Greece: The Problem and the Solution

Alexis Tsipras has sent a letter to Jeroen Dijsselbloem of the euro-group (you can download the letter here, pdf), in which he requests a separate bailout from the ESM, essentially proposing that the ESM take over Greece’s liabilities for a period of two years. Unsaid, but implied, is that this would result in the referendum being recalled. More likely it is just a ploy to enhance Syriza’s chances of obtaining a “no” vote in the referendum.


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Rumor has it that this letter was sent in the wake of “infighting at Syriza” over whether or not to hold the referendum. Reportedly some in Syriza fear that there is a risk that the “yes” vote will prevail and force Tsipras to resign and call for new elections. Anyway, these are just rumors, if not entirely implausible ones. The letter Tsipras sent in any case didn’t change anything, because the stance of the euro-group is that nothing new will be decided until after the referendum.

What struck us as far more interesting however, is how far Angela Merkel was apparently prepared to go in order to accommodate Greek demands. She let this slip when briefing her government coalition partners in Germany, the Social Democratic Party (SPD). She didn’t appraise her colleagues in her own party of this, apparently fearing their wrath. As Der Spiegel reports in its German language edition:


“On Monday evening, Angela Merkel had two messages to distribute. One of them the CDU chief delivered personally to the SPD parliamentary faction: She told the parliamentarians that she had in the end made offers in the negotiations with Greece that went way beyond the official line taken by EU finance ministers. The second message, this one to her own party, was delivered by finance minister Wolfgang Schaeuble on the chancellor’s behest. At its core it amounted to: “We haven’t allowed them to pull a fast one on us”.

In reality, it seems that in order to arrive at an agreement with the Greeks, Merkel was prepared to make concessions which her own colleagues would undoubtedly have interpreted as “allowing them to pull a fast one on us”.


In case Tsipras had accepted the extension of the second aid package with its altered conditions, Merkel is said to have offered him the following in a final talk on Friday last week:


  • A third aid program
  • Debt relief, i.e., a partial debt restructuring
  • Investments amounting to EUR 35 billion


Especially the first two points are tricky, as they clearly go far beyond the position hitherto adopted by the euro zone countries.”


Is there anything else you need, Mr. Tsipras?

Photo credit: Stephanie Pilick / EPA


This is quite something. Of course, this wasn’t an “official” offer just a political promise: If you play ball, you’ll eventually get all you want and then some. Obviously, Merkel could neither sell such an offer to her own party, nor to the German electorate. The comments section below the article in “Der Spiegel” is seething with outrage, and probably represents a good overview over what the average German currently thinks about making such concessions.

Note that we have not mentioned the task of selling this offer to other members of the euro-group. They all know that the Greek debtberg can never be paid off. They are merely seeking a face-saving way of admitting it, and if possible, they want that to happen at a much later point in time, preferably when other people are in office.

Anyway, the above shows why in spite of Greece’s IMF default (sorry, “arrears situation”) and in spite of the negotiations having been broken off and the surprise announcement of a referendum, chances are high that the extend and pretend scheme will in the end be continued anyway. The only way it doesn’t happen is if Tsipras and Syriza have actually planned to erect a socialist paradise in Greece along the lines of Hugo Chavez’ Venezuela from the very beginning and have only strung everybody along.


Germany's greek liabilitiesGermany’s total Greek liabilities as of June 30, click to enlarge.


The Root of the Problem

In recent email correspondences we had the impression that we may have been misunderstood, or that it perhaps appeared that our assessment of the situation was partly contradictory. In one recent article, we e.g. pointed out that Greek finance minister Varoufakis is hated by EU politicians/bureaucrats precisely because he is not one of them. Admittedly he seems a bit volatile, but in this case, the underdog clearly has our sympathies.

Next we condemned Syriza and its ideological bent, and expressed bewilderment at Mr. Tsipras breaking off negotiations in which the two sides were only a smidgen apart. In the meantime it has turned out that the creditors had even backed down on a specific sticking point with respect to the VAT issue. Greece has a very complex VAT system, which includes exemptions for the tourism sector. In this case, the Greek government was actually correct in insisting that a repeal of this exemption would be disastrous for the only sector of the economy that seems to be doing well (we made a remark that whether or not such an exemption existed didn’t make a difference, but that was only in reference to the debtberg. It makes no difference with respect to the ability to pay it back).

Anyway, we have discussed our view the fundamental issues many times, but just to clear up where we stand once and for all, we will summarize it here again. Let us begin with the EU. In its current incarnation, it is a largely unaccountable, bureaucratic Leviathan, well on its way to becoming a centralized socialistic super-state. This is not what the European Community was originally meant to become according to its founders (for a detailed discussion of this, see: “The European Idea”).


Shuman,deGasperi and AdenauerShumann, de Gasperi and Adenauer – the founders of the EU. Their vision of the European Community was quite different from what it has become in the meantime.

Photos via Wikimedia Commons


In brief, the founders of the EU wanted to roll back the damage done by the anti-liberal ideologies that had completely swamped Europe between 1914 and 1945, i.e., fascism and socialism. They wanted to restore the Europe that had existed before this time: One in which trade was free and people and capital could move freely as well. We don’t believe they would ever have expected that the supra-national bureaucracy of the EU would one day make decisions such as how much water may pass through a shower-head, or that it would be in a position to outlaw the incandescent light bulb.

In the wake of the 2008 crisis, the underlying problem that bedevils the fractionally reserved banking system came to the fore rather forcefully in Europe. Given the design of the modern monetary system, in which government debt represents one of the most important “assets” held by banks and in which the banking cartel and government are deeply intertwined on many levels, a sovereign debt crisis automatically becomes a banking crisis as well.

Since fractionally reserved banks are in fact only able to pay out money entrusted to them by depositors to a vanishingly small number of account holders “on demand” (in clear violation of the contractual stipulations governing demand deposits), even a small wave of withdrawal requests can bankrupt them immediately. The only reason why they can escape immediate bankruptcy is that the central bank can start up its printing press and lend newly created money to distressed banks in exchange for what are often illiquid assets.

Normally, a similar mechanism applies to governments in debt distress. Everybody knows that not a single government will ever pay back its debts according to term of the contract (at the very least, it will be continually devalued by monetary debasement). Nevertheless, holders of government debt usually rely on the fact that in extremis, if a government finds it can no longer continue the debt roll-over Ponzi, the central bank will print money and bail it out. Too big a bailout may result in the currency losing its value completely, but most debt holders of course believe that they will be able to side-step such an eventuality.


banking-crisisA taxpayer trying to withdraw her share

Cartoon by Ed Stein


However, in the euro area, there is now a supra-national central bank in charge, and its statutes explicitly proscribe the financing of governments. Thus the twin sovereign debt and banking crisis had a chance to fester for a while, reminding everybody of the inherent insolvency of both fractionally reserved banks and hopelessly over-indebted governments. Before things could get out of hand completely, it was decided that the statutes were open to interpretation. In the meantime, the euro area’s true money supply has been inflated by nearly 60% and its current annual growth rate stands at nearly 13%. Problem seemingly “solved”.


Euro area money supplyEuro area money supply – print, print, print and click to enlarge.


And yet, the euro area’s construction means that the costs of bailouts have to be shared, and this is an open invitation for governments to break the rules. It is essentially a tragedy of the commons situation. Hence the efforts to somehow make every country comply with said rules and the need to tie bailouts to conditions. Those who get bailed out have to relinquish quite a bit of their vaunted “fiscal sovereignty”.

For the reasons discussed above, bailouts of governments are always also stealth bailouts of the banking system. The “Guardian” has apparently only noticed this very recently, but the rest of the world has always been aware that the bailout of Greece was in reality a stealth bailout of banks both domiciled in Greece itself and farther to the North. Note here that EU governments were indeed facing a very difficult situation, which results from the very nature of the fractionally reserved banking system.

It would have been best to allow unsound credit to be liquidated and insolvent institutions to go under. However, this would immediately have revealed the situation of depositors, many of whom would have been wiped out. From the perspective of politicians having to decide whether or not to bail out banks and assorted governments, they only had to ask themselves what was more likely to cost them their job: bailouts that are unpopular, but the financial impact of which is distributed across the entire citizenry and stretches far into the future, or bankruptcies in which countless depositors lose the bulk of their savings right away.


Scenes no politician wants to see: People line up outside the Postscheckamt in Berlin to withdraw their deposits in July 1931

Photo credit: DPA – Bildfunk


The credit bubble that has been festering since Nixon unilaterally cut the final tie between money and gold has grown to such monstrous proportions, that a liquidation of the unsound debt claims the system has created would be politically completely unpalatable. Those who demand a “debt jubilee” have to keep in mind that every balance sheet has two sides. If someone’s debt is wiped out, so are someone else’s assets. Many of those on the asset side of the equation are not really there voluntarily. Depositors generally believe the bank has their money; the fact that this is not so, is not something they have voluntarily agreed to.


What Needs to be Done

Another question we received was: What would you do? What’s the solution? There is one interesting remark in the above mentioned Guardian article that requires comment in this context. After listing where all the bailout money went, it is noted that:


“Less than 10% of the bailout money was left to be used by the government for reforming its economy and safeguarding weaker members of society.”


Since when is money required to “reform the economy”? And if a government has to worry about “safeguarding weaker members of society”, what keeps it from shifting its spending priorities? Governments that spend between 50 to 60% of total economic output every year surely have room to maneuver in this respect.

It is certainly true that the bailout of Greece was largely motivated by the desire to bail out banks. This in turn was driven by the desire to postpone the eventual bankruptcy of the entire “third way” welfare/warfare state system, this allegedly so wonderful mixture between socialism and capitalism. It is not true that bailout money is needed to reform Greece’s economy and administrative system. All that is needed for this is the willingness to implement reform.

This willingness is practically non-existent among all Western governments. The only situation in which they are prepared to take the often unpopular but necessary measures to reform their sclerotic economies are severe crises. It is also untrue that a devaluation of the currency is required to deal with an economic crisis. The devaluation “solution” is nothing but smoke and mirrors. It benefits only a small sector of the economy, and even that benefit is strictly temporary.

If we look at Europe, we can see that the Baltic nations retained the euro pegs of their currencies when they were struck by crisis and embarked on a truly wrenching austerity retrenchment, involving GDP declines by 30% or more. Naturally, with such a large proportion of “GDP” these days attributed to government spending, large spending cuts will make this phantom growth component disappear. For the past several years, the Baltic nations are the envy of Europe in terms of economic growth and in terms of the small size of their public debt.


greece-government-spending-to-gdpThe ratio of government spending to GDP in Greece. This essentially shows that GDP has declined, but government spending hasn’t declined commensurately.


Even Spain and Ireland – which were beneficiaries of bailouts (contrary to the Baltic countries) – can boast of sporting some of the best economic growth rates in the euro area over the past two or three years. They were also forced to accept far-reaching reforms and wrenching adjustments as their huge capital malinvestment bubbles deflated.

It has been suggested to us that our criticism of Syriza and its Marxist ideology implied that we thought previous Greek governments were better. This is not the case. None of them have in fact done what needed doing, or alternatively, have done too little. The problem with Syriza is that it is even less likely to implement the kind of reforms Greece needs. The “troika” in many ways represents quite an obstacle as well, mainly due to its nonsensical insistence on tax hikes in the middle of a depression.

If one wants to see Greece return to a sustainable growth path, an effort should be made to cut through what is best described as a Gordian knot. It could actually be argued that important foundations for growth have by now been laid, as a lot of malinvested capital has definitely been liquidated in Greece. In a severe economic depression, people need to be given a chance to help themselves. In Greece, this is one of the biggest problems. Its byzantine labyrinth of regulations and inefficient bureaucracies is smothering all attempts by people to get something going on their own initiative.

We have previously discussed the example of a company run by young Greek entrepreneurs who wanted to sell olives over the internet. Given that the company is selling food items, it requires permits. In the US, it received all necessary permits within 24 hours. In Greece it was involved in a ten-month long unnerving and costly battle with intransigent bureaucrats, who seemingly did everything to stop this business from coming into being. In one hysterical development along the line, one of the bureaucracies that needed to give its placet even demanded that the owners of the web site supply it with samples of their stool.

Given that there are tens of thousands of often contradictory regulations and an impenetrable jungle of decrees and responsibilities, the complexity of which is such that ministers often have no idea what their own administrative apparatus is doing and whether it will actually implement their directives, radical surgery has to be applied. How difficult can it be to simply put over-arching laws in place that unmake this tangle by taking precedence over it? Why hasn’t this been done long ago already? Our guess is that the culprit is the clientelism of Greek politics. Statesmanship doesn’t pay. The party that gets the majority of the vote, receives an extra 50 seats in parliament. As a result, only the interests of relatively small voting blocs need to be satisfied in order to remain in power.

The most essential tasks in Greece are the liberalization of the economy and streamlining of the bureaucracy. The latter is more difficult, but surely it is not impossible. Syriza should use the support it currently enjoys to make the effort, but this would be contrary to its ideology. As Aristides Hatzis recently remarked, many in Syriza are laboring under the misconception that Greece is already some sort of neo-liberal paradise. Nothing could be further from the truth.

Naturally, we do agree with the argument often forwarded by Mr. Varoufakis that the entire extend-and-pretend bailout scheme was madness from the very beginning and is even more unsustainable today than it was before. However, as the leak of Mrs. Merkel’s offers mentioned above indicates, it is certainly possible for the Greek government to eventually get out from this debt straightjacket. It only requires a bit of diplomatic finesse.


Greek debtThe Greek sovereign debtberg



Greece should really give the free market a try. Meanwhile, the “institutions” should be careful not to create fresh obstacles to economic growth by insisting on more and more tax hikes. Greece’s private sector is battered more than enough already. Greece also doesn’t need promises of even greater showers of money in the form of EU-funded “investments”, which usually end up producing little but white elephants. What it needs is genuine reform.


Greek debt paymentsSchedule of Greek debt payments until October 2015 – click to enlarge.


Charts by: Der Spiegel, TradingEconomics, ECB