Tuesday, June 23, 2015

Last Greek thoughts

A few salient points that don't seem to be on the top of the outpouring of Greece commentary.

1. Greece seems to be coming to a standstill.  Kerin Hope at FT  (HT Marginal Revolution):
... many [Greeks] have simply stopped making payments altogether, virtually freezing economic activity.
Tax revenues for May, for example, fell €1bn short of the budget target, with so many Greek citizens balking at filing returns. 
The government, itself, has contributed to the chain of non-payment by freezing payments due to suppliers. That has had a knock-on effect, stifling the small businesses that dominate the economy and building up a mountain of arrears that will take months, if not years, to settle.
“Business-to-business payments have almost been paused,” one Athens businessman says. “They are just rolling over postdated cheques.”
 Around 70 per cent of restructured mortgage loans aren’t being serviced because people think foreclosures will only be applied to big villa owners,” one banker said.
2.  If a Greek goes to the ATM and takes out a load of cash, where does that cash come from? The answer is, basically, that the Greek central bank prints up the cash. Then, the Greek central bank owes the amount to the ECB. The ECB treats this as a loan, with the Greek central bank taking the credit risk. If the Greek government defaults, the Greek central bank is supposed to make the ECB good on all the ECB's lending to Greece.  It's pretty clear what that promise is worth.

Some observations on what these stories mean.

1.  The argument is not about "lending" to Greece, i.e. covering this year's primary surplus. The argument is whether the IMF, ECB, and rest of Europe will lend Greece money to... pay back the IMF, ECB, and the rest of Europe. This is a roll over negotiation, not a lending negotiation.

The loans were not intended to be paid back now. The loans were intended to go on for decades. But with conditions. The negotiation is about enforcing or modifying the conditions for a roll-over.

Rolling over short term debt with periodic reviews is a nice incentive mechanism. Foreign policy should try it.

2. The latest proposed agreement includes sharp increases in tax rates.  Now? Are you kidding?

Source: theguardian.com
I am reminded of the story of a town, that had a bridge, that had a 50 mph speed limit. A drunk driver, going 85, caused  horrific crash. The town lowered the speed limit to 25.

What Greece needs is to get going again. That is, to persuade anyone that this is a good country to start a business, invest, hire people, and so forth.  In particular, if Greece is to pay back debts, it has to become an export-oriented growth economy, and run trade surpluses Higher VAT, higher corporate taxes, and higher taxes on successful entrepreneurs are hardly the way to go about attracting investment.

I think of taxes in terms of incentives. Keynesians look at aggregate demand. Either way, raising tax rates, now, in an economy where nobody is paying much of anything because they see the big explosion ahead seems destined, pragmatically, to raise no revenue. And, incidentally and humanely, to further crater the economy.

Despite cuts, the Greek government is still spending north of 50% of GDP. If you want to get primary surpluses, that seems the place to cut.

But with an economy at a standstill, major structural reform (like, go back and put back in the structural reforms that Syriza scuttled on arrival) seems like a more promising short-term set of conditions. And we'll see you on the next big roll-over.

3. Rolling over post-dated checks is a fascinating story to a monetary economist. Money is created when needed, apparently.

4. The bank run, or "jog." Remember, the big Greek bailout already happened. Private investors, largely European banks, who held Greek government debt got to sell their debt to government and IMF. Bailouts are creditor bailouts.

One way of viewing the current slow motion crisis is an invitation for ordinary Greeks to join these investors. Take euros out of the bank. The government default will happen, possibly with bank closures, capital controls, currency exit, and expropriation. But lending to Greek banks is now bailed out, with the losses sent to Europe via the ECB, just as German bank's lending to Greek banks was bailed out in the first round. Too clever, maybe, but that is the effect.

Too clever, really, to describe the situation. It only works if the government actually does exit, and soon. Getting money out of the banks and then defaulting is one thing. But a frozen economy can't go on long.

I repeat: the run and non-payment, freezing the economy, happen largely because people see capital controls, bank account expropriation, grand all-around default (your mortgage might get redenominated to Drachmas too, and forgiven once the bank goes under, so why pay now) and Grexit in the future.  The simplest way to stop the run and economic cratering would be a solid commitment from both sides that government default will not mean Grexit,  capital controls, etc.

5. Without the banks, this would all be simple. Greece could default, stay in the Euro (unilaterally if need be) and Euro zone. One government defaulting on debts to other governments is not a crisis.
All along though, the involvement of the Greek banking system makes it much harder.

Greece has 11 million people, $242 billion GDP and 51,000 square miles. That's as many people as Ohio, the GDP and land area of Louisiana. Why does Greece need its own banking system in a common currency and free market zone?

Think how much easier this would all be if Europe had gotten around to integrating its banking system. In any city in the US, the major banks are all national. If California defaults on state bonds, your Chase bank account is safe, and not because of Federal deposit insurance. Because the bank has no exposure to California bonds.

Imagine if Greeks deposited money in a local branch of a large pan-European bank, backed by assets spread throughout Europe. Imagine if Greeks borrowed money from the same bank, funded by deposits spread throughout Europe. Imagine if, when a remaining Greek bank defaults, the European equivalent of Chase could sweep in, and take over loans and deposits seamlessly. A default by the Greek government on its bonds would be inconsequential to Greek banking.

Why not? Well, such banks would not hold vast amounts of Greek government debt. Such banks would not have Greek ownership, or be controlled by the Greek regulatory system. Such banks would not be available targets of Greek capital controls, or a currency change.

Greece needs an independent, national, banking system about as much as Ohio or Louisiana need independent, state banking systems.

6. And currency. Many economists keep saying how wonderful it is for tiny countries to have their own monetary policy, so they can devalue their way out of crises like these. They advocate "capital controls" (English translation: expropriation of savings). That's how Argentina, say, is such a success story. We may be about to see.


  1. Thanks for clarifications Prof Cochrane. Mario Draghi has the 'Zeus' task now to accomplish trying to keep system together.., wadr prof hwr can't compare to US..many national & cultural differences that needs to be 'bonded' together due to centuries of controversies ..& adversary..best

    1. I disagree. This is a fairly simple and small economic question of sovereign default. Throwing up our hands and saying it's all cultural and centuries old gives up far too soon.

  2. Get Greece going? How? If the collapse of the Greek stock market by 60 percent is any indication of how far real consumption has to fall to be sustainable, we're talking another 50 percent. Why any Greek with any options outside Greece would stand for that I don't know.

    The Greek government openly defrauded European lenders, borrowing money they had no intention of paying back. A corporation that tried this would gave been liquidated and its management jailed long since.

    As it is, the Hellenic Republic is no more reformable than the German Democratic Republic at an acceptable cost in living standards. Had the Federal Republic of Germany been in a position to dissolve the Hellenic Republic and take over outright, as they did the GDR in 1990, they might have done just that long before now.

    1. Who is this "Greek government" of whom you speak? Did the people from Syriza borrow this money? Did they make promises that everyone knew they couldn't keep? Did people loan money to them, knowing the ECB would bail them out and push the losses on the taxpayers of the European Union?

  3. "Greece has 11 million people, $242 million", you mean "billion" I suppose.

  4. 'Greece is still spending north of 50% of GDP. If you want to get primary surpluses, that seems the place to cut.'

    Correction: '50% of a shrinking GDP', largely because of the demand-side shock Greece has experienced the last four years. Nominally state spending has been cut considerably.

    1. This is a good point. GDP has shrunk over 25% since 2008. Can you imagine the social tragedy of that? 25%. And government expenditures have been slightly below to slightly above 50% of GDP for this whole period, meaning it has been cut almost as drastically.

      To the point about taxes, even though raising taxes is not a good idea when trying to kickstart the economy, tax evasion and fraud have been a major contributor to the problem of raising government revenue. So the government is reacting to the problem. This is a good article on revenues and spending relative to the rest of Europe: https://www.americanprogress.org/issues/security/news/2010/05/14/7831/the-greek-myth-of-profligacy/

      Finally, here is a good article comparing the Greek depression to the Great depression in the US: http://www.bloomberg.com/news/articles/2015-06-22/greece-is-in-a-worse-spot-than-america-was-in-1933

      What a tragedy

  5. *$242 billion (!)

  6. True but unfortunately there is the problem with the banks. Emergency liquidity assistance (ELA) by the Greek Central Bank (and thus the ECB) has been increased once and again. Currently, it amounts to roughly 50% of GDP. Collateral is apparently mainly Greek government bonds. If Greece defaulted, this collateral wouldbe eligible not even to the Greek Central Bank. Hence, the Greek banking sector would go bust in a second. (In fact, the European bank got more intergrated before the crisis but this has been reversed since the crisis started. I guess a major reason was that governments can tell only the local banks to buy their bonds.) Therefore, a government default will probably go hand in hand with a Grexit which would put the Greek government into the position to prop up the bank with new Drachma.

  7. believe or not, In Greece...Total public sector employment declined from 907,351 in 2009 to 651,717 in 2014, a decline of over 255,000. That is a drop of over 25%....(per Karl Wheelan https://medium.com/bull-market/the-ft-lets-itself-down-again-francesco-giavazzi-on-greece-92988bc675eb), also Greece has reduced its fiscal deficit from 15.6 percent of GDP in 2009 to 2.5 percent in 2014 and they did streamlined a few things because moved from 108 to about 61 in the world ranking of ease to do business (still lousy, but less so).

    So, if they now get rid by defaulting of austerity and they bring their currency at the exchange rate corresponding to their productivity (say 65 cents to the dollar instead of 1,15$) they will stop importing virtually everything that you see in the aisles of an Athens supermarket. They now import 60 billions, among which they could produce about 30 billions.
    What is so difficult to understand that if you have an artificially high exchange rate you will import a bunch of stuff you would otherwise produce ?

    1. GZ,

      Currency can be used to buy more than goods. Suppose Greece did have it's own currency and devalued it to $0.65 on the Euro. Suddenly, everything in Greece becomes cheaper to buy for owners of Euros (land, stocks, corporate bonds, buildings, etc.).

      Currency devaluation alone is not enough to reach a balance of trade, it can only help to restore a current account balance.

      To reach a balance of trade, you need to lower the cost of production of new goods without lowering the value of existing goods / capital assets.

    2. "Total public sector employment declined..." mostly by allowing (or even inviting) public servants to get early (and usually very early) retirements.

  8. John,

    "In particular, if Greece is to pay back debts, it has to become an export-oriented growth economy, and run trade surpluses."

    The only thing Greece needs to do is ensure enforcement of existing tax policy and convert its externally held debt to internally held equity. Everything else will fall into place.

    1. What would be the mechanism for Greece to "convert its externally held debt to internally held equity"?

    2. Anonymous,

      Greek government sells discounted liabilities to Greek population that can be used to discharge a future tax liability. For instance, Greek government sells a $90 euro "stock" that will cover $100 euros of tax liability two years from now. Greek government uses that sale to buy back $90 euro of its existing debt.

      Germans, French, Italians, and other foreign investors would have little reason to buy them since they don't pay Greek taxes.

  9. Thanks for the post. If I am not mistaken, at the current moment practically all Greek debt is held by the ECB. Thus, a default of the Greek government should not have an impact on Greek banks' solvency. I understand the fear then comes from a panic-driven bank run. Is this right?

  10. Superb clarity, especially point 5.

  11. "Without the banks, this would all be simple. Greece could default, stay in the Euro (unilaterally if need be) and Euro zone. One government defaulting on debts to other governments is not a crisis.
    All along though, the involvement of the Greek banking system makes it much harder.

    Only harder because governments like to have captive banks to buy up their debt. Greece could default tomorrow even with its own banking system, so it isn't the presence of that banking system that makes thing difficult, but the fact that the Greek government would like to stay in the Euro with a central bank that can print Euros.

  12. I'm fairly certain that there are numerous "European" and international banks operating in Greece. I.e., Greek depositors don't have to use local Greek banks. They can just as easily walk to a local branch of a German, Austria, Swiss etc. bank in Greece.

    1. I'd like to understand this better. Any Greeks reading? Is taking your money out of a Greek bank and putting it in a local branch of UBS the same as starting an account abroad? I suspect no, that the local branch of a non-Greek bank operating in Greece does so under Greek law, so deposits will be confiscated and redenominated under capital controls and Grexit just like everyone else's.

      Or, why not transfer your money to a money market fund operating in Europe? Is there no Vanguard? Or am I being Marie-Antoinette naif here and money market funds (legally operating on a european basis, immune from a Grexit) are not available?

    2. I have no idea. I was under the impression that they couldn't "confiscate" money from foreign-owned banks. But that may depend on how these foreign banks are operating in Greece (i.e. they may be required to operate their local branches as subsidiaries or not). Other countries may have different rules.

      Either way, opening an account in a foreign bank can't be all that hard.

    3. "deposits will be confiscated and redenominated under capital controls and Grexit just like everyone else's."


    4. I believe that this is not the same thing. Banks have to open susbsidiaries to operate in different countries and these subsidiaries are subject to the laws and regulations of that country, so I would assume that the option mentioned above would be any different. In the event of a currency change, if euros in greek banks would be converted to drachmas, the same thing would happen in any foreign subsidiary.

      Regarding the Vanguard funds, I think the major problem there would be the European Universal Banking model. I am from Portugal, and there as far as I know, if you want to invest your money in a fund, it typically goes through a bank at some point. Nevertheless you would be right, I believe that given the money is in a foreign mutual fund, your money should be safe no matter what happens to the bank. I suspect the problem here is lack of awareness and the fact that in practice, the bank has the power to move your money around (even though that would be totally ilegal, if everythinhg goes bananas, I too would feel funny owning shares in a mutual fund bought through a bankrupt retailer...)

  13. Speaking of Zeus and Draghi, it seems to me that Zeus was less cruel than the Troika. The rock Sisyphus had to push didn't get bigger with each iteration.

  14. I would guess that in Greece it works as in any other EZ country, like Italy for instance, and here putting money in a local branch of UBS or Deutsche is not the same as putting it in an account abroad. In theory, even if you send money (legally) to a US broker in London, you are liable to pay or getting confiscated (in practice is more fuzzy, you can open without disclosing your EZ tax id...). But you can buy all the Fidelity, Pimco, Vanguard or Doubleline you want, in dollars or pounds, while being in Greece or Italy and you will be safe. This is what I recommend for instance....

    (@F.Restly...Greeks Banks had to borrow 113 billions euros from the ECB because Greeks citizens more or less took out all that money, as JC discuss and therefore with that money which is like 40% of GDP (plus other stashed in London from before) they will be buying assets in their own country once the dracma is back... And yes, now that Greeks have improved a bit they will go back to produce food, clothes, shoes, furniture and the like once their currency will be worth 50% less than the euro...)

  15. Cochrane - (whose distant perhaps relative Thomas Cochrane of the UK fought for the Greeks in their war of independence vs the Turks, and his life and exploits served as inspiration for the naval fiction of 20th century novelists C. S. Forester and Patrick O'Brian) states: "Greece needs an independent, national, banking system about as much as Ohio or Louisiana need independent, state banking systems" - but professor, didn't the early states, under a gold standard, have state banking systems? And save a panic or three, they did just fine, with GDP per capita growth rates in the late 19th C about the same as today's (source: A. Maddison). BTW I bank in Greece, live there, and am indifferent to a default.

  16. "Without the banks, this would all be simple." The most important sentence in this post. The most important lesson around the greek drama is not that the greek government is inefficient, corrupt and unsustainable (this is known for decades!).

    No what it shows is that fiscal policy, monetary policy, and banking regulation are inextricably linked to each other. And all the links lead back to banking.

    -A sovereign default leads to a bank run with potential contagion effects.
    -Banks stuff their balance sheets with government debt and do not have to put any capital up for it
    -Because of liquidity guarantees from the ECB, banks take on more credit risk than they can carry in bad times, so they offload the credit risk to taxpayers if things get ugly
    -The ECB has to load on credit risks via ELA to keep banking in Greece afloat.
    -The ECB has to do QE and load on sovereign risk (yes, Spanish and Italian bonds are not risk free!!) to prevent the explosion of the spread to the Bund and stabilize the banking system in these countries as well

    Banking is the real problem that needs to be addressed, so that sovereign defaults are no longer a threat to financial stability. Jonathan McMIllans End of Banking makes exactly this point and proposes a blueprint how to separate the financial system into a public sphere of money and a private sphere of credit. If money is no longer prone to runs, and monetary policy no longer forced to support credit, we could address the underlying problems of the greek tragedy.

  17. Monetary union with no Banking union and ECB oversight from the beginning was a grave mistake indeed,

  18. I do not undestand why greeks do not take all their deposits from the banks. I say that with all my Argentine experience of so many crisis. I think they are crazy-
    Luis M. Aguirre
    Buenos Aires - Argentina

  19. John, this is a very considered and very intelligent post. It makes a change from Krugman etc who just see models and gadgets that have been drummed into them during all their lives as theoretical economists whatever they look at. I think when we look at the Greek case like many others, it is one where we need to know something about the country and put models away for a while.

    I think you are right that ultimately the solution for Greece, a small import dependent country with a structural terms of trade problem that has existed before the Euro (since its independence from Turkey) is export led expansion. But its pre-Euro history suggests that devaluation and default did not achieve this, and will not achieve it. Olive oil does not pay for German machinery or Middle East fuels. My guess is that if it goes alone it will have to follow something like the East Asian model - which involved licensing of foreign capital and infant industry protection and aggressive mercantilism (if you think they followed neo-liberal free trade policies, you are very wrong).

    The Greeks want a strong currency like the Euro for good reasons - trading countries want the stability hard currency brings. American Keynesians do not understand what it means to be a small country and have to work in a trading system denominated in US dollars and how difficult that is if you do not have a strong currency like the DM or Euro to buy those dollars. You need the forex to buy the essential inputs to export. But a hard currency is something that has to be earned. And I think fiscal (which will mean political) and as you point out financial, integration in Europe is the only way forward. Then it can properly function as the United States of Europe. This was made more difficult, however, by the rushed expansion eastwards in the 2000s.

  20. wake up.....Greece has never been a viable country and is becoming even less so.

  21. When Greece was accepted into Eurozone, it was political decision. It was clear that they were outside of all parameters, but everybody turned a blind eye. For decades in Europe, at least in southern part, exists saying "Indebted like Greece". Direct cause of the Greek crisis were European institutions who decided that middle of the crisis is the right time to emphasize that ECB won't cover debt of individual countries or provide them money as lender of last resort. Part of the reason why Greece has so high debt was that when Euro started, risk premiums for Euro countries were slashed because of common currency and implied common responsibility.
    Greece has turned primary deficit of 2.1% in 2007. and 2.9% in 2011. (highest was 10.2 in 2009) into primary surplus of 1.5% in 2014. Greece has slashed spending by over 30% from 2009, lost 25% of GDP and some 20% of income (IMF numbers). And IMF and Euro negotiators are still claiming that further surplus generation will increase GDP.

    Italy had big devaluation in 1992 and another in 1995. In total, Lira fell to around 70% of previous value. Italy lost some 20% of GDP in 1994, but returned to 1993 level by 1997. Devaluation (impossible in Euro), if used properly, instantaneously provides wage adjustment and cuts nominal government spending, in essence delivering full extent of austerity in one day instead of 5-10 years and instantaneously stimulating the economy, specially exports.

    1. The cause of this crisis was monetary union without fiscal and financial union. The intention in the 1990s was to move towards closer convergence, that would mean fiscal and political union. Britain was firmly against this - and French dominance and the German/French socialist model being imposed on the system. It pushed for the rushed entry of the A8 of the former eastern bloc countries who were much poorer. This successfully diluted the union's push towards closer integration. Their entry also put intense competition on the southern European periphery. Capital increasingly moved to the eastern bloc, eastern workers moved in their millions to the old EU. Their entry also derailed further economic and political integration, leaving the Eurozone as a monetary union without fiscal and political union.

      Devaluations never solved the problems in the southern European periphery pre-Euro. The problems in these countries relate to their industrial structures. Olive oil, goat's yoghurt and tourism does not pay for German machinery or Arab oil needed for production and to industrialise their economies. There has always been a structural current account surplus between Germany and the South of Europe. The south needs German capital. Germany is looking for a return on its surplus capital. Germans, however, are only willing to give it if the institutional framework is in place. They want a say in how the capital is spent and invested. That is how the German corporatist system works. That will require unified fiscal and financial structures.


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