series of distortions in the economy, in the political system and the social order; while they have produced perverse incentives that lead to several unpleasant phenomena - such as the ongoing strikes of civil servants or special interest groups who wish to cling on to their privileges; or a highly ineffective and unfair tax system that puts the burdens only on the lower parts of the income distribution; or even economic cartels that do not wish to see their state-sponsored monopolies/oligopolies be liberalized (professional drivers, pharmacists, public universities etc.).
Greece entered the EEC in 1981 even though it never complied with the criteria. The decision back then was political and had to do with the balance of power between "West - USSR" in the broader region of the Balkans and the Eastern Mediterranean. Nonetheless, the European funds that suddenly started flowing in to the underdeveloped country, gave the impression that the European Community is a cornucopia, an infinite source of wealth that will be feeding the Greeks for decades to come. In short Greece started growing (not a robust growth, but a bubble really), without making any reforms in its economy and state. As such the European funds ended up in unproductive expenses, instead of improving key sectors of the economy, or accumulating technology and other industrial goods that increase productivity.

Conclusion:

Decades of malpractices cannot change within a few months, especially when several interests are involved. For Greece to escape from the greatest economic crisis of its history the entire Greek polity will need to be redesigned. This requires deep reforms in the economy, so that individual genius replaces bureaucratic interventionism; changes in the internal structure of the state, allowing peripheries to control considerably more power that will allow for balanced growth all across the country; modernization of the public administration so that procedures become fewer and faster and costs diminish.

The Greek nation will have to be constructed anew. The problem is that the Greeks are not willing to accept that, while the inane policies of the troika are only making things worse, as the crisis deepens, thus supporting the (insane) idea that Greece would be better off outside the Euro. The Greek failure represents a conundrum that none seems able to solve.

Monolithic fiscal discipline is not a solution but a problem

2012-02-06T16:33:00.001+02:00

The greatest fallacy of our times is the belief that the crisis is caused by the lack of fiscal discipline.

The fiscal compact, the new international treaty that will impose stricter budget rules on its signatory states, is considered by many as the only realistic solution to the ongoing crisis. The political forces pushing for the ratification of this treaty have identified the causes of the crisis in the excessive fiscal finances of some states. They advocate that the debts/deficits of Greece, Ireland, Portugal, Italy and Spain are what create uncertainty about the integrity or even the viability of the eurozone. Though it is an undisputable fact that certain fiscal finances were/are not in good shape and could indeed be the weak spot of the euro edifice, the assertion that these alone have brought us to this point is misleading as it omits several parameters of the actual crisis, while it completely neglects the dynamics in the real economy and the financial sector, clinging only to a few fiscal indices - which by the way show little and mislead a lot as they are imperfect macroeconomic aggregates.

Had the discussion been about the role of the state in the economy, or the ideal degree of government spending, it would indeed make sense to speak of fiscal discipline. Yet the eurozone is much more than a laboratory "optimal currency area", whereby academics can apply their theories under ceteris paribus conditions. The eurozone is a very complex and dynamic system as:

It is a currency union without a fiscal union backing it - this is unique in capitalist history.
It encompasses 17 nation-states with diverse economic models, public administrations, cultures and political systems. Thus it is not a unified entity by any measure, economic, legal, social or political.
It is influenced by the broader EU architecture, which is in itself a sui generis entity; while it is also connected to the world economy and the dynamics of international trade.

The above would have been enough to suggest that no easy answers exist along these lines. Hence no one-sided proposal, such as the monolithic fiscal compact, could possibly be an effective remedy. Yet there is much more to the argument than abstract observations of the essence and form of the eurozone, since real world facts also are against the arguments of the narrow-sighted acolytes of fiscal discipline.

In particular, the current crisis, started as a financial crisis in Wall Street which spread to the European financial system. The super-speculators of Wall Street proved to be much less greedy than their European counterparts, since at the time the leverage ratios across the eurozone where significantly higher than those across the Atlantic. When the average leverage ratio (debt to equity) in Wall Street was approximately 30/1, in Europe it was around 50/1. Had European banks been austere and conservative, they would have never fallen into such a crisis, which brought the need for massive bank bailouts that have been taking place ever since 2008 either directly or indirectly (and of course when a state finances its banks on a massive scale, it can fall on a debt crisis itself - a vicious cycle).

Moreover countries like Ireland or Spain who have been seen as members of the "PIIGS", had impressive fiscal finances prior to the collapse of Wall Street, yet these failed to protect them from the negative dynamics of the crisis. For instance the public debt of Ireland was a mere 24.9% to GDP in 2007 and 41.8% in 2008 when the crisis came in. Also its government budget was either on surplus or on ancillary deficit prior to 2008. Similar story for Spain, which had better fiscal finances than Germany before the crisis. These two countries are enough to suggest that fiscal finances alone, do not mean much, when a crisis of such proportions hits us. So why did these two countries fall into trouble since their finances were in good shape? Ireland had to bail out its private banks, who were seriously hit by the financial crisis, while Spain suffered from the collapse of the housing bubble and from rigidities in its labor market. In short the financial and real economies of these two countries were the source of trouble, not the state's finances.

The logical conclusion here is that if a fiscal compact with automatic sanctions - that is with extra costs on states in recession - existed prior to 2008 it would have failed to control the situation, while it could easily make things worse. The gist is that the economy is a complex system and the eurozone an even more complex entity. To find solutions one needs to take into account all parameters. Failing to do so, implies an inability to see the whole picture, or a dogmatism that verges on being dangerous for the common good of the Eurozone.

With these and many other secondary issues in mind, I maintain the view that the monolithic fiscal discipline that is being propagated as a solution to the crisis, will fall short of its expectations. Only when European leaders start thinking outside the box will they find a viable solution for the benefit of all Europeans - and indeed the whole world.

My podcast series

2012-02-05T12:46:00.002+02:00

In case you have not noticed I have incorporated a podcast on my website. A podcast is a series of rich media files (audio in my case) that are disseminated across the internet using feed technology (RSS). In short a podcast is just another means of expressing yourself.

You can view all my podcasts either my navigating through the horizontal menu bar below my site's header, by clicking on the tab "Podcast" or by visiting podcast.protesilaos.com

I have just published a new episode titled "Introduction to the systemic crisis of the euro". In this 32-minute speech I provide the outlines of the systemic crisis of the euro. The idea underpinning this analysis is that the architecture of the euro, the design of the "system" is the root of the problem. I speak about the three facets of the crisis that we are dealing with in the eurozone, namely (1) sovereign debt crisis, (2) banking crisis, (3) real economy crisis.

You may listen to it by clicking here. In addition you can subscribe to the podcast series here.

Greece will not exit the Euro - Groundless threats and speculation

2012-01-29T09:18:00.000+02:00

Greece will never exit the euro nor will it ever be forced out. Image source: Herald Sun

The negotiations between Greece and its private creditors for the restructuring of the sovereign debt are continuing and are expected to be successful within the next few days, even though "success" is a very relative term when speaking of the worst economic crisis in the history of the Greek state (a history very rich in defaults and crises). Personally I have always been against the whole process, the so-called PSI programme, since I believe that it does nothing to make the country's national debt economically and socially sustainable. As if the PSI was not enough, another far worse proposal was published in the Financial Times, which asks for "Absolute priority to debt service" and "Transfer of national budgetary sovereignty".

If we accept that what FT published is actually on the (secret) agenda of some political powers, then three are the logical explanations I can come up with at this point:

this maximalism is part of a psychological war, within the context of tough bargaining, in order to make the current draconian measures acceptable in the Greek interior.
it is propagated by certain interest groups who wish to speculate against Greece by spreading rumors of an exit from the eurozone
it is indirectly addressed to other peoples who are protesting against harsh austerity, by "making an example" of Greece

For now, since this is just a publication of an (esteemed) newspaper I shall not expand on that preposterous proposal for it might never become open and official. Instead I shall attack the speculation that it has already fueled about a default of Greece in March, followed by an exit from the Eurozone (for the economic implications see Analysis: Exit of Greece from the euro is collective suicide).

Greece cannot be forced out of the eurozone nor can it voluntarily exit the eurozone. There is no legal mechanism, no matter the circumstances that gives power to other member-states to decide on such an issue. In fact the Lisbon Treaty is so restrictive on this matter that not even Greece itself is allowed to exit the eurozone, except if it wishes to exit the European Union altogether (under Article 50), which is a wholly different issue. Greece will never consider the option of exiting the EU as a whole, since that would be a debacle for the whole country in the extremely hard situation it finds itself.

Since Greece cannot be forced out of the euro nor can it leave voluntarily and for as long as the exit from the EU is completely utopian, then why is all this being discussed? Why do we read all the time lengthy articles about the "possibility" of a forceful euro exit, or why do we hear several politicians, market speculators and opinion makers speak about the matter?

The answer to these and other relevant questions is rather simple. These are all groundless threats which are very beneficial for those who express them. Let me be clear:

Populist politicians exist everywhere and are perfectly willing to repeat whatever nonsense might make them more popular. In some countries Greece was depicted as the "profligate child" of the Eurozone - as the country which is largely responsible from the situation in the whole Euro area - even though this is completely detached from reality as it omits the structural flaws of the euro itself, the malignancies of the European banking sector in conjunction with the maladministration of EU policies and trade barriers. Nevertheless these politicians need to show that they listen to their voters by showing their "iron fist", which can be used "to kick the Greeks out of the euro".
This story is very profitable for the established media. It provides an infinite source of ideas that are "analyzed" in articles or tv/radio shows. In addition all the discussion around this myth creates gossip and interest for more information on the matter. In short it creates a cycle that brings in a lot of cash to established mass media.
Speculators also love such kind of stories. Of course they never say that they are willing to make a small little earning for their selves, but they put forward their expertise to propose what is "good" for Greece and the eurozone as a whole.
Academics and other economic "guru" are also sufficed by the story. They use the "option" of the exit from the euro, to justify their otherwise inane theories and outdated beliefs.

I could go down the line to demonstrate how many interests are involved in the cultivation of the Euro-exit myth, but I believe my point had been made clear. We are dealing with groundless threats, wild delusions and unbridled speculation. Greece will not exit the euro for as long as it needs to exit the whole EU. Nor will there ever be such a forceful exit because it is legally impossible, but would also constitute a very bad precedent, eventually opening up the Pandora's Box for the collapse of the eurozone.

The money printing bonanza of the ECB will not end well

2012-01-27T20:45:00.001+02:00

I have long now been saying that the European Central Bank has been producing oceans of money (out of "thin air" of course), creating artificially low interest rates for sovereigns, at the expense of liquidity in the real economy. Thanks to its loose monetary policy, under the LTRO and the SMP, in conjunction with the bank recapitalization programme, private banks have been buying sovereign bonds of Italy, Spain and France en masse, pushing interests rates for governments well below the normal rate.

Before proceeding into reviewing the policy of the ECB, I need to show the following chart, which compares the assets of the ECB with those of the Fed, which has by the way been openly engaging in unprecedented quantitative easing for quite some time now.

The balance sheet of the ECB is exploding. Image Source: Zero Hedge

Debt monetization has long now been among the top demands of several power groups, from political parties to market interests. The principal idea being that by relaxing its monetary policy, the ECB would buy enough time for the hardly-pressed euro-states to carry out all the necessary reforms. And indeed it is true that by creating artificially favorable market conditions for sovereigns to issue debt (draw loans) the ECB has alleviated much pressure. Hence as far as the aspect of time is concerned, the now-relaxed monetary policy, seems to fulfill its function.

However this is miles away from saying that the policy is successful overall, for two very specific reasons:

The (unreal) loanable funds remain scarce, meaning that not everyone will be able to get the desired amount. In other words, the demand for money is greater than the supply. Two are the sources of demand for loans: (i) states, (ii) individuals. Currently banks have a greater incentive to give loans (buy bonds) to sovereigns, firstly because they can use the bonds as part of their Core Tier 1 capital to comply with the new capital ratio requirements by June 30, 2012; secondly, individuals are considered much riskier than states, because of the high uncertainty in the real economy, deriving from the ongoing stagnation/recession, in contrast with the "risk-free" government bonds.
Individuals are facing decreasing revenues and increasing pressures to pay back whatever debts they may have. The economy is now in a recession, suggesting than strong demand will not come in the following months. To cope with this increasingly hostile economic environment, firms are in need of fresh cash (loans), to finance their activities. If firms can survive, then unemployment can also be contained and supply-led growth can gradually kick in. If they fail to do so, then bankruptcies accompanied by an increase in unemployment, will certainly follow.

Because states and individuals are both opting for the limited amount of loans available at the same time and because banks discriminate in favor of states, for their own reasons, we have already starting witnessing the following effects:

interest rates for sovereign fall since demand for their bonds has increased spectacularly, as banks have been rushing in to secure their newly-acquired money (as well as new loans from the ECB) and fill in their capital gaps ahead of the recapitalization programme,
interest rates in the real economy have been increasing since the amount of funds that is available to individuals is far less than the actual demand - excessive demand means higher prices,
the above two effects create the "perfect" conditions for large scale malinvestment, since resources are taken away from productive activities to fuel a cycle of artificial "economic activity" between bankrupt states and quasi-bankrupt banks.

With these in mind, we can return to the argument about buying time to save the system. Yes it is true that the collapse is postponed, but the fundamental cost is borne by the society at large, while the productive capacities of the economy are being diminished, suggesting that in the long-run, real economic growth will be weaker. All this will bring more debt, prolong stagnation and at some point inflation will kick in, to eat in the savings of the middle class.

Money printing bonanzas do not end well and this will not be an exception, especially since it is being followed all across the globe.

Merkel is correct about Eurozone reforms - But which reforms?

2012-01-26T11:29:00.000+02:00

The policies of Merkel do not align with her rhetoric. Image Source: Flickr

In her speech at the World Economic Forum in Davos, German Chancellor Angela Merkel said among others the following (from euronews):

Do we want coherence without ambition? If we do, we will meet somewhere in the middle. Or do we want to see who is best and try to do like the best in Europe, so we have a chance to play a role on the world markets?

Merkel points out a reality that sooner or later the European Union will have to face. Indeed reforms are necessary if the EU is to overcome the crisis and have an important role to play on the world economy, in the decades ahead. Any objective European citizen, regardless of ideology knows, at least unconsciously, that the current EU architecture is unsustainable over the medium to long term. As such the ongoing crisis is perhaps a unique opportunity to push for all those necessary structural reforms.

Though a broad consensus among diverse political groups could be reached over the need for change it is doubtful that the same will hold true once the objects of reform are put on the table. In other words what is that needs change? Which are the areas of policy that are problematic? What sort of beliefs, ideologies and mentalities underpinned the practices that brought us to this point? These and many others are the kind of questions that Merkel and the rest need to answer.

However, judging from the ongoing negotiations on (a) the fiscal compact, (b) the ESM, (c) the second Greek bailout; it seems to me that the kind of "reforms" Merkel spoke of are nothing more than a reshuffling of the same sort of (mal)practices that have brought the EU in general and the Eurozone in particular to its knees.

Let me be precise and specific. The negotiations are based on the mindset that gave birth to the Maastricht Treaty, the Stability and Growth Pact and the Euro. It maintains the following "principles":

No debt mutualization. National economies remain perfectly partitioned, in legal terms, despite the existence of a single market, single currency, and increased harmonization in other economic areas. In other words every single state is held solely responsible for asymmetric shocks even if those are caused by the structure of the system itself.
No genuine fiscal union. Fiscal transfers, i.e. a credible set of mechanisms to rationally recycle accumulated surpluses into deficit regions, is completely out of the negotiations. So is a common treasury, with powers to raise revenue and issue bonds of its own.
No deficits. All economies must maintain current account surpluses, following the paradigm of Germany/Netherlands, or must always strive to reach that goal. This is pure fallacy from beginning to end even using simple arithmetic, since the surpluses of one country will necessarily constitute the deficits of another. For instance Germany cannot have a surplus vis a vis the rest of the Eurozone, while at the same time the Eurozone has a surplus with respect to Germany. This is impossible. As Dutch econometrician, Thomas Colignatus once told me in an interview "[the IMF] wants all countries to become surplus exporters with somewhere some magic deficit hole".
Continuation of political status quo. The democratic deficit and the political complexity of the EU are not taken into account. It is well known to anyone who has been following EU politics that one of the main reasons behind the inability of policy-makers to draw a line under the crisis, is the multi-faceted complexity of EU decision-making, where the citizen has minor to no impact. Decisions are made behind closed doors, completely detached from the needs and desires of the average European entrepreneur, worker, consumer, voter. The political dimension of the economic crisis is not addressed at all.
No failures - no deflation. Massive bailouts, both direct and indirect, have been given to private banks and sovereigns (and there are more to come) with the sole purpose of preventing the natural failures from occurring. The goal is to maintain the current order of course, since failures on a large scale will have a cathartic effect, which is not good for those who wish to preserve the system. In other words the ends are political and serve some particular (big) interests. In addition the economic theory that underpins this support for bailouts argues that deflation is a purely bad thing. What they miss though is that deflation in the midst of a crisis is a natural part of the business cycle and functions as a shock absorber that eventually kills off the crisis (see Deflation, haircuts and the ECB printing money to prevent them).

In addition to the above no serious reforms are being proposed with respect to other core EU policies. For instance the Common Agricultural Policy is a paragon of irrationality and malinvestment, yet it remains practically untouched, just because it favors certain cartels.

The purpose here is not to point out, one by one the flaws in the current architecture. My argument is that the rhetoric of Chancellor Merkel, which calls for reforms, does not align with her actual policy proposals. And this applies to several politicians, not just Merkel. The gist of the discussion is that the EU is in desperate need for reforms, yet those are nowhere to be seen in the months ahead. The EU requires drastic changes in the architecture of the Euro, in its "social" and "growth" model, in its institutional framework, in the way decisions are made.

The EU needs to implement healthy free market regulations that allow space for individual initiative and creativity, while at the same time ensure more transparency, accountability of policy-makers and real democracy, so that every policy is made "of the people, by the people, for the people". These are the real challenges for Europe and not how to "play a role in the world markets". When policy-makers realize this profound difference between the real world and the "markets", our lives will be improved, otherwise expect more of the same practices that benefit the political and economic oligopolies.