A Short Comment On Greece

I see that Varoufakis has resigned as Finance Minister in the Greek Cabinet.  Primarily due to his “abusive” personality and thus a hindrance to any further negotiations with the EU creditors, the EU Parliament, and The ECB.  Frankly is would have been simple enough to merely keep him from the table, let his stay in Greece and attend to what finance ministers do when they are at home.  BUt I suspect it might be more than it appears.  The fact that Tspiras wants to resume negotiations says a great deal about this latest development.  First a little math.  As we all know, 2 + 2 always equals 4.  Take two clam shells and add to that group two more clam shells.  How many clam shells do we have in front of us?  Four clam shells.  Ok, so far, so good.  Next, Greece owes all the other EU nations and private creditors.  No one owes Greece anything, that is, Greece has no assets that would include the government bonds of other nations in or without the EU area.  So Greece equals zero, the other countries equal 340 billion of Greek government bonds.  Add in the EL and other funding programs and Greece still equals zero and the rest of the EU equals at least 130 billion, if not more.

So Greece wants to remain in the Eurozone and in the EU trade zone.  Well, one can see that remaining in the EU trade zone has its advantages and its disadvantages.  France and Poland produce a great deal of wheat and rye.  The point of a trade union is that each country can use its comparative advantage to balance exports and imports.  When it is merely a trade union, then an excess in trade balances affects the foreign exchange values.  That is, if I am a net importer then my currency must have less value than if I am an net exporter.  It’s a matter of who owes whom.  If I have an excess amount of French Francs then what should I do with this excess?  Perhaps everyone has an excess of French Francs.  If the French don’t have many exportable goods and services that other countries want then this deficit means that the French Franc is worth less because it is unwanted.  That is, as an exporting country, I have too many French Francs and my ability to use then in the buying of goods and services provided by France is limited.  It’s like having too many Bob Uceker baseball cards, no one wants them because he was a very minor player.  You want Mickey Mantle or Willie Mays, got to pay a premium,  But Bob Uceker, we’re giving them away.  I might even have to plead that I’ll give twenty Bob Uceker cards with every Mickey Mantel card.  Bob Uceker has no comparative advantage, even in the cheap seats.  So trade zones have their pitfalls.  This means that countries are urged to cheat in order to either obtain or keep their relative comparativbe advantages.  If France and Poland have vast agricultural areas that produce wheat and rye, then allowing Hungary into the Trade Union merely add capacity for more wheat and rye, thus depressing prices.  Well, this is not good for the other two countries.  Then Italy wants to grow wheat for its pasta makers.  Now we have a real problem because we have reduced the market for wheat grown by France, Poland, and now Hungary.  The function of the EU Parliament is to find ways that satisfy the various country’s need of comparative advantage while allowing more countries to indulge in that same comparative advantage.  Do you start to see some of the problems?

The real comparative advantage for Greece is in shipping.  It has one of the largest flagged fleets in te world.  Problem, the Baltic dry Index says that demand for shipping, the type Greece has as a comparative advantage, is declining and thus not much or a comparative advantage since the demand is very low.  Ah, the economic problem in a nutshell.  When demand for a service or good is low, then that service or good will become low in price.  If I am selling Bob Uceker baseball cards and the market has thousands of individuals selling twenty apiece, then the price I may get for mu=y baseball card will be pennies on the dollar.  Okay, we’ve come this far.

The current Greek government says it wants to pay its debts but not only is the service too high but the amount to be paid back is unsupportable.  But there is both advantages and disadvantages in staying in the Eurozone.  One can, as a small country without the manufacturing and service economy to support the lifestyle your people wish to become accustom can use credit to its immediate needs while prolonging any payback on that debt incurred.  The whole idea of the European Monetary Union is other people’s money.  When a country such as Greece, with a weak currency, can join a monetary union, its currency is immediately inflated by the credit and faith of the other nations.  Did those nasty bond people limit your indebtedness?  Join a currency union and see how much more you can borrow.  If Greece can count on the EU and the ECB to keep funding its banks then why depart that currency union?  So the game is: we are honorable men and wish to repay our debts.  We are honorable men and cannot pay our debts in total, therefore we need debt reduction to remain honorable men.  If you don’t reduce our debts then we shall do the dishonorable thing and default.  I’m sure that Varoufakis has told Tspiras this won’t work and that is why he is no longer the finance minister.  The mistake that Tspiras makes is that a deal to reduce the debt can be made when in reality such a deal is impossible.  Do you understand why?  If my income depends of the money yo owe me and I owe other people, then you asking me to take less is likely to have an affect on my ability to pay those other people.  The math is against me.

So the easy money of the EMU is not so easy as it turns out.  credit has limits and when debt is too great the propensity to repay becomes low.  Let’s take a look at the ECB tools to deal with the situation.

Tools to stem contagion

  • Accelerating QE. QE is not designed to assist individual countries, but with a monthly firepower of €60bn, it remains a powerful force. Moreover, contrary to the OMT that requires agreement on an ESM programme to be activated for a specific member state, the QE tool is already fully active. Should contagion from Greece become more substantial, the ECB could front-load QE without further notice. The ECB could also seek to step-up QE from its €60bn pace, officially to fight an unwarranted tightening of monetary conditions but within the 25% issue limit and 33% issuer limit. We are doubtful, however, that the national central banks (NCBs), where the bulk of the risk of the QE programme is assumed, would buy anything other than their own national debt. Moreover, were the ECB to substantially increase QE it may be open to criticism of monetary financing at a time when the German Constitutional Court is still reviewing the OMT. If contagion is limited to a few member states, arguing on the grounds of deflation risks for the broader euro area – the justification for QE – may also be more complex.
  • ESM and MoU for countries facing tension. Different facilities exist in the ESM: loan, credit lines, bank recapitalisation and primary or secondary market purchase. The latter is likely to be the most efficient and easiest option. The ESM may buy bonds either in the primary or secondary market of any Member States that requested it. The primary market facility is only opened to countries under a programme (i.e. only Cyprus as of now) while the secondary market is also available for non-programme countries whose economic and financial situation is sound. However, in that case a Memorandum of Understanding (MoU) detailing the conditions attached to the facility would need to be approved.
  • OMT. The tool to deal with the risk pertaining to individual sovereigns is the still untested OMT (purchases of bills and bonds having a maturity lower than three years). The OMT programme requires the backing of an ESM programme as well as a clean bill of health on debt sustainability. If that is not the case, step one in the prescribed process as set out in the ESM Treaty is restructuring.

The implication here certainly seems to be that the preferred contagion containment tool is the acceleration of QE (“more cowbell” so to speak).

This will come as no surprise to the Zero Hedge faithful. Less than two weeks ago in “Goldman’s Conspiracy Theory Stunner“, we remarked that the bank (and Mario Draghi’s former employer) seemed to be suggesting that the ECB would actually be just fine with Grexit, because it would give the central bank an opportunity to expand QE. Sure enough, just a little over a week later, the ECB effectively primed the pump by expanding the list of PSPP-eligible SSA bonds.

This is why the ECB will still play hardball with Greece.  Call for the repayment of the ELA funds by the Greek Banks and then Tspiras has to nationalize said banks or his Greek depositors pay by having their deposits take a severe haircut.  It seems that staying in the EMU will not be so easy.  True, Greece, when it nationalizes all the Greek banks can then issue script as California did during the Lehman disaster, but that is a short term solution.  The only currency authorized for use in the EMU is the Euro. Since it has a Euro printing press it could of its own accord start printing euros by the billions but that end badly for both Greece and the ECB.  Desperate measures usually do.  Greece needs GDP now and selling contraband to Russia is one on the many ways to obtain the cash they need.  Granted, they will be paid in Russian Rubles and there will be an exchange premium.  But with a Russian gas pipeline, those rubles can be exchanged for natural gas.  So ultimately Greece may be forced out of the Eurozone by Mario Draghi and the ECB.  Of course quantitative easing is its own reward and Draghi will live to regret that gross mistake.  The problem with QE is that it means more credit creation ith no assurance of debt service let alone payback.  Draghi’s mistake is believing that QE will solve all the EMU problems.  Tsiperas’ mistake is believing that there is a deal that can be made.  Point in fact, Greece is better off going alone in the same way that Iceland did.  Hang your previous government officials for having gotten the country in this mess and then default and pick up the pieces.  Of course should that happen then the EMU and the EU fall from its own weight.  Spain, Portugal, Italy, and maybe Ireland and France will join the movement to leave the EMU.  That would leave Germany and Merkel holding the bag.


One thought on “A Short Comment On Greece

  1. Absolutely. The most effective QE is in the form of debt relief at this stage. The problem for the ECB is that whatever Greece gets Spain, Italy, et al will also want – but they also need it. So do many consumers around the world as well.
    QE is one thing, but the declining velocity of money along with QE has rendered it totally ineffective. The only way to boost velocity is debt relief, and without that we can QE all day and see no stimulus at all.


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