Posts tagged ‘Greece’

20 May 2012

Greece is not real (it’s nominal)

I enjoyed this post from Scott Sumner:

This tiny country is 2% of the EU.  If (God forbid) it was destroyed by an asteroid tomorrow, stock markets would soar upward all over the world.  The Greek crisis would be over.  Yes, banks would hold some worthless Greek debt; but with no further moral hazard concerns, the rest of the eurozone would gladly bail out their banks, and add that Greek debt to their own public debts.  Remember, Greece is 2% of the EU.

Why would stocks soar on the destruction of Greece?  Because it would end the uncertainty, the fear that a Greek departure from the euro would have a contagion effect.  People who talk about structural problems talk about things like malinvestment in too many houses or BestBuy stores, or Obama’s big government policies, etc.  But the markets don’t care very much about those things; they care about things like Greece.  And not because Greece is big enough to have a real effect on the global economy, obviously it isn’t.  Rather Greece matters because it could trigger a financial panic that would reduce AD [aggregate demand] all over the world.  That’s why global equity markets lose TRILLIONS of dollars when the Greek crisis intensifies.  The real problem is nominal.

Everywhere I look I see more and more evidence that the developed world has a massive AD problem.  Yes, individual countries (southern Europe, to a lesser extent the UK, and to a still lesser extent the US) also have some structural problems.  But the NGDP problem is both easy to fix and a big part of what’s hurting the world economy.  It’s frustrating to see us ignoring it.

It’s now far too big a problem to be addressed by any token fiscal stimulus that could come out of this recent Camp David push for “growth.”  Monetary policy is our only hope.

18 May 2012

Would a Greek default immediately lead to a euro exit? No.

A lot of the discussion of the Greek elections has focussed on the strong performance of anti-programme parties such as Syriza (17% on 6 May), Independent Greeks (11%), the Communist Party (8%), Golden Dawn (7%) and Democratic Left (6%) – and their expected further gains (particularly Syriza) on 17 June. This is what’s prompted the fears of an imminent exit. But would an anti-programme government necessarily mean a euro exit?

I can see two parts to this question. Firstly, is there a political incentive for a newly-elected anti-programme government to exit the euro? And secondly, is there an economic transmission mechanism whereby a disorderly sovereign default rapidly forces Greece out of the euro? I’m thinking only about short-term events here – i.e. if a default happens shortly after 17 June, would a Greek euro exit be announced within the next few weeks?

On the political point – anti-programme parties are on the rise, but polls show most Greeks (c.80%!) remain pro-euro. And most votes on 6 May went to pro-euro parties: of the seven parties that made it into parliament, only the two most extreme – the Communists and Golden Dawn – are explicitly anti-euro.

One or more of the anti-programme parties could form a government after 17 June. If they stick to their pledges, this would lead to a drying up of EFSF/IMF loan tranches, an inability to meet Greece’s bond maturities and interest payments as they fall due, and a need to balance the budget overnight to make up for the lack of external funding.

But these parties aren’t yet arguing for Greece to then leave the euro at that point. Indeed, you can imagine that short-term political incentives would make them even less wiling to agree to a euro exit once they’ve formed a government.

The first move in a euro exit would be to freeze bank deposit withdrawals, which would no doubt irk voters; the final move is the actual devaluation, reducing the purchasing power of those very same voters. If you think the Greeks are rioting over austerity, wait to see what they do when their government does these things to them. Meanwhile, all those other anti-programme pro-euro parties outside the government would be going for the jugular, lamenting the prime minister’s awful decision to impose this unnecessary additional hardship on the voters when all they really wanted was someone who could go to Brussels and Frankfurt and negotiate a different deal. There is not, therefore, an obvious political reason why a euro exit would quickly follow on from a sovereign default.

So I therefore wonder: is there an economic reason?

Martin Wolf gave one view in today’s FT:

[…] a cessation of external official funding could trigger a disorderly collapse. The government would default. The European Central Bank would argue that Greek banks no longer possess good collateral, which would prevent it from operating as a lender of last resort. There would be comprehensive bank runs. Athens would impose exchange controls, introduce a new currency, redenominate domestic contracts and default on external contracts denominated in euros.

In Wolf’s scenario, it’s the collapse of the banks that forces Greece to exit. I can certainly envisage such a channel:

  • lack of central-bank funds would lead to a system-wide bank run, as depositors try to get their cash out before the banks collapse;
  • euros would now be hoarded under mattresses or outside the country, out of fears over bank solvency and redenomination respectively;
  • ultimately forcing the government to introduce a new currency just so that ordinary day-to-day transactions can actually take place in Greece.

Yet crucially, I think Wolf is mistaken in suggesting that all central-bank funding would be cut off at the point of a sovereign default. Yes, the Greek banks would no longer be able to use their defaulted Greek government bonds (GGBs) to access ECB facilities; but would they not just turn to Bank of Greece ELA as an alternative? They’ve done this once already, in March/April, when their GGBs briefly became ineligible for ECB operations after the PSI and so they moved them all over to Bank of Greece facilities. And there doesn’t seem to be a constraint on ELA – the Irish did €100bn of it, after all.

Anyway, if the Bank of Greece can continue funding the Greek banks after a sovereign default, I don’t think there’s the same obvious short-term mechanism that will force Greece out of the euro. This isn’t to say that there aren’t other things happening: as I said the other day, central-bank-addicted ‘zombie banks’ don’t default, but they also don’t lend, so the medium-term outlook for Greece would remain fairly grim.

But the point I’m trying to make is that a Greek default soon after 17 June doesn’t necessarily mean a Greek euro exit will immediately follow. Greece could exist in a kind of limbo for while. Indeed – there could be many months between a disorderly sovereign default and an eventual euro exit!

And during that lengthy interlude, could we be hopeful that cooler heads might prevail?

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17 May 2012

Bank runs in the periphery: why they matter and how to stop them

Lots of attention over the last few days on deposit outflows from Greek banks, an acceleration of the slow-motion bank run of the last two-and-a-half years that saw €95bn of deposits leave the country’s banks between September 2009 and March 2012 (i.e. more than one-third of Greek banks’ peak €282bn stock of deposits).

In spite of the deposit flight, the Greek banks have continued to fund themselves through ECB/ELA facilities. So why exactly does this matter?

Tyler Cowen explained the point well in this article looking at similar deposit outflows from the Irish banks:

This flight of capital reflects a centuries-old economic principle known as Gresham’s Law, sometimes expressed casually as “bad money drives out good money.” In this context, if two assets — euros inside and outside Ireland — are not equal in value in the eyes of the marketplace, sooner or later the legally fixed price parity will fall apart.

If enough depositors fear frozen accounts, the banks will be emptied out, and they also will require additional government bailouts, on top of the bailouts for the bad real estate loans. The banks come to resemble empty shells, conduits for public aid but shrinking and unprofitable as businesses — and, to a large extent, that is already the case in Ireland. Portugal is moving in this same direction, toward being a land inhabited by zombie banks.

Essentially, if you think about bank deposits as distinct financial assets, it becomes clear that the value you would place on a euro held in a bank with a low risk of default is different to that of a euro held in a bank with a high risk of default. But as there’s a fixed legal parity between the price of a euro in the two banks, which prevents prices adjusting, the quantity takes the full brunt of the adjustment instead:

Within a currency union, this problem is usually solved through bank deposit guarantees. We’re content to treat sterling deposits in HSBC, RBS or Manchester Building Society as equivalent assets, despite the very different business models of these banks, because the UK Financial Services Compensation Scheme (FSCS) stands behind their retail deposits (at least up to a limit) – and the UK government ultimately stands behind the FSCS.

But within the euro area, deposits guarantees are still done on a national basis. Deposits in German banks are guaranteed by the German authorities and deposits in Greek banks by the Greek authorities. And the German deposit guarantee is patently going to be more creditable than the Greek scheme –  particularly once euro exit concerns are brought into play.

The pre-crisis assumption that bank deposits in different parts of the euro area were equivalent was therefore clearly as misguided as the assumption that different euro area governments had the same (low) credit risk. And, as with credit risk on euro area governments, I don’t see how investors will ever go back to the old assumption unless there is a fundamental change to the structure of euro area banking.

Alongside some form of eventual fiscal union, I therefore think the euro area will need to introduce a form of mutualised deposit guarantee as a necessary condition for preventing a future crisis once this one is over. Indeed, it may even be a necessary condition for ending the current crisis, given the lending and growth implications for Europe of this breakdown of the monetary system. Returning to Tyler Cowen:

It’s the zombie banks that doom the current European bailout plans. On any single day, or even for a year or two, an economy can survive with zombie banks, but over time functional domestic banks are needed to allocate credit.

If they don’t find a way to return to a situation were euros in German banks and periphery banks are valued equally, deposit flight and the consequent dearth of credit will continue – and bang would go hopes for Spain.

14 May 2012

The first days of the Greek exit

Given widespread discussion of a possible imminent Grexit (aka ‘Greek exit’) – including by some European officials – it’s worth briefly sketching out what it would look like.

In terms of actually introducing a new currency, I think this is a massive logistical challenge that would take months – just in terms of printing notes, distributing them, reprogramming ATMs, etc, let alone the legal quagmire. But in the immediate aftermath of the decision, I would expect all of the following three things from Greek and European leaders:

(1) Greece would pass emergency legislation introducing capital controls and creating the new currency in legal (if not yet physical) form. This would unilaterally violate the Maastricht Treaty, which provides for free movement of capital between EU members. The widely-expressed legal view is that there isn’t a legal mechanism for quitting the euro, unlike for quitting the EU – so this Maastricht violation might be the first step towards an EU exit and consequent application to rejoin the EU or EEA post-Grexit.

(2) The New Drachma would start trading at a shadow exchange rate, even before it exists physically. The currency would no doubt depreciate heavily against the euro.

(3) The institutions of the euro area would have to announce, immediately, a massive extension of support to the remaining periphery. There’s been a lot of talk – e.g. from the Dutch finance minister today – about the ‘firewall’ Europe has put up since the start of the crisis. This counts for absolutely nothing: if you’re a depositor or investor in Portugal/Ireland/Spain/Italy and you see Greece exiting and people with money in Greece frozen there by the overnight imposition of capital controls – in spite of two years of protestations that there will be no Grexit – then the rational thing to do would be to pull your cash immediately and ask questions later. In the short term, the policy response would have to include:

  • a clear public announcement by the ECB that they’re willing for banks in the remaining periphery to become reliant on central bank cash on whole different scale to what we’re used to (as a result of depositor flight and wholesale funding freezes), including larger banks there, and probably as part of a jointly-guaranteed Eurosystem scheme (which means loosening Eurosystem collateral standards) rather than nationally-guaranteed ELA funds;
  • pre-approved second EFSF programmes for Portugal and Ireland to ensure their funding (if required) through to late in the decade and precautionary credit lines for Spain and Italy; and
  • perhaps most controversially, some sort of explicit commitment by the ECB to deploying its balance sheet to support any euro area sovereigns that need it, either through: (i) an explicit cap on secondary market yields for euro area states; or (ii) giving the EFSF a banking license and letting it borrow as needed to fund euro area states.

None of this sounds pleasant. But they’d have to act like this after a Grexit because the consequences of not acting would be too catastrophic – and I’d bet in this situation (and here’s sticking my head out…) that the imminent continent-wide economic catastrophe and consequent changing electoral arithmetic would lead even the Germans to sign up to this programme.

I think Greece could leave. But if this doesn’t jolt the institutions of the euro area into belated action, nothing would.

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7 May 2012

Super Sunday (2) – Inconclusive in Greece

Yesterday’s Greek election delivered an inconclusive result, as many feared. With almost all votes counted, New Democracy (centre-right) has fallen to 19% of the vote from 33% three years ago and Pasok (centre-left) has crashed to third place with 13% down from 44%, behind the Syriza party (radical left), which is up to 17% from less than 5%.

On this basis, the two parties that supported the EU-IMF programme (ND and Pasok) would have 149 seats between them in the 300 member parliament, so would lack a majority to pass austerity measures required to unlock future tranches of the bailout loans. Even if they had a couple of extra seats, I’d wonder about the crisis of democratic legitimacy that an ND-Pasok coalition would engender – implementing further austerity with the backing of only 32% of voters (contrast with the 59% who voted for the UK’s two coalition parties in 2010).

A second election seems likely, but is far from certain to deliver a more pro-programme result. Indeed, if Syriza can win over around 131,000 voters out of the almost 1 million who voted for the next three anti-austerity left-wing parties (the Communist Party, Democratic Left and the fantastically-named Anti-Capitalism Left Cooperation for the Overthrow), then Syriza would overhaul ND as the first-past-the-post winner and benefit from the 50 bonus seats that the top-placed party receives – completely changing the context for the next parliament’s coalition negotiations and making a left-wing coalition much more likely.

A final note on Super Sunday. Buttonwood rightly points out that it is primarily this Greek result, rather than Francois Hollande’s win, that has riled the markets this morning. This of course isn’t to say market players are thrilled about Hollande. But we shouldn’t conflate the market implications of the Greek and French results, as some of the press coverage this morning seems to have done. The Greek election does raise serious questions about the sovereign’s solvency (even post-PSI) and perhaps the country’s euro membership.

France, though, will have merely unsettled people by promising a bit more political disagreement at a time of uncertainty when the markets are desperately seeking short-term stability. But if bond traders want stability, they should move to North Korea. My view remains that a more-balanced ‘good cop, bad cop’ dynamic between France and Germany may be a necessary condition for preserving the euro – and so the long-term outlook for the single currency may have been enhanced by the French voters’ choice.

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