This guest post is by Carlo Bastasin, a visiting fellow at the Peterson Institute for International Economics. An economist and a journalist, Carlo is a leading commentator for the Italian daily Il Sole-24 Ore and for German newspapers. He reacts here to recent proposals that Greece should bring in the IMF.
The Greek crisis has at least two different dimensions. One is a fiscal deficit, aggravated by Athens’ mismanagement and deception; the other is the protracted loss of competitiveness, especially within the Eurozone, leading to a large current account deficit.
The IMF can be very effective in tackling the problems of solvency and liquidity arising from the fiscal emergency – and it has probably more expertise than the European Union (EU) or the European Central Bank (ECB) in this regard. But the Fund is much less able to address the problem of restoring equilibrium in current account balances within the Eurozone.
Unfortunately these two problems must be solved together. The Greek fiscal deficit and the loss of competitiveness are connected, because a current account deficit (i.e., imports above exports, implying a deficit in net total domestic savings, otherwise known as importing capital) will make it much more difficult for the Greek government to raise taxes to cover its public deficit. The financial equilibrium of the country is exposed to a sudden increase in risk aversion by foreign investors – this is when they would run for the doors, e.g., if taxes increase.
Classic answers to the loss of competitiveness are also problematic. Lowering wages can be useful to restore an efficient cost structure but may also be destabilizing in the short term, because this would reduce tax revenues and thereby affect severely the public fiscal deficit.
Healing the current account problem by reducing Greek domestic demand relative to the demand of the trade partners (mainly countries of the Eurozone) can transform the trade problem (and the debt refinancing problem) into a structural debt sustainability trap – if Greece’s growth prospects are more limited, its existing debt burden is more onerous. This can only be avoided if domestic demand in Greece’s trade partners increases sufficiently.
In other words, the Greek problem is a mirror image of the “hidden” German problem — too low domestic demand and trade competition based on lowering labor costs in Germany. You cannot imagine really solving the Greek imbalance without – at least somewhat – correcting the German imbalance.
This is not a problem that the IMF can address. It is not conceivable that in any intervention on Greece, the IMF would turn its “conditionality” to Germany, i.e., asking it to change its trade practices and its social model.
We face a problem of policy coordination within the Eurozone. And this must be resolved collectively – through shared governance mechanisms.
It will need to be an extremely delicate set of policy changes. Correcting the German imbalances cannot be allowed to damage the successful – but socially very painful – recovery in productivity that Berlin was able to stage in the last seven years.
Probably there is no other way than accepting the political task that the Eurogroup will have to face. Policy coordination needs to reach down to the root of the social model – the relation between Capital and Labor, the holy grail of national political consensus – and move it to the level of governments sharing the euro (i.e., the Eurogroup level).
The Baseline Scenario 
If IMF cannot and should not help Greece, what should we do? I am not sure that those policy changes (what should be done exactly?) can be implemented quickly and would address the current account imbalances in the short and medium term.
Very true; the challange is that there are no more means – financially, fiscally, or similar – that would help ease the pain in Greece or in Germany where many people are working for very little income. The profits of the benefitting global players have long been eaten up or gambled away.
“The Greek problem is a mirror image of the “hidden” German problem” to the extend that Greek bonds are held by German banks…German exposure amounts to €43bn in Greece
… yes, and when there is no more to share, no vivid construction where all ends can benefit from and share out then it is time to take shelter. The EURO as it was is history.
Think that Chinese guy who talked about living in ‘interesting times’ was on his death bad, and added, “Good luck with that”…
“Athens’ mismanagement and deception”
In case nobody noticed, the perpetrators of the fraud (so called Conservatives) have been fired, and a new team (so called Socialists) brought in to uncover and clean up the mess.
To blame the crisis on “Athens” or “Greece” is ignorant or dishonest.
I’m sure if this guy talks long enough he will suggest the solution to Greece’s problems and the Eurozone in general is to privatize Social Security in the US and cut Medicare subsidies.
If he talks even longer, he will eventually say just give all of our money to Mr. Peterson.
Maybe they should try having different national currencies or something.
It’s actually a Chinese curse. And its meaning has been quite vivid these past couple years!
Greece should look to how Argentina solved its financial difficulties stemming from their misguided attempt to peg their currency to the dollar.
1) Greece should leave the European Monetary Union and default on all debts denominated in Euros. Greece can then offer to pay back a certain percentage of any foreign held debt in its own currency. This solves the solvency issue.
2) The Greek government should allow the new sovereign currency to float against the Euro and all other foreign currencies. This solves the trade imbalance issue (well, maybe solves is too strong a word, but it will certainly help).
3) The Greek government should inform its citizens that all debts private and public are now only redeemable in the new sovereign currency and that the federal government will convert any private Euro holdings into the new sovereign currency at some fixed exchange rate. This will probably be the most difficult step as there is the possibility that widespread panic and currency speculation will occur as individuals unsure of the viability of the new currency seek safety in more established currencies or other hard assets. However, if the experience of Argentina is a reliable guide to what will occur if Greece pursues this path, then history suggests any disruption will be short lived.
When Argentina defaulted on its dollar denominated debt there was a good deal of hysteria about how Argentina would be cut off from international capital markets and that without foreign investment the economy would wither, but as it turned out these dire warning turned out to be mostly baseless. Argentina showed that an economy can grow and prosper through social policies designed to encourage human capital development and promote strong domestic investment. If Argentina could do it so can Greece.
“The financial equilibrium of the country is exposed to a sudden increase in risk aversion by foreign investors – this is when they would run for the doors, e.g., if taxes increase.”
To what extent is that true of a land tax, since land cannot run away?
“In other words, the Greek problem is a mirror image of the “hidden” German problem — too low domestic demand and trade competition based on lowering labor costs in Germany. You cannot imagine really solving the Greek imbalance without – at least somewhat – correcting the German imbalance.”
A very important point.
Here I would like to quote Yvee Smith’s remark:
“The EuroBanks have written off less in the way of losses than their US peers, are also exposed to any EU sovereign debt defaults, and yet the biggest are still crucial parts of the international capital markets infrastructure (and therefore still tightly coupled to the very biggest US/UK firms). While any EU sovereign debt defaults could morph into a full blown crisis, the EU responses to the joint sovereign/bank debt overhang could lead to more radical changes in EU banking rules and practices that could blow back to the very biggest US banks in unexpected ways.”
http://www.nakedcapitalism.com/2010/02/martin-wolf-is-very-gloomy-and-with-good-reason.html
Imho, given the anger of German public opinion, in front of the looming House of cards’s sovereign debt
defaults, and with none of its members wanting to pick-up the Greek tab, the Eurozone, is lingering between a ‘liquidity fund’ or the creation of Euro-bonds
It’s actually not even Chinese and can’t be documented as such anywhere.
Nevertheless I don’t see it as a curse or a blessing. It can really be either, depending on the moment and how events play out. ;-)
As in all and any European crisis, the solution lays into more European integration. There is indeed a Greek-German problem, and Germany is not all pure, nor not well compensated already.
It is therefore a problem which is none of the USA’s business…
Except in the sense that France and Germany will be very sorry that the euro goes back down to where it was designed to be, the long term value of the French Franc against the dollar… France and Germany will be very sorry for the Sino-American couple, and their undervalued currency, and overvalued economies, that is…
Please accept the expression of my deepest condolences…
PA
If Greece did that my bet is others would follow . Where does that leave the Euro then
Dead, which is where it should be. The Euro-zone was never an optimal currency area, the current crisis has just made it painfully obvious.
Nope, sorry folks “mirror problem” is an absurd way to frame the issue.
Sure, if Germans consume more of everything they will also consume more Greek products and make it easier for the Greeks to manage their dual problem of too much debt and producing too little of stuff at prices that people actually may want to buy from the Greeks.
But Germany whose official public debt and unfunded pension liabilities are in excess of 250% of GDP are in no position to overconsume just to help bail out the Greeks. If they do they will be the next Greece in the not too distant future…
I think that is a really smart idea. Maybe we should suggest this to California?
Writing receivables off is a bookkeeping entry. The owner of the debt still pursues collection. But, sovereign debt is either wholly uncollectable or partially collectable if the owner of the debt is able to apply a devious compulsion in a way that works politically for the debtor nation. Failing a political solution, or a sucker that will buy the debt, the debt is never going to be paid.
As a minimum, if the PIIG’s debt problem is as difficult as is being touted, the debt owners must get very creative. Every shylock knows that you never , never put the debtor in a corner where their are no palliatives… if you eventually want to collect or in this case unload the debt for some value. You must at all costs keep the vig being paid, for starters. In the real world sovereign debt rolls over forever… or else you get the collection problems experienced today. The debtor cannot make the weekly vig.
In Greece, a political solution means that mass job loss is forbidden turf. Already, Greece, Spain and Portugal are joining together to consider counter offers to the debt owners that cannot be refused .
So, it will be a sophisticated version of pay what you can called rescheduling. At all costs you keep them paying whatever can be extracted. This will be the best that stupid shy’s can hope for.
On the other hand, the PIIG state finance ministers understand that the debt owners are very likely covered by CDS’s. That is a very new wrinkle. Simply force the CDS writers to pay off and then deal with them as the new owners. That and hope, the original owners simply bought cash settlement CDR coverages. That being the case, they will gladly take partial settlements in Drachma’s in the case of Greece.
The problem is hard nosed and requires the state finance ministers to look to the salvaging of their state and people. To that end, Portugal, Italy, Ireland, Greece and Spain should get together and stay together.
I very much suspect that every state in the first world fears a CDS ignited conflagration from sovereign defaults. Here is the lever for the PIIG states to extort their way to a solution. This extortion will have consequences but any other solution will have consequences. At least, the debtor states can settle the problem.
The E.U. was ill conceived and we should all be relieved the British Pound was not surrendered.
As for German Economy it has been a bully to other traders. Problem how to split up the ERUO currency
I just ran across an article on Bloomberg that indicates there is very little outstanding credit default contracts on sovereign debt. Greece was a pittance. Similarly , for the other culprit nations.
Of course, that might change somewhat in the future. What is suggested though is that the holders of sovereign debt of even the PIIG nations are not unduly alarmed. Then, the debt owners may have waited too long.
I understand that Greece will try to sell some bonds next week. I have no idea what the price parameters are. But, long term bonds at say 80 to pick a figure might be a way to generate cash flow to cover current maturities.
Is the current flap just that. A bunch of EU bank bureaucrats worrying up a flap?
Today’s lead front page piece in the Wall Street Journal is ” Hedge Funds Pound Euro”. John Paulson apparently had heavy positions in CDS protection against Portugal,Italy , Greece and Spain that have now been closed out . My guess is the CDS positions he held were low in price, say 100 and he closed them out at around the highs of 400. Paulson is has now taken the other side of the deal. That is he has bought Sovereigns at a considerable discount on the same debt he had CDS coverages on. Given the low total outstanding CDS protection on these sovereigns alluded to in my prior post: were they mostly held by Paulson?
The hedge funds involved here are quoted as being leveraged 20 to 1. The banks have plenty of money for these kinds of loans. Soros and others are now claiming the Euro should have parity with the Dollar.
Yet, the institutional holders of these sovereigns obviously did not seek CDS protection if the article yesterday in Bloomberg was correct.
All of this was presented at an ” idea dinner” on February 8th according to the WSJ. Getting the divisions in place for an all out attack on the Euro. Three days after the ” idea dinner” the Euro was driven down to $1.36.
What do the academics make of all this? GS and others are placing a particularly cheap bearish bet with huge payoffs in a year if the Euro is driven to parity with the dollar. Soros is apparently very hot on the trail here claiming the Euro will fall apart unless the EU fixes it’s finances. He knows that the Herr Doktors inside the EU apparatus will squabble rather than strangle opposition to achieve a fix which may not even be politically possible.
Will these speculators bring down their own system?
I think even Greece can reduce deficit under EURO condition, they may fail to lower debt-to-GDP from the much declining growth. The main Greece problem is the lower productivity and higher inflation and these cannot be solved by lower budget deficit.
The best solution of Greece is to default within the EURO currecy rather than leaving EURO. The default will help Greece reduce debt level without causing the large loss in output growth. This solution will help Greece spend the surplus money on the productivity and efficiency investment. But if grrece choose Germany to reduce much deficit, Greece get nothing but Germany get all because Germany is the major lender and seller for Greece. What Germany wants is only the full debt payment and Germany donot want to bailout Greece because they donot want to bailout German’s private investors who get the higher yield in Greece.
Greece should negotiate the lenders to reduce the nominal and interest expense than is much higher than German interest cost. Imagine even if Greece can reduce deficit, they still pay higher interest cost than other EURO countries, how can they survive? no way. They cannot compete with higher investment cost with the same currency.
I this at the end, it is the game theory. If Germany donot fully bail out Greece, the best choice for Greece is to default and this will cost Germany than Greece because the Greece’s debt holder are mainly from the external lenders. I think Greece is stupid to reduce deficit without any bailout. I think even though Greece defaults, they still in EURO currency; that means they cannot get any instability from default but surely the whole region will face instability but not much.
For Germany, if the best choice is that Greece reduces deficit and pay all the debts and this is the way they actually did. Germany is cleverer than Greece but Germany also has no choice because if Greece chooses default, Italy Spain Portugal and Belgium also default.
At the end, we will see the result. The optimal solution is not the Greece to pay all debts because Greece at the end, they cannot pay all debts because they will face the depression after large deficit reduction. They will face the high unemployment and large output loss and this will cause Italy, Spain, Portugal and Belgium follow the same policies with the depression.
The best solution is Germany has to bailout all and this will cause no depression in EURO area but surely Germany credit risk will equal to Greece.
This morning’s papers quote Papandreou as calling for ” Brutal Steps”to win a bailout from the EU. We have talk between technocrats. What will matter will be the political reaction.Politics in popular adversity is emotions,true belief and personal gain protection first in most nations . Greece has a political unifier… against the state. It will be very interesting to watch the political developments. Will there be a massive Greek popular reaction? A March on Athens genre political reaction?
Today’s Wall Street Journal has a graph showing German banks as having lent Greece, Spain,Portugal and Italy $540 bn. It is Germany that has the problem not Greece, Spain, Italy and Portugal.
The Greek debt is the pittance amount and nearly sixty percent matures in 2010. Germany simply rolls it over or else. Greek debt is only 8% of the total German lending to the four nations.
Germany is being hard nosed with the bit player to try and send a message to the 80 % plus players Spain and Italy.
Unfunded pension liabilities is nonsense, but if you stick with that nonsense, you should agree, that the current payments in the retirement system are effectively interest payments on that liability. This payments are ~10% of GDP, e.g. enough to finance 250% of GDP – which of course means, there is nothing unfunded.
“. . . for the Greeks to manage their dual problem of too much debt and producing too little of stuff at prices that people actually may want to buy from the Greeks.
The Greeks real problem is the euro, which prevents each member of the EU from controlling its currency. The euro “standard” is a clone of the gold standard, whereby individual nations have lost the ability to create money at will.
We went off the gold standard, for the express purpose of acquiring that ability. Thank heavens we did. If we were still on a gold standard, we would be mired in the deepest depression imaginable, with no way to emerge.
The euro always was a disaster, waiting to happen. See: http://rodgermmitchell.wordpress.com/ for more on this.
Rodger Malcolm Mitchell