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How Syriza crashed Greece.

Consider a single-currency area, like the UK. There are bits of it that are doing well. London and the South-East for example, that subsidises the rest from its excess taxation over expenditure. Only London and the South Eastern regions are net contributors to the UK treasury, but it is barely questioned there that it is reasonable for taxes levied in Reading be used to build roads in the Rhonda or Rothesay. Thus the Welsh for example are compensated for having an interest rate not quite suitable for their economy, as interest rates are set for the economic centre of Gravity, which in the UK probably lies somewhere around Oxford.

Now consider the Eurozone. There are no fiscal transfers, because Germans, who didn’t mind subsidising other Germans upon unification, baulk at subsidising Greeks whom they regard as feckless layabouts (erroneously – further discussion here). But the centre of Gravity of the Eurozone probably lies somewhere around Frankfurt. Thus the Germans, and their associated northern European countries have an appropriate interest rate, and the Spaniards and Italians do not. The Spanish Government, denied monetary levers in the run-up to the crisis, sought to cool an over-heating economy by running a fiscal surplus. You cannot accuse the Spanish Government of being “profligate”. The same is true of Ireland. Portugal’s situation wasn’t quite as clear-cut, but their debts were not out of control. 
Obviously, the asset price bubbles built up in Spain and Ireland, and the subsequent bust took out their banks, which required bail outs. Denied the stimulus of looser monetary policy, by an excessively hawkish European Central Bank, who’s setting rates effectively for Germany, the only other option to these economies is a devaluation in place – cutting wages and living standards until they’re competitive with Germans.
The falling tax revenues mean deficits. Lack of EU fiscal transfers mean Austerity, and meanwhile the ECB is still not responding with interest rates. For the periphery, even Governments like those of Spain or Ireland who sought so, so hard to be prudent in the good times, the Euro is massively pro-cyclical. There will be booms, there will be massive busts and there’s little, if anything any Government in Madrid or Dublin can do about it. This was predicted by economists from the notorious pinko Paul Krugman to arch-“neoliberal” Milton Friedman.
Added to this, the Greeks were not prudent. They near-openly lied about their debts and deficit to get into the Euro, hoping lashing themselves to the mast would encourage some degree of fiscal sanity. But the problems were too entrenched, and sorting them out meant unpicking the settlement of a civil war. The result is that while the Spanish and Irish have endured a savage recession, the Greeks “devaluation in place” was a depression costing 25% of GDP. A grinding, seemingly endless round of austerity and reform that left 50% youth unemployment and an economy in tatters.
The ironic thing about the election of Syriza in January 2015 is that Greece had done the hard work and by mid 2014 was the fastest growing economy in the Eurozone, and had a primary surplus (meaning they were balancing the books before debt service was considered). Given the bailout terms, Greece’s debt service took a smaller proportion of GDP than did Ireland, Spain, Italy or Portugal. By 2014, Debt to GDP in Greece was actually falling. All they needed to do was keep up the reform, and “Austerity” – continual tax rises and spending cuts would no-longer be necessary. The Germans would get their money back, eventually. Greek growth would take over the heavy lifting from austerity after years of tax rises and spending cuts. Economies emerging from such depressions can often grow fast.
Then, in January 2015, they elected a bunch of hard-left Yahoos, who encouraged a bank-run, shattered what was left of business confidence, and were forced to introduce capital controls because of a childish and unreasonable petulance wrought by economic fantasy which could only have come from a Marxist academic “economist“.  Privatise state assets? The horror! Make civil servants turn up to work, and don’t let them retire on 80% of salary at 58? The inhumanity! The Greek people may have been sick of Austerity. But if they’d just seen it through, they’d be heading up now, rather than enduing a 3 week bank-“holiday” and queueing up at ATMs for their daily ration of cash. Syriza have probably cost Greeks another, entirely unnecessary, 10% of GDP, and the resultant continuation of Austerity that comes with it. This makes Yanis Varoufakis (the “minister of Awesome” according to twats on Twitter) the most unsuccessful finance minister in history.

All the pointless yes/no referendum on the terms of the bail-out did was make a Euro exit, something Greeks apparently don’t want, much more likely. As it happens, Alexis Tsipras, after sacking Varoufakis, looks like a man who’s about to capitulate completely. It would’ve been better had he done so much, much earlier, and not caused such a catastrophe for the ordinary Greek citizens.

*slow hand clap*
There is a theory that all this was deliberate; a means to build socialism in the ruins of post-Euro Greece. But this assumes skills and ability “anti-establishment” parties almost never possess. Never ascribe to malice that which can be put down to incompetence.

This crisis is ultimately the fault of Generations of Greek governments, especially the ones who conspired to get Greece into the Euro by all means fair and foul. It’s the fault of the designers of the Euro who ignored all economic advice and wanted Greece in for silly, romantic reasons: Hellas is mythologised as the birthplace of a European idea of democracy. But the current acute crisis was not inevitable. And the blame for that is the hard-left morons of Syriza and the Greek people who voted for them.

“Democracy is the theory that the common people know what they want, and deserve to get it good and hard.” HL Mencken

If you elect the hard-left, you get a financial crisis. Every. Single. Time. Basically because capital is faster-moving than the people who want to confiscate it. Greece was warned. They did it anyway. The only thing people like Syriza and their supporters are any good at is shifting blame onto anyone but themselves. 

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Charybdis and Scylla

Alone among the PIIGS (Portugal, Ireland, Italy, Greece, Spain), Greece was running a massive structural deficit before the crisis. Ireland and Spain in particular were torpedoed by the financial crisis, despite running prudent fiscal surpluses in 2007, which was the only bubble-cooling option available to their governments in the absence of monetary levers. The Irish and Spanish were not partying on Germany’s tick, but were instead trying to manage the structural flaws in the Euro. The Greeks on the other hand were using Germany’s credit card to pay the settlement of their civil war.

Since the 2008 crisis, the Greek right has, inflicted enormous pain on the population, removing graft and non-jobs which had become a birthright for many, and tried to deal with the widespread tax-evasion (evasion probably isn’t strong enough. Many Greeks simply ignored the need to pay much in the way of taxes). Tax rises (for that is what making people accustomed to not paying cough up is) and cutting spending (for that is what dealing with graft and non-jobs is) represents a fundamental re-structuring of the Greek economy, which is now 25% smaller than it was before the crisis. This is beyond depression, and looks more like an economy emerging from a major war.
However, on its own terms, Greece’s austerity has worked. The population now has a GDP per capita more appropriate to their actual productivity, and the country is running a primary (ie before debt service) surplus. More taxes are paid, and public sector jobs mostly exist and require their holders to turn up. This is an appropriate time to default as the smoke can clear before the country needs to tap the bond-markets again. The Greek right will take the opprobrium for the pain of the last few years, the left the plaudits for the recovery. Ain’t it ever thus?
Germany, for its part, will have to wave goodbye to the money it lent Greece, and muse on the fact that it has the European empire the desire for which has burned in the Teutonic heart since the country was unified under the Hohenzollerns, and that means it must sometimes pay others’ bills. Think of it as payback for living under the US security guarantee, which costs American taxpayers 4% of GDP, when Germany spends 1%. With power, comes responsibility.  
Greece should default. Germany should pay. Greece cannot default unilaterally, as they lack the resources to stand behind their banks, so they need Troika co-operation to do so. There’s ultimately no need for Greece to leave the Euro, even though this would probably be better in the long-run for everyone; this would allow the Greeks to default, devalue and move on. However there is no political will for this amongst the players that matter (Greece and Germany), however much British anti-EU types yearn for it. Grexit won’t happen. The default and devaluation would probably mean another 2 years of economic uncertainty, and Greek society may not be able to cope without descending into violence, and it’s probably not worth that risk.
Syriza will not be able to deliver promised spending increases, though the austerity is probably going to be a lot less severe from now on. This is going to leave a lot of people very disappointed. The non-jobs, the state pensions paid for life to siblings, the fictional tax returns Greeks used to enjoy are not coming back. The only certainty is whatever happens, Alexis Tsipras is going to get a very sharp lesson in economic reality and power politics when he sits down in front of Frau Merkel.
Muddling through with a Grumpy German taxpayer picking up the bill for a Battered Greek economy, leaving the fundamental structural flaws of the Euro in place is probably the least bad solution all round.
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A Layman’s Guide to the Euro Crisis.

There is a lot in the news about the crisis in Europe, and a lot of the coverage is filtered through political lenses as people project their beliefs onto what’s going on. Eurosceptics are enjoying saying “I told you so!”. Left-wing parties are blaming the banks and the political right is seizing an opportunity to ‘shrink the state’. It’s often difficult to separate fact from journalistic wishful-thinking. So what’s really going on?

The EuroZone is a ‘currency union’ without a ‘fiscal union’. ‘Currency union’ means sharing the same currency. The 50 States of the USA are in a currency union with each other, and so are the nations of the UK. The EuroZone is a currency union between some European Union nations.

A ‘fiscal union’ is where a central government makes spending decisions for a currency area. Despite devolution in the UK or the American states’ tax and spending powers, the USA and UK are ‘fiscal unions’. The American Federal government distributes funds from a central pot to the individual states to spend on things, such as roads or law enforcement. In most fiscal unions, richer areas pay more tax, but don’t get more state spending per head than poorer areas, resulting in a ‘fiscal transfer’. Some ‘entitlements’, what people in the UK would call ‘benefits’ for example are paid out of a federal pot. In the UK, the greater South East subsidises the poorer areas of the UK by this method.

In the EuroZone, many thought this union would cause problems, and indeed the designers of the currency knew this too, but considered the problems would act as a driver of ever closer union, their ultimate end aim. The Euro was a political, not an economic construct.

What precipitated the crisis around Europe was the inability or unwillingness of Northern Europe to subsidise the periphery in the way London and the South East subsidises the rest of the UK. As the periphery ran out of money, and succumbed to financial crises, one-by-one the markets lost faith in the ability of these governments to meet their debts.

Governments issue debt as bonds. If investors think the risk is low, they will be willing to pay a high price, resulting in a low yield to the investor and low costs to the borrower. If the risk goes up, the price falls, and the yields rise. Countries afflicted by the financial crisis saw bond yields rise as investors sold. The money investors raised by selling this debt flooded into the good risks at the core – especially Germany, which has seen yields fall sharply as a result. The UK and Switzerland have enjoyed a similar effect, being perceived as safer-havens. This rapidly became a self perpetuating downward spiral for the bonds of the afflicted governments.

The problem with the Euro is that small countries or those which had poor track records of paying back debt, suddenly saw their borrowing costs fall when they joined the Euro. This is because the markets initially thought all EuroZone bonds ranked equal, or nearly so, to those of Germany. Because the peripheral governments’ borrowing costs fell, so too did those for business and consumers. This resulted in banks lending and people borrowing much more than they would otherwise have done. Some governments, notably Greece, fell into the same trap too.

In Ireland and Spain in particular, this very low interest rate resulted in a huge speculative property bubble as a flood of new money inflated property prices. People got rich very quickly, and numerous new developments were built. However all bubbles must burst, and the oversupply of property meant there was insufficient demand for all the new flats and houses. The market crashed. The bad loans secured on overvalued property created losses which overwhelmed the banking sector. The Irish government, despite the fact it had been ‘fiscally prudent’, by running large budget surpluses during the boom was also overwhelmed. In 2007, Irish debt was just 25 per cent of gross domestic product (GDP) – a measure of the size of an economy. Despite this, the Irish state, unlike that of the UK, simply didn’t have the line of credit to finance the enormous banking losses, and needed help from the EU and UK. Because of the banks’ losses assumed by the Irish state, debt to GDP ratio has now risen to nearly 100 per cent.

Portugal, however did not suffer such a crisis, as it lacked a big banking sector of its own, so much of its property bubble was financed from across the border in Spain. However the Portuguese government didn’t run significant surpluses in the good times, and when the economic crisis came, tax receipts fell, and the market lost confidence in the government’s ability to pay its debts. As the country was running a large deficit, when interest rates hit 7 per cent, a burden totaling 80 per cent of GDP, the market considered this unsustainable. The EU & International Monetary Fund was forced to ride to the rescue.

Spain, being a larger economy than Ireland, took much longer for the bubble to deflate. Its banks were also sounder, carrying more capital than Ireland’s. Like the Irish, the Spanish government ran a prudent surplus during the boom, but it too may now struggle to raise sufficient money to bailout its banking sector, which has suffered the same fate as Ireland’s. As a result, Spain needs a bailout. And the EU has made €100bn available. Because it is not clear whether this is from the European Financial Stabiliity Fund (EFSF) or European Stability Mechanism (ESM), existing holders of Spanish debt are unsure whether the new creditors are ahead of them in the queue for repayment. Investors fear they have been ‘subordinated’ by the new line of credit. As a result, after brief euphoria on the markets, borrowing costs in Spain and Italy rose on the news.

Italy did not have a property bubble, nor did it have a banking crisis. Instead, it enjoyed a cheerfully chaotic political system which was incapable of balancing its books. Short-lived governments had little incentive to save money, finding it easier to buy off supporters without taking long-term decisions. Their problem as a result is simply an enormous debt burden of 130 per cent of GDP. Currently, Italy is running a ‘primary surplus’, that is, it is able to meet its costs – public sector wages and so on, and would be able to balance its books, were it not for debt interest. Italy’s budget deficit is therefore a direct function of the yield on its bonds. Perversely, this is the moment countries are most likely to default, as they will not need to tap the bond-market to meet existing expenditures. As a result, investors have fled Italian debt in a self perpetuating downward spiral in their bonds and increasing the likelihood of default.

Greece’s problems can be summed up as ’all of the above’, and then some.

As a result, everyone in the EuroZone is seeing their borrowing costs rise, except the dwindling core of Northern European AAA rated countries. Even France isn’t safe – they haven’t had a balanced budget since the early 1970’s, and borrow at nearly twice the price of Germany.

The UK’s debt burden is 80 per cent of GDP or so (worse than Ireland in 2010), a deficit in 2010 of 11 per cent (the worst in the developed world) and an enormous banking sector relative to GDP. So why doesn’t the UK have a massive economic crisis like Ireland, Italy and Spain? Why is UK 10-year debt yielding a paltry 1.8 per cent when equivalently indebted countries with far smaller deficits find their debt yielding over 7 per cent? Ultimately, it’s because for the time being, the debt markets have confidence the UK can meet its obligations, if necessary by printing money. This option is not open to the EuroZone, who have subcontracted this to the European Central Bank. Furthermore, the UK’s government debt has a much longer maturity than many equivalent countries, so does not need to access the bond market to ’roll over’ maturing issues, giving the UK’s government time to bring the finances under control. Finally, and this is almost certainly the least important effect, the UK’s government is committed to gradually cutting the deficit.

The EuroZone therefore is suffering from the logic of a ’currency union’ without ‘fiscal union’. As the breakup of the EuroZone looks increasingly possible, bank depositors in Greece (most urgently), Portugal, Spain, and Italy do not want to risk waking up one morning to find they’re holding Drachma, Escudos, Peseta or Lira instead of Euros. So they open bank accounts in London, Geneva or elsewhere in currencies – Euros, Dollars, Swiss Francs or Sterling which they trust to remain ‘hard’, and where their cash-strapped governments can’t get at it.

This causes a collapse in the money supply – often a cause of deep recession. Unlike in a ’fiscal union’, this money is not replaced by transfers such a grants paid out of EU pooled funds, which are simply not large enough to do this job. As the economies of the EuroZone periphery shrink, so do tax revenues. With no corresponding shrinkage in obligations, the deficit can only rise. Spending cuts cause further short-term pain as public-sector workers get laid off, and the economy risks spiraling down. Wages, for those who retain jobs get cut and living standards fall. This is the mechanism by which ’austerity’ is accused of driving economies down.

Unfortunately, for the citizens of the EU, from an economic point of view this fall in living standards and wages is exactly what is needed. The underlying problem is competitiveness. Italian workers are just more expensive than Germans per unit of output. Italians’ wages have to fall by around 20 per cent to regain competitiveness, Spaniards by 30 per cent and Greeks by 50 per cent.

The Italian economy was never really as large as the UK’s, nor were Italians as rich as Germans. They just got access to Germany’s credit card for a decade and so thought they were. Bringing the economy back to reality will be a painful process. This is called an ’internal devaluation’. It will be miserable, and scar the people forced to endure it for life, and result in a flight of talent and capital, from places suffering its effects. An internal devaluation on the scale needed may not be possible without violence.

Devaluation of the currency means most countries overcome these effects, and make their exports and workers competitive. It’s worked for the UK many times, but for the periphery, this means leaving the Euro. A new Drachma would probably fall by 50 per cent almost immediately, achieving competitiveness with the German worker in a matter of months rather than years. This is no easy option though, either from the point of view of the Greeks who will see imports, even of staples become prohibitively expensive; or the rest of the EU. Once the market has forced one country out, the next one (Portugal or Spain) looks more likely to go too, creating a cycle of instability. It is this EuroZone policymakers fear the most.

If Southern Europe is to remain in the Euro, and yet avoid grinding recession for a decade or more sudden economic catastrophe, it is going to need vast injections of cash to pay the bills. It also needs its productivity and wealth to catch up with that of Germany and Northern Europe. For an idea of the scale of cash transfer needed, look at fiscal transfers from the North to the ex-Confederate states after the US civil war, or from West to East Germany after unification. 10-20 per cent of GDP. It is unlikely the (West) Germans can be persuaded to pay on that scale again. Nor do Germans seem willing to underwrite the deposits in EuroZone banks (a so-called banking union) or underwrite the bonds of the struggling EuroZone states (the so-called Eurobond).

People describing themselves as ’Keynesians’ think the death-spiral of austerity and internal devaluation can be averted by governments injecting demand into the economy by borrowing huge sums in order to spend. Who is going to lend to these peripheral governments? The German government seems unwilling to let the European Central Bank print enough money and the open market has already said “no”.

It is not a binary choice between ’growth’ and ‘austerity’. Even if these governments could raise the money, they may not achieve the necessary growth. There is evidence that the negative effects of increased public spending can cancel out any stimulus to the economy. Public debt often ‘crowds out’ private investment. High debt burdens may also cause people to anticipate future tax rises and rein in spending and increase their savings which will hurt the economy. These negative effects seem to become greater than the positive when the debt burden reaches 80 per cent of GDP, though this is not a hard and fast rule. Furthermore, economies seem to find any growth at all very difficult to achieve if public debt reaches 120 per cent of GDP. Thus, attempting to spend your way out of recession, an indebted Government risks fruitlessly adding to the debt burden, to no effect on overall GDP growth.

It seems the money for stimulus has probably already run out.

In my opinion, the best thing to have done is to not join the currency union in the first place! The UK’s ejection from the European Exchange Rate Mechanism in 1992 and Iceland’s experience since 2008 seem to bear this out. ’Austerity’ and the devaluation in place is painful, so ’stimulus’ is superficially attractive, but it risks creating a bigger problem for the future for little gain now. The unfortunate conclusion is what is necessary is impossible, and what is possible is unappealing. There are simply no easy answers. The Euro crisis is likely to form the backdrop to investment decision for some time to come.

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Greek Options

Plan ‘A’: Stay in the Euro, drop wages & prices for local produce, until Greeks are as productive as Germans. This will take a decade or two of grinding, unrelenting economic misery, during which anyone with any talent, ambition or ability will leave the country and everyone else will be scarred by the experience. Each year brings more “austerity” more riots and more chance of extremist politicians gaining power. Germans effectively run the Greek economy. I cannot see how this will not end up with bombs in the streets.

Plan ‘B’: Leave the Euro on a Friday evening, and by Monday morning, all bank deposits are in Drachma, which then falls by 50% against the Euro. Greece’s principal export, sunshine, becomes cheap as drachma-denominated hotel-prices fall. Once-empty hotels become full of people looking for cheap sunshine. The pain and turmoil of the inevitable capital flight and economic chaos lasts 18 months to 2 years before the economy returns to growth, but may result in extremists getting power in the mean-time.

Either way, Greeks are much poorer and may end up with an unsavoury demagogue in charge. They were of course never rich, but just thought they were because they nicked the Germans’ credit card for a while.

The same is true for Spain & Portugal, though their overspend is less egregious and their political culture an order of magnitude more mature than Greece’s. The Spanish people in particular have been impressively stoic – they voted for austerity, and haven’t so far chucked many rocks. They would, of course be better off leaving, but they may, just, be able to hang on in the Euro by the skin of their teeth. The public & political will appears to be there, for now.

Italy should go too, but as a founder member of the EU, there is probably just enough political will outside Italy to keep them in the club and as they’re running a primary surplus, they’ve probably the financial ability to achieve plan ‘A’ without too much pain. It will of course be a decade before Italy grows again.

Or Plan ‘C’: the ECB can announce that all €zone bonds rank Pari Passu with Germany’s. Everyone pays 4% but Germans’ living standards fall steadily towards the Eurozone average as capital floods south, but the Eurozone holds together but with one economic government. The Germans will get control over the cash jar and European nations cease to be independent in any meaningful way. Good luck with those treaty negotiations!

Conclusion: Greece, and probably Spain & Portugal too will be picked off by the markets and be forced out of the Eurozone. Italy will probably stay in.

The Euro miserably failed its first stress-test, because idiot politicians thought they could defy economics and make water flow uphill by means of a resolution of the Council of Ministers. The single currency was a silly idea, badly implemented. It is a disaster which is going to cost the life chances of hundreds of millions of southern Europeans.

Be suspicious of a politician with a big idea. The safest thing to do with these creatures is shoot them on sight.

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What to do with your Euros…

So. You’re a moderately wealthy Greek person. Do you keep your money in a Greek bank, in Greece or do you make sure all your Euro notes are printed in Germany, where your bank account is and open an offshore £/$ account?

The Euro, a poor idea, badly implemented.

That’s right, you get your money as far away from Greece (and the risk of being told one day “you’re now holding Drachma”) as you can.

Now imagine you’re Spanish, Portuguese, Irish or Italian. You have a bit more time, but the result is the same – any money you have gets out of the country if you’ve any sense.

No bail-out can replace the money flooding out of these countries. The people have lost faith in the Euro project, and as confidence is the only thing underpinning a fiat currency, the Euro has already failed its first test. Even strong German GDP numbers are evidence of the flood of money from the periphery to the core not the underlying strength of the German economic model. Germany rigged the system in its favour, and is now parasitically sucking money out of its empire, an Empire even the German people never wanted.

Is there anyone NOT shorting the Euro right now? I don’t think even the most pessimistic Eurosceptic expected to be this right, this soon.

Now my standard prediciton is that political will can see the Euro hold together at great cost to the wealth and living standards of the people, particularly in the periphery. I am becomming less confident they can pull this off by the day and the rise of the Anti-Austerity left means even the Iron political belief in the project of “ever closer union” is waning.

So, to hedge the Euro’s demise, buy* banknote printer De La Rue.. It’s going to be a bumpy ride.

*Doesn’t constitute financial advice, this may not be suitable for your circumstances. Past performance is not a guide to future performance. Stocks and the income from them can go down as well as up, seek advice from a professional advisor, yadayadayada.

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