Tuesday, June 30, 2015

Greece on the verge

Jean François Ponsot, Jonathan Marie and @NakedKeynes

I'm in France for a talk at the Université de Paris XIII, invited by Jonathan Marie and Dany Lang. The Greek crisis looms large in everybody's minds. I gave a talk based on two papers, one published here, and the other (specifically on the Spanish crisis) just finished, which will soon come as a working paper. But I discussed to a great extent the debate between Sergio Cesaratto and Marc Lavoie on the nature of the European crisis, that is, whether it is a balance of payments crisis or a monetary sovereignty one.

Cesaratto argues that a balance-of-payment crisis is possible in a currency union, and that the financial crisis of the Eurozone is indeed such a balance-of-payment crisis. Arguably Pérez and Vernengo (2012; the one linked above) suggest the same, even though the paper was written to argue that the crisis was not fiscal, as per the mainstream hypothesis, and the actual policies pursued by the Troika, which require fiscal adjustment as a solution (presumably because the problem was fiscal).

In the balance of payments or Cesaratto hypothesis, the problem would be that there are no federal transfer payments from the surplus to the deficit countries to help compensate the negative impact of CA deficits on GDP and budget balances. Or to make it more correct, it would be that there are no fiscal transfers from a federal government to the federated units, as has been shown is the case by Nate Cline and David Fields here for the US case.

Yet, as noted by Lavoie, the Eurozone crisis seems to have been mainly caused instead by a banking problem, which transformed itself into a public debt problem. In other words, the currency issue, and the functioning of the monetary union seem to be at the core of the crisis, not a balance of payments one. The monetary union clearly eliminates exchange rate risk, but not country risk, which might explain the interest rate differentials between euro countries. So some countries remain more vulnerable than others.

Marc suggests that the interbank payments system, the so-called TARGET2 (Trans-European Automated Real-time Gross Settlement Express Transfer System), used by the European Central Bank (ECB) can be seen as being at the heart of the problem. In his example, if a Spanish firm imports cars from a German firm, the ECB credits the German firm in a German bank and debits the Spanish one in his correspondent bank. There is no limit to the debit position that the Banco de España, the Spanish central bank, can incur at the ECB. The overdraft capacity of the ECB is unlimited.* So in this view the solution would be for the ECB to use its overdraft capacity to create the conditions for the euro periphery to continue to function without austerity.

Alternatively, this could be solved if the ECB bought bonds from the member countries. However, the rules of the euro imply that the ECB cannot purchase sovereign debt, and, hence, the mechanism by which a risk free asset is normally created is precluded to function. The creation of the risk free asset is the essential function of the central bank in relation to financial stability. According to Lavoie the Eurozone setup should have incorporated a central bank that holds and purchases large amounts of securities issued by the participating national governments. Something that was done in the US by the Fed after the crisis.

My argument, discussed briefly here before, is that the Cesaratto and Lavoie hypotheses are one and the same. The balance of payments and the monetary sovereignty views of the European crisis are two sides of the same coin. The fact that overdraft facilities involved in the TARGET2 system could be used to create credit to finance euro imbalances, or that the ECB could buy government bonds in the secondary market does not preclude the fact that the actual crisis is, in the absence of these policies, the result of the inability to manage a CA deficit. In his example, the origin of the debit position of the Banco de España is an import of German cars, which presumably corresponds to a current account deficit position.

In this sense, the European crisis is caused by the failures of the euro design, but it is also one that forces countries with banks that over-borrow, or that have firms that over-import, to adjust by reducing its imports through austerity, and, hence, increasing its ability to repay. Note that leaving the euro (in particular for Greece, i.e. Grexit), which would imply some degree of depreciation of the newly created currency, might not be sufficient (or even necessary) to solve the crisis. I discussed this here before. Yanis Varoufakis, the Greek finance minister, has also been skeptical about depreciation and Greexit.

* Marc compares TARGET2 to Keynes bancor, and suggests that Keynes might be, more than Mundell, the father of the euro. Two things come to mind. I think in principle, the adjustment rules based on austerity, are closer to Mundell than Keynes (poor Keynes, this institutional mess should not be pinned on him). Second, Keynes' plan also implies that there is a need for surplus countries to finance deficit ones. What really matters in this is who creates the overdraft, who has the power to create money, so to speak. Normally that has nothing to do with having surpluses. National governments are not in surplus against its subunits. Globally the US is a deficit country, and is still the one issuing the global currency.


  1. I tend to very much agree with the idea that the Greek and other situations in the EU, like the Baltics and ireland, were basically current account issues fueled by a global and also european credit boom, as described well by the books of M Pettis, a recurrent scenario. To a large extent within the EU exporter countries have had a policy of "vendor financing" (some call it euphemistically "savings glut") and then abruptly stopped it. Using TARGET2 to work around the legal limits on the ability of the ECB to monetize member government debts would be in effect a restart of "vendor financing".

    What has happened is that in effect "gold" has been flowing out of Greece to buy the "good stuff"and when the flow of borrowed "gold" stopped and even reversed bad things happen.

    Currently Greece has a balanced foreign account and government budget, at 20% lower GDP than the peak fueled by borrowing "gold". Can greek GDP grow without hitting the foreign account constraint? I doubt that very much in the short and medium term.

    But this statement seems strange:

    «the euro design, but it is also one that forces countries with banks that over-borrowed, or that over-imported, to adjust by reducing its imports through austerity, and, hence, increasing its ability to repay.»

    The euro is for members sort of like gold, like dollars for states and municipalities in the USA. But when a country systematically overimports, eventually it has to increase its ability to repay, whether it prints its own money or uses some kind of hard currency.

    All that using own money does is to give the option to default by inflation instead of by nonpayment. Eventually foreign suppliers get tired and ask to be paid in hard currency.

    As H Minsky said, anybody can issue their own currency, it is very easy, the difficult is to get it accepted by vendors as payment.

  2. The fault, IMV, is analysing the countries within the Eurozone rather than the currency zone itself.

    Do you analyse Alabama wrt. California, or Ontario wrt. BC or Scotland wrt. Wales? Rarely if at all.

    If you analyse the currency zone and ignore the largely meaningless political borders then you get a better idea where things are.

    This 'over importing' nonsense goes away when you start analysing entities based upon the currency zone(s) they operate in.

    You can't 'over import' because for the imports to have happened somebody somewhere has to have got what they wanted at precisely the same time or the deal would not have taken place. If that is financial savings, then that is fine. If that turns out to be a bad deal in the future, then that's just business.

    The problems in the Eurozone have been caused by continuing to pretend that the national governments are something other than a corporation. Once they lose the sovereign right to issue money, they cannot rectify an unsustainable debt position on their own. They have to go through a pre-pack administration process to eliminate the debts and resolve the situation.

    The problem with the Eurozone is a lack of a Chapter 11 type process for government entities.

    If you want to treat governments like corporations, then you need to treat them like corporations - including bankruptcy mechanisms to wipe out over extended loans.

    1. «Do you analyse Alabama wrt. California, or Ontario wrt. BC or Scotland wrt. Wales? Rarely if at all.»

      That is done by wise people, and regional GNI is a thing. Because there are immense disparities within diverse countries. For example in the USA the "Rust Belt" was effectively let go bankrupt by the rest of the country, never mind Detroit, and so was the "North" in the UK, never mind Sunderland. The UK North was rescued a bit, like Ireland, Poland, Greece, by EU "regional policy" funds and some (pretty modest) support by the UK government.

      «Once they lose the sovereign right to issue money, they cannot rectify an unsustainable debt position on their own.»

      This is the usual delusion of the delirious wing of the MMT that issuing your own currency means one can always «rectify an unsustainable debt position on their own». The condition for being able to default indirectly is not having the "right to issue money", but the credibility to issue debt in whichever currency lenders are willing to be repaid in. There are plenty of countries that issue their own money and nobody wants to lend them ten rials.

      «The problem with the Eurozone is a lack of a Chapter 11 type process for government entities.»

      Well, the issue with bankruptcy is appointing a receiver/trustee. So in the USA municipalities can go bankrupt and the State they belong to appoints a receiver. But in the USA the States themselves cannot be subject as they are constitutional level entities and they have sovereign immunity and any it is inconceivable except perhaps in case of war or rebellion for the federal government to take over a bankrupt State government.

      I would think that the same will always be true of the EU too.

    2. My personal take on the Greek/Irish/Latvian/... problem is that the problem with the Eurozone is the lack of financial and regulatory discipline in the core countries like Germany.

      It is them that created the conditions for regulations that had the following two fatal properties:

      * All EU member debt is assumed to be AAA by decree and "wink wink" we may make it AAA if there is a problem but "nudge nudge" not going to put that in writing.

      * AAA debt can be put on the balance sheet at infinite leverage ratio, or 100 to 1, or whatever.

      In essence, "core countries" legalized balance sheet fraud for their financial sector to enable zero-cost "vendor financing" to boost their exports as a "feel good" cover for introducing right-wing policies, and countries like Greece borrowed as much as they could to make even richer the "friends of friends" of the government of the day, knowing that when it came to repaying it would be somebody else (usually low income workers and the poor, those without Swiss accounts) to suffer the price of default.

      The above has very little to do with the euro, simply with the eternal desire of "core country" financial sector executives and traders to legally steal ("asset strip") as much capital from their employers as they can, and the eternal desire of insider shysters of debtor countries to scam a lot of loans and let the suckers be the fall guys (BTW in the UK currently those "insider shysters" are the owners of residential property voting in marginal seats in the South East).

      There is a very good observation as to the above, summarized in this old article:

      «'Private sector involvement'
      Collectively, The euro-area public deficit and debt figures are actually better than either those of the US or Britain. Interest rates in many peripheral countries are much higher than those in Britain or the US. There are two reasons for that:
      * No implicit central bank guarantee for public debt of members of the euro area
      * The insistence on 'private sector involvement' (PSI) for Greek debt.
      Let's start with the latter. Problems within the euro only really started to hit the market when, on Germany's explicit insistence, and against much opposition (most notable from ECB president Trichet), talks of a 'haircut' for Greek bondholders (mostly banks) became public. This spooked the markets and opened a new front in the euro crisis.»
      «Word has it that Jean-Claude Trichet, the president of the ECB, goes to every meeting armed with a graph displaying interest rate differentials, which began to diverge just after that day in October, which is marked by a little flag 'PSI' in Trichet's graph.
      It culminated in the second bail-out for Greece (July 21st of this year) which introduced a 'PSI' in the form of a one-off 21% voluntary haircut. The cat (the possibility of default on public debt within the euro area) was out of the bag, despite insistance that this was a one-off, would not be repeated, and was entirely voluntary.»

    3. «the eternal desire of "core country" financial sector executives and traders to legally steal ("asset strip") as much capital from their employers as they can,»

      As to that JK Galbraith's eternal "The Great Crash 1929" which describes the current world fairly well (Chapter 4 is titled "In Goldman-Sachs we trust", and it was written in 1954 about events of 1929) reports the following, page 198 of a recent Penguin edition as to what became Citigroup:

      «The bank did a large business in Cuban bonds. In contemplating these loans, there was a tendency to pass quickly over anything that might appear to the disadvantage of the creditor. Mr. Victor Schoepperle, a vice-president of the National City Company with the responsibility for Latin American loans, made the following appraisal of Peru as a credit prospect:

      "Peru: Bad debt record, adverse moral and political risk, bad internal debt situation, trade situation about as satisfactory as that of Chile in the past three years. Natural resources more varied.

      On economic showing Peru should go ahead rapidly in the next ten years".»

      90 years ago Peru, today (and about every 10-20 years) Greece.

      And there is in M Pettis "The volatility machine" the amazingly funny description of the story of a "money doctor" in Chile in the 1890s IIRC.

  3. Re: Keynes and the bancorp

    My understanding that Keynes did not want a Target2 style system, but preferred the imposition of strict borrowing caps.


  4. «Normally that has nothing to do with having surpluses.»

    As a rule it has much to do with surpluses, even if, once a "core country" switches into trade deficits, it can take a long while before their currency loses its status.

    The reason is very simple: people want a currency for the same reason they usually learn a language, to gain access to a supply of things they want. People who want to study philosophy learn greek and german because they give access to a vast body of material in that topic. People used to buy dollars because with dollars you could buy directly practically anything from the USA. Nowadays people buy dollars not to buy trade goods, but to buy USA assets instead, as a way of managing political risk.

    As to that there is a very interesting story about the Bancor and the IMF. The USA counterpart to Keynes at Bretton Woods refused to agree to the Bancor because he thought that Keynes wanted it so that the UK, which had run out of gold and assets to buy war material from the USA, could issue themselves Bancors to pay for imports from the USA with worthless paper.

    This was when the USA was a mighty exporter, and having dollars in your pocket meant you could buy a chocolate bar or a typewriter or a bulldozer.

    And there is a very interesting story as to that as to IMF Article XIV (inconvertible currency) and Article VIII (convertible currency) countries where the former were "borrower"/"importer" countries and the latter "creditor"/"exporter" countries in practice. In 1961 most EEC countries and the UK were promoted from article XIV members to Article VIII member, "entirely coincidentally" around the time the so-called dollar-shortage had become a dollar-glut, and the USA trade balance had started swinging the other way.

    «Ten members of the International Monetary Fund today [February 15] announced the formal convertibility of their currencies within the meaning of the articles of agreement of the Fund. The 10 are the United Kingdom, the 6 members of the European Economic Community—that is, Belgium, France, Germany, Italy, Luxembourg, and the Netherlands—together with Sweden, Ireland, and Peru. These actions are heartily welcomed by the United States. They represent the culmination of the efforts of the 10 countries to achieve one of the major objectives set forth in the Fund articles. They constitute further evidence that the system of monetary cooperation embodied in the Fund is working successfully. Most of these countries announced the convertibility of their currencies for nonresidents some 2 years ago.»

    There is a note in V Bonham-Carter's diary dated May 14th 1963, where during a conversation President JF Kennedy demonstrated he was very aware of all this:

    «[President Kennedy] went on to describe how [de Gaulle] was now blocking all progress in Europe- in defence, economic, etc. I asked him how he thought this road-block could be broken. He said, 'The root of the matter is that not only you in Britain but we in the USA have now become debtors and not, as we always used to be, creditors. The gold reserve had ebbed at the following rate (he then gave the figures for the last few years). Europe is economically for the moment in a stronger position than we are ...'.»


The End of Bretton Woods

    End of Bretton Woods with Barry Eichengreen, myself and Lilia Costabile, organized by L-P. Rochon and the Review of Political Economy.