Satyajit Das: New & Old Greek Lessons

By Satyajit Das, a risk consultant and author of Traders, Guns & Money: Knowns and Unknowns in the Dazzling World of Derivatives

Contained Again…

The language is reminiscent of the start of the sub-prime mortgage problems. The problem is “small” and “contained”. Despite the “solution” announced by the European Union (“EU”), the problems of Greece have deepened.

Greek borrowing costs have increased sharply. Greece now must pay around 4.00 % p.a. more for their debt than Germany, the most creditworthy EU borrower. That is, if anyone will lend to them. This is a rise of over 1.00% p.a. over the last few days and roughly a doubling of the margin since January 2010.

Recent Greek debt issues are now deep under water. The most recent attempt by Greece to raise money was substantially under subscribed, proving almost as popular as Ebola fever and. This combined with the day-to-day volatility of the risk margin for Greece makes it difficult for traders to price and investors to commit to purchases of Greek securities.

Greek banks are now experiencing difficulties in funding in international markets and have been forced to seek government support.

Greek Salad…

Greece’s immediate problem is one of liquidity – it must find cash to roll over existing debt. Greece needs around Euro 50 billion in 2010, of which around Euro 25 billion is needed by June. With characteristic insouciance, Greek officials have assured creditors that they are fine till end April 2010!

Unfortunately, the Greek problems run far deeper. Beyond 2010, Greece needs to re-finance borrowings of around 7%-12% of its Gross Domestic Product (“GDP”) (around Euro 16 billion to Euro 28 billion) each year till 2014. There are significant maturing borrowings in 2011 and 2012. In addition, Greece is currently running a budget deficit of over 12% that must be financed. Greece total borrowing, currently around Euro 270 billion (113% of GDP), is forecast to increase to around Euro 340 billion (over 150% of GDP) by 2014.

Greece’s problems were inevitable. Like many of the economically weaker EU members, Greece fudged the numbers to meet the qualifications for entry into the Euro. One example of this is the use of derivative transactions with Goldman Sachs to disguise the level of its real borrowing.

Membership of the Euro resulted in Greece losing its costs competitiveness. The sharply lower Euro interest rates set off credit driven a real estate boom and chronic over-borrowing.

Membership of the Euro also reduced the ability of Greece to manage its economy. It lost the ability to use its currency, via devaluations, to improve competitiveness and stimulate exports. It also lost the ability to set interest rates (now set by the European Central Bank (“ECB”)). It also cannot print its own currency to fund sovereign borrowing.

Greece also has low levels of domestic saving and is heavily reliance on international capital flows.

The current episode exposed an underlying weak and unbalanced economy with few sustainable competitive advantages. It has also exposed poor political leadership and inadequate financial controls.

Stephen Jen, a former economist at the International Monetary Fund, told the New York Times on 8 April 2010, that: “This is no longer about liquidity; it’s a solvency issue.” The language was eerily similar to statements earlier in the global financial crisis (“GFC”).

Pouring Olive Oil on Troubled Finances…

In March 2010, after protracted and acrimonious negotiations, the EU and International Monetary Fund (“IMF”) announced a “bailout” package. The flowery rhetoric of “familial” duty and EU “unity” was taken at face value by gullible investors who assumed that the problem was “fixed”. In reality, despite changes announced in April, the package is highly conditional and does not address core issues.

The now Euro 40-45 billion package (up from the original Euro 22 billion) proposed may still fall short of the Euro 50-75 billion that Greece needs at a minimum to get through the immediate future.

The package requires that Greece must exhaust commercial debt market sources prior to accessing the package. The aid requires “unanimous” agreement amongst the EU members. All money will be provided at market rates, rather than on concessionary terms (although under new proposals full market rates will not be used). The entire package requires IMF participation, which limits the amount of any bailout package and also makes it conditional on Greece meeting the Fund’s stringent economic prescriptions. Germany’s original support was also conditional on enacting changes in the EU framework to tighten control over future bailouts of this type.

The poor design of the “bailout” package is evident in the fact that it assumes that the announcement will cause Greek risk margins to fall to the level prescribed under the “bailout” funding. If it does not and remains above the 3.00% p.a. agreed, then Greece will have no incentive to fund in capital markets and will need to access the package.

The position is exacerbated by Greek’s indifferent attitude to its current problems. For much of this year, the Greek government insisted that it did not need and had not asked for any help. Lack of transparency about the level of debt, actions taken to deliberately disguise borrowings and generally poor information about public finances has presented an increasingly unfavourable image to foreign investors and international agencies. Greece appears unwilling or unable to meet the draconian conditions prescribed.

Greek fund raising has bordered on the farcical. Earlier in the year, Greek officials hinted at Chinese purchases of Greek debt, which was promptly denied by the putative investors. Most recently, seeing its problems as one of marketing and branding, Greece proposed to re-position itself as an “emerging country” borrower, rather than an advanced EU member. As one wag pointed out, “submerging country” would be closer to the reality.

Earlier in the year, the Deputy Prime Minister of Greece blamed Germany for it troubles: “They took away the gold that was in the Bank of Greece, and they never gave it back. They shouldn’t complain so much about stealing and not being very specific about economic dealings…” The Greek version of “How to win friends and influence people” did little to endear them to potential saviours or investors.

Beyond saving…

Greece’s problems are probably incapable of solution and terminal. Temporary emergency funding may help meet immediate liquidity needs but do not solve fundamental problems of excessive debt and a weak economy.

Orthodox economic theory suggests that the Greeks must cut government expenditure and raise taxes to reduce its stock of debt. But the government is too large a part of the economy and the suggested austerity measures will put the economy into a severe recession. In turn, this will drain tax revenues making it difficult to reduce the budget deficit.

Greece has limited opportunity to grow or inflate itself out of the problem. Without the ability to devalue the currency, Greece cannot address its fundamental lack of competitiveness quickly. The narrow economic base, primarily agriculture, tourism and construction, further limits options.

Greek’s level of indebtedness may already be too high. Kenneth Rogoff and Carmen Reinhart in their survey of financial crises “This Time It’s Different” argue that once the debt of a country goes above 60-90% of GDP, it acts to restrain growth. Greece’s high levels of debt mean that interest payment now total around 5% of GDP and are scheduled to rise over 8% by GDP. Rising interest costs will only worsen this problem.

High levels of sovereign debt are sustainable where three conditions are met. Firstly, the debt is denominated in its own currency. It is helpful if the currency is also a major reserve currency, an advantage enjoyed by the U.S. dollar. Secondly, there is a large domestic saving pool to finance the borrowing, such as exists in Japan. Finally, the country possesses a sound and sustainable economic and industrial base. Greece does not meet any of the above criteria.

There are no more easy solutions to Greece’s problems. Deep spending cuts, higher taxes and structural reforms will curtail growth. If Greece is unable to finance its debt or elects to default and exit the euro, then Greece will become isolated and enter a period of forced economic and financial decline.

The likely social and political consequences are extremely severe. They point to the real issue – Greeks have lived unsustainably beyond their means and now must face a sharp reduction in living standards.

Greek Lessons…

Ironically, the optimal course of action for Greece may be to withdraw from the Euro, default on its debt (by re-denominating it in a re-introduced Drachma) and then undertake a program of necessary structural reform.

Lenders to Greece would take significant writedowns on their debt, reducing its debt burden and give it a chance from emerging as a sustainable economy. The current debate misses the fact that the “bailouts” are mainly about rescuing foreign investors. These investors were imprudent in their willingness to lend excessively to Greece assuming EU “implicit” support and are now seeking others to bail out them out of their folly. As Herbert Spencer, the English philosopher, observed: “the ultimate result of shielding men from the effects of folly is to fill the world with fools”.

Such default would not affect the Euro. Many countries have defaulted on their U.S. dollar obligation without any effect on the currency.

Much depends on the politics of the EU and the attitude of Chancellor Angela Merkel and succesors who is more Deutschland centric than her predecessors. Support for Greece may depend on her judgement of ordinary Germans’ willingness to aid its Club Med neighbour and the risk of future claims on the German taxpayer.

The chance of a clean and logical solution is minimal as the EU may mistakenly try to defer the inevitable. Greece may face a future of a “rolling crises” and stopgap measures, much like Argentina from 1999 until its eventual default in 2002.

Greece highlights a few new and old truths about the GFC. The level of global debt has not been addressed. Sovereign debt was substituted for private sector debt. As trillions of dollars of private and government debt matures and must be refinanced, the next stage of the process of de-leveraging will play out. Vulnerable borrowers, such as Greece and earlier Dubai, highlight this risk.

The problems of contagion in highly inter-connected economic and financial systems have not abated.

As at June 2009, Greece owed US$276 billion to international banks, of which around US$254 billion was owed to European banks with French, Swiss and German banks having significant exposures. What happens in Greece is unlikely to stay in Greece creating new problems for the fragile global banking.

Greece’s problems have also drawn attention to the looming financing problems of other sovereigns. In a world with significant reduced liquidity, the strain of funding these requirements is likely to restrain growth prospects.

The EU bailout of Greece would require the participation of Spain, Portugal and Ireland (the other three members of the debt laden “PIGS”) further straining their weak finances.

The bailout would also merely transfer the problem from the “weak” economies to the “stronger” European countries. In a nice irony, the EU attempts to ensure “financial stability” through the bailout increases the risk of longer-term “financial instability”.

The Greek bailout also has interesting parallels to the shotgun marriage of Bear Stearns before the precipitous collapse of Lehman Brothers.

Iceland’s problems brought forth creative headlines – “Iceland Erupts”, “Iceland Melts” and “Geyser Crisis”. The common refrain this time has been about the “Greek Tragedy”. The term describes a specific form of drama based on human suffering, rather than anything Athenian. But it seems this Greek tragedy may be coming soon to a location near you in the new phase of the GFC.

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  1. AK

    It’s very strange article. It adds nothing to what has already discussed here in the last few days. Looks like author read the discussions and decided to rephrase them somewhat.

  2. Kevin de Bruxelles

    I agree that Greece should default in one way or the other. The part I am not sure about is their withdrawing from the Euro. I know the standard way of thinking is that having a weaker currency would make them more competitive; but as Vinny has been pointing out over the last few days, the Greeks are not particularly interested in becoming “mini-Germans” and start making lots of stuff for export.

    Wouldn’t another solution be that the Greeks default and stay in the Euro? The problem has been that joining the Euro has allowed the Greeks to temporarily enjoy close to a German standard of living without putting in a German amount of effort. So the way to redress this imbalance is that the Greek standard of living would fall back to a level commiserate to the amount of effort they put in. This would happen either way but staying in the Euro would mean fewer dislocations and less chaos for everyone.

  3. gronk

    Yawn, yawn, yawn. Greece’s problems will be over as soon as they get better at collecting taxes. There’s 97 billion dollar parked at unnamed luxembourg and swiss bank accounts, all of it black money. Two thirds of the population don’t pay taxes or a far lower amount than they should do. If greece fixes that, there’s almost no need for ‘austerity’ and ‘deflation’.

  4. sunny129

    Greece’s problem is not liquidity but insolvency but also negatively affecting balance sheet of Banks in France, Germany and Switzerland.

    By kicking the can down the road,this infectious virus’ has been put in festering mode for the time being. Long term effect on Europe is anything but good.

    Just like the policy of ‘Pretend and Extend’ here, they all are hoping to put it on back burner to become some one’s else headache.

  5. steve from virginia

    The issue is for Greece to export more. This by virtue of devaluation of some kind or other, ether a devaluation in a new Greek currency or by wage/price ‘internal’ deflation/austerity. This would allow Greece to ‘export’ some cheap, Greek labor to other Euro countries to compete in the ract to the bottom with cheap Hungarian, Irish, Portuguese and Latvian labor.

    The latter is clear from all economic standpoints to be self defeating; see Michael Hudson.

    At the same time the export of Greek goods is unlikely with that country having little to export as it is not an industrial economy. Ironically, Germany and the other ‘thrifty’ Europeans have been the beneficiary of increasing Greek imports along with Middle Eastern energy suppliers who are never given mention in economic reports on the Greek dilemma.

    If Greece cannot export more, it must import less, beginning with its energy consumption which is treated everywhere as an untouchable sacred cow. Greece needs to cut its energy imports by at least 10% and shelve the means of wasteful consumption beginning with automobiles. This would mean far less imports from Germany, Spain, Italy and France whose auto exports to Greece are the primary enablers of Greek insolvency.

    Such default would not affect the Euro. Many countries have defaulted on their U.S. dollar obligation without any effect on the currency.

    The only dollar default that would effect the dollar would be a dollar default within the US. A euro default within the Eurozone would certainly effect the euro, how could it not? The euro does not exist in isolation but against other currencies particularly vis the dollar and what can be obtained by use of the two currencies.

    It also depends what you mean by ‘effect’! For the dollar is becoming as scarce as nuggets of gold laying on a sidewalk. The dollar scarcity reflects is increasing hardness and the desire of dollar holders to hang on to them at all costs.

    Likewise, the pseudo- bailout or ‘Shadow Bailout’ of Greece illuminates the dollar’s strength – now in its infancy – pegged to crude oil, not just one of many reserve currencies but soon to be THE reserve currency.

    Welcome to 1931!!

  6. Panayotis

    The author of this article knows very little about Greece and his analysis is an exxageration of the problem. There are two main problems. First, there is a huge tax evasion where 405 of GNP goes unreported. Second, the private sector is unproductive but not because of high wages but brcause of lack of investment and low quality products. Greek entrepreneurs prefer to import and retail than produce their own products. The strong euro is not helping. However, the private sector is wealthy, net saving with low private debt and over 300 billion euros invested abroad. The government can finance its deficit by borrowing from the Greek private sector and collct more taxes due. The Greek banks are in good shape and do not carry much structured products. There is a need for debt restructuring with a hair cut and lower rates and use of EU cohesion funds(29 billion euros are alloted for Greece) for growth. Investment nad return of Greek human capital from abroad must be favored which is highly competent and qualified. The rest of you that are making demeaning comments, there is a Greek saying which I wont repeat….

    1. Sid Finster

      True that if the Greek government could simply collect income taxes more effectively, this discussion would become moot. No need to change any laws or bailout anything, just enforce existing laws.

      The problem lies in doing so. If only it were just a matter of decreeing “Let the Law Be Obeyed!”

    2. Captain Teeb

      I don’t argue with your first point.

      Regarding tax collections, I think that Mr. Das would respond that better tax collection would remove money from the consumer economy and thus depress private-sector activity, which would in turn reduce tax receipts (even if taxes are collected properly).

      Regarding the private sector, suppose you were a rich Greek with, say, 10 million to invest. Would you risk it on Greek bonds, which could default (or be forcibly switched to a new drachma)? Or would you get your money out of the country, just to be safe? And if you bought Greek bonds, what interest rate would you need to make it worth the risk?

      The real problem is that, once you are in this situation, there are no easy answers. The best method is to stay out of the situation in the first place, but modern social-welfare democracy seems to have a hard time thinking for the long term.

  7. Mickey Marzick in Akron, Ohio

    It matters little whether it’s Greece, Western Europe, or the United States, for the past four decades the standard of living has increased at the same time that the “real economy” has been scaled back and/or relocated offshore, undermining the foundations on which this standard of living was predicated. Funded by ever increasing mountains of private and public sector debt, the “bill” is now said to be coming due. Or at least the debt collectors are starting to make their rounds… IMF AUSTERITY is nothing new. But now it’s US who will be the victims of the IMF scalpel. So it’s different now… An accurate assessment of the what is deemed to be the writing on the wall? Yes – no?

    But a choice has to be made: either we remain hostage to the capitalist mode of thinking in which DELEVERAGING and AUSTERITY become the order of the day with their attendant social dislocation and human misery, in effect making the world safe for capitalism, or we realize that capitalism is obsolete insofar as scarcity of the basic goods and services fundamental to human life are no longer at issue in most developed countries in North America, Western Europe, and Asia. It is no longer a question of producing enough but rather of producing it within a capitalist mode of thinking – for sufficient profit only. Excess capacity is an admission of this socio-politically derived economic condition. It is anthropogenic – a human created condition – not some neoclassical economics fairy tale. If we created it we can change it but not necessarily by reducing supply in accordance with some economic model. Fitting reality to the economic model/theory, if you will, not the reverse.

    We have to choose whether we will allow the material forces of production to be deliberately scaled downwards to adjust supply to a decreased demand induced artificially by deleveraging and austerity or discard the capitalist mode of thinking on which such deleveraging and austerity are predicated. So long as we remain captive to this mode of thinking we ensure that deleveraging and austerity become the only “viable” course of action to be taken. It becomes a self-fulfilling prophecy. But is it?

    This financial crisis has heralded calls by many for the obvious need to think outside the box but somehow we keep returning to the same old economic models in which bills come due for the many while the few sit back and watch US impose their rules on ourselves. Why? Have we become so thoroughly indoctrinated in their ideology that we cannot conceive of an alternative? Surely the raw intelligence exhibited on this blog suggests otherwise but yet we remain whetted to the capitalist mode of thinking…

    Just think about what has been said and, if you agree, then take the next logical step, getting beyond the capitalist mode of thinking by considering an alternative. No, SOCIALISM is not upon us but a return to outdated economic models in which reality is made to fit the theory is hardly an answer either unless… AUSTERITY and DELEVERAGING are deemed the only outcome possible.

  8. ray l love


    So what is the “next logical step”? History suggests that every system tried to date evolves into cronyism. That is why austerity becomes a necessary evil. It is the choice other than providing cheap capital to a system held hostage by class-corruption. The very people who have hidden accounts are the same people pulling the strings so how does international pressure weaken that crony influence without conditionality? Policies are only as good as their enforcement and of course urbane corruption is more about doing nothing, (which is an easy/lazy choice for the enforcers), than it is about doing something. Something that typically is not conducive to career advancement in a corrupt society. Corruption in an a modern society is in fact very subtle and difficult to address. So do you have anything that you can support?

  9. Tortoise

    The billion drachma question is how Greek households will react to and fare under the austerity measures. If the government manages to reduce significantly its budget deficit without the Greek households buckling under the pressure and the economy tanking, then Greece will be able to avoid default. A recession is a given but it does not need to be a disaster.

    The numbers we see in the Anglophone press about the Greek economy are plain awful. But there are also other numbers we do not see that provide a ray of hope … Like high accumulated savings, investments abroad, subterranean economy, etc. Satyajit Das may want to visit Greece to see what I am talking about …

    At this point, I think that it is still up to the Greeks to win or lose this crucial battle. Default is possible, even likely, but not mathematically certain by any means. We will have a much better picture of the situation in six months.

  10. Don @ currency day trading

    This isn’t going to work out for the Euro-Zone. In my opinion they made a huge mistake when choosing for one currency.

    You can not have one currency, If all countries in the Euro_Zone keep there own governments.

    Now every government/country has to be successfull to push the Euro up. Which is impossible, so the weaker countries will always pull the strong countries down.

    If you have 1 currency you need ONE central government and one monetary pollicy. You would have to have a set up like the USA. 1 president leading all the separate states.

    For Europe and the EUro the only way is down. THe issue that countries can not print more of their currency to solve or help with their deficit problem will show to be a economical fatality.

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