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Sunday, June 3, 2018

At Some Point Germans May Discover That They Are In Deep Trouble

Below are some interesting charts which I picked up in this Zerohedge article.

First, the phenomena which got the problem countries into trouble in the first place - current account deficits: Greece & Co. had been spending much more money outside their borders than they had revenues outside their borders, having to cover the gap with loans from outside their borders. Today, 8 years later, the situation is as follows:


There are current account surpluses wherever one looks. Almost wherever one looks: France seems to have become rather problematic with a current account deficit representing almost 4% of GDP but Greece's current account deficit is now minute compared to what it used to be.

A current account surplus doesn't mean that the domestic economy is in order. All it means is that the country is financially self-supporting as regards its economic activities outside its borders. It has enough revenues outside its borders to pay for all the essential and non-essential imports the country is buying. Theoretically, the country could be barred from any foreign credit and yet, it could continue its cross-border transactions.

The next chart is particularly interesting. The credible narrative had been that the ECB's Target2 payment system - as a quasi unlimited credit card - allowed countries to run current account deficits even though the foreign private banks were no longer funding them. That was certainly true in the early years but following that logic and seeing current account surpluses now, one would expect Target2 claims of the North to decline.

The following chart shows the development of the (in)famous Target2 balances:


The earlier narrative no longer holds because Target2 claims of the North, specifically of Germany, have increased phenomenally even though current account surpluses were recorded in most countries. There is only one other explanation: capital flight. Now here is something to ponder for all those who always blame Germany for bleeding out the suffering South: Germany has run up nearly a trillion Euros worth of Target2 claims so that, mostly, Italy and Spain could transfer money out of their countries (even back to Germany). Should Italy or Spain ever exit the Eurozone, the Bundesbank might say to them "We want you to give us our money back" and Italy or Spain would respond "The money is already back in your banking system, except it's now in our name and no longer in yours!"

Much has been said about the brutal internal devaluations which the South has had to go through. No doubt that's true for Greece but when one looks at Italy, one sees that nominal unit labor costs, the most crucial element of international competitiveness, have actually increased by 10% since the crisis began. The new Italian government intends to increase deficit spending which is unlikely to favorably impact nominal unit labor costs.


And now to the final chart which leads J. P. Morgan to the conclusion that an exit from the Eurozone may be Italy's best option:


Italy's net foreign investment position is only minimally negative which leads J. P. Morgan to conclude that an Italian Euro exit should be a lot less threatening to creditors than a Spanish one. Put differently, with a current account surplus and a walk-away from Target2 liabilities, Italy would owe only very little to foreigners. Well, not quite because the above foreign investment position is a net between assets and liabilities. While the assets/liabilities are not necessarily owned/owed by the same parties, it is still a fact that there are about 3 trillion Euros of Italian financial assets outside the country's borders and foreign creditors would use all legal expertise to get a hold of some of them.

The old saying goes "If you owe the bank 100.000 Euros, you have to be nervous. If you owe the bank 100 million Euros, the bank has to be nervous." Germany has many more reasons to be nervous about an Italian exit from the Eurozone than Italy itself. And here is another thought.

Deutsche Bank, once Germany's financial calling card, is in great difficulties. Should Germany ever be called upon to bail-out Deutsche Bank, they will discover that Deutsche Bank is counter-party in derivatives with a notional amount totalling almost 3 times the GDP of the United States!

Certainly at that point, Germany will stop educating others about reforming their financial sectors and economies.

Wednesday, May 30, 2018

Parallel Currency - Revisiting Justified?

Ever since it became public that Yanis Varoufakis had worked on a Plan X for a parallel currency, the term 'parallel currency' has assumed a bad odor. When it became public that Star-Lega of Italy were also eyeing the alternative of a parallel currency, markets went into shock. But why?

Before the introduction of the Euro, every country had a parallel currency. It was called 'local currency'. Business was conducted in other currencies as well and they were called 'foreign currency' (I remember when, years ago as a tourist, Greeks seemed to prefer getting paid in Deutsche Marks rather than Drachma). The difference between the two currencies is that the local currency was the only legal tender in each country and it could be printed by each country whereas the foreign currency had neither advantage.

With the Euro, the members of the Eurozone gave up their local currency and opted for a foreign currency as their only legal tender, a foreign currency which they could not/cannot print. What's badly missing now is a local currency which a country can print, even though it may not be legal tender. In short, a parallel currency.

Greece, actually, already has one parallel currency - postdated checks. If B accepts a check from A, dated for payment 3 months later, in lieu of cash payment, then the postdated check has assumed the character of a currency. B will only accept the postdated check in lieu of cash payment from A if he knows that he can pay his creditors' bills with that check. I do not know how common this practice is today but I remember that, only a few years ago, I was told that postdated checks were a rather common form of payment among small businesses.

Assume that Greece starts with a parallel currency called 'Drachma' with an exchange rate of initially 1:1 to the Euro. Assume further that the Bank of Greece commits that the new Drachma is fully backed by the gold reserves of the Bank of Greece, i. e. each holder of a Drachma can redeem his notes in gold at the current gold price. I doubt that Greeks would have a problem accepting this new Drachma at the same value as the Euro. The only problem is that the Bank of Greece will not have enough gold to back all the new Drachma issued.

As a result, the new Drachma would be backed by the full faith and credit of the Greek state, no more. And since the Greek state would generously print the new Drachma (that would be the idea of the whole thing), it is near certain that this new Drachma would lose value against the Euro very quickly.

The great advantage of a parallel currency over a Grexit would be that Greece remains a fully-fledged member of the Eurozone and those who have Euros can happily continue to do business in Euros without incurring any additional fees. The advantage for the Greek economy is that the state could provide financial breathing space by issuing the new Drachma. Greeks may discover that it is better to receive payment in a parallel currency of lesser value than no payment at all in a Euro of full value.

The great challenge of a parallel currency lies in its implementation. Since it is not legal tender (only the Euro is allowed as legal tender within the Eurozone), no one can be forced to accept it. And people will only voluntarily accept payment in a parallel currency if they know that they can pay others in the parallel currency and how much they can buy with it.

Perhaps the time has come to revisit Yanis Varoufakis' Plan X.

Tuesday, May 29, 2018

Greece's Debt Profile Per March 31, 2018

Below is one of the best graphs which I have seen of late, Greece's debt profile per March 31, 2018:



The most expensive sources of financing for the Greek state are freely placed bonds and Repo's (both currently around 4%). Yet, the state seems to be in love with its two most expensive forms of financing: the famous 'return to the market' is being celebrated every other day and Repo's are treated like a permanent source of financing.

The least expensive source of financing is the ESM (a little over 1%). That's the source which Greek politicians are bragging to get rid of before long. The GLF is irrelevant for the purpose of comparing costs because it is not available for fresh money (GLF stands for Greek Loan Facility. It was the first financial support program for Greece, agreed in May 2010. It consisted of bilateral loans from euro area countries, amounting to €52.9 billion, and a €20.1 billion loan from the IMF).

There is only one argument for not taking advantage of the least expensive source of financing, and it is a political one: if freeing Greece from the shackles of foreign domination has been elevated to the most important political objective, one cannot very well continue doing business with those who allegedly had imposed the shackles in the past.

A very high price to pay for a political objective!

Monday, May 28, 2018

Yanis Varoufakis In Overdrive

In a blogpost after Varoufakis's resignation as Finance Minister, I predicted that he would remain in the public eye for a long time to come and I put the following words into his mouth: "The only thing I have not yet decided is the timing of my future publications. I do not intend to put everything out there at once. Instead, I will time my publications in such a way that they keep the flame burning for a long time."

For almost 3 years now, I have been amazed at the media's fascination with a failed Finance Minister of a small country. Time and again, and rather often, Varoufakis was able to place thought pieces in major international publications and give interviews to prominent news media. But this was nothing compared to the last 24 hours.

In the last 24 hours, I received a total of 12 alerts to publications, interviews, podcasts, etc. authored by Varoufakis. One of the publications was a very interesting article about Italy in The Guardian which was appropriately titled: "With his choice of prime minister, Italy’s president has gifted the far right!"

I am now pondering an article with the title: "With its enormous political turmoils, Italy has gifted Yanis Varoufakis!" My prediction is that Greece will turn out to have been only a warm-up for Varoufakis. Italy will give him a much broader audience and my guess is that he will play that audience better than most other commentators.

Friday, May 11, 2018

Piraeus & Cosco: A Pure Success Story!

The Piraeus Port Authority S.A. (PPA) is a publicly traded stock corporation which operates everything that takes place in the Piraeus harbor (the land is leased from the state; not owned by PPA). The largest shareholder is Cosco Shipping of China with 51% outright. Another 16% are held in escrow in favor of Cosco until 2021 by which time they will also pass into outright Cosco ownership provided that Cosco completes the mandatory investments. The Hellenic Fund and Asset Management Association (HRADF), i. e. the Greek state, still owns 7,14% after having sold the above 67% to Cosco in 2016. Domestic and foreign institutional investors own roughly 8-10% each and the rest of the stock is widely distributed.

PPA has made a comprehensive Presentation of Financial Results 2017 to the HRADF. Here are some highlights:

* PPA recorded total revenues of 112 MEUR in 2017, spread over 5 business divisions: 3 container terminals (64 MEUR), 1 car terminal (12 MEUR), cruise operations (11 MEUR), coastal operations (10 MEUR) and ship repair (7 MEUR).
* The 3 container terminals are named Pier I, Pier II and Pier III. Already in 2008, Cosco had signed a lease for Pier II and it subsequently added, in 2013, Pier III. Pier I had operated under Greek management until Cosco's majority acquisition of PPA in 2016.
* PPA recorded earnings before taxes of 21,2 MEUR, which is a return of 19%; an outstanding performance!
* Leaving aside Pier I, the pre-tax earnings were contributed by Pier II and III (33,4 MEUR), car terminal (1,7 MEUR), cruise operations (2,0 MEUR), coastal operations (1,9 MEUR) and ship repair (1,0 MEUR). Since the sum of these individual parts amounts to 40,0 MEUR and since the total pre-tax earnings of PPA were 21,2 MEUR, it is obvious that there is a rotten apple in the group.
* Pier I, the pier which had been operated by Greek management until Cosco's majority acquisition of PPA in 2016, contributed a pre-tax loss of 15,1 MEUR! (this on revenues of 20,0 MEUR!). In previous years this loss had even been substantially higher.

The non-financial part of the presentation includes the following highlights:

* Piraeus is the 7th largest container port in Europe with good chances of moving into the top-5 in the near future.
* Piraeus is the 6th largest cruise port in the Mediterranean.
* Piraeus is the largest passenger port in Europe.
* 150 MEUR will be invested into the expansion of the cruise port.
* 20 MEUR will be invested into the expansion of the car port.
* 55 MEUR will be invested into the expansion of the ship repair operation.
* the cruise passenger terminal will be expanded and 2 warehouses will be converted into 4* and 5* hotels.

Conclusion
It is hard to think of a better foreign investment for Greece. A 'good' foreign investment is an investment which leads to something positive which would not have happened without that foreign investment. It is obviously impossible to say how PPA would have developed if Cosco had not become involved in 2008 but one point of reference is that the pier which had been operated by Greek management until 2016 had essentially been a money-squandering machine until that time (almost 100 MEUR pre-tax losses in 5 years!).

Thursday, May 10, 2018

ESM's Klaus Regling: Germany's 1953 Debt Restructuring A Model For Greece?

Klaus Regling, head of the European Stability Mechanism (ESM), this week drew a parallel between Greece today and postwar Germany in a speech in Aachen, Germany. Germany, he reminded the audience, had repaid the last instalment of the 1953 debt restructuring only in 2010. Successful debt restructuring was all a matter of long tenors, according to Regling.

Regling casually overlooked a few details in his speech. One, a very major debt forgiveness had been part of the 1953 debt restructuring (50% of all debt). And, two, there was the Marshall Plan which provided a key stimulus for the unfolding Wirtschaftswunder in Germany.

But still, the valid question is: Would the Greek economy experience its own Wirtschaftswunder if only a sufficient external stimulus and adequate debt relief were given? That is really the key question haunting Greece observers since 2010. Yanis Varoufakis, for one, had argued tirelessly in his blog, long before he became Finance Minister, that only a major public stimulus could get Greece out of its depression because, he said, when the situation is as depressed as it was/is in Greece, no private initiative could accomplish this goal.

One thing is certain: whenever there is an economic problem and one throws money at it, there will be an improvement. If Greece were given, as a present, say, 10 BEUR, the Greek state would spend most of that money domestically. The expenses of the state are incomes/revenues for privates. The privates, in turn, spend their new incomes/revenues and they become incomes/revenues of others. And so forth.

But here is the great uncertainty: Will that initial improvement trigger a lasting recovery or will it only turn out to have been a flash in the pan?

One can liken the situation to a large campfire. A cup of gasoline will certainly convert a flamelet into a darting flame. The question is whether that darting flame will lead to a lasting fire and lots of glow. If the campfire is built well; if there are small pieces at the bottom and the larger ones at the top; if the wood is dry; etc. --- the darting flame will likely lead to a full-fledged fire. If, on the other hand, the campfire is poorly built; if there are only few small pieces at the bottom; if the wood is wet; etc. - well, then the darting flame will soon extinguish and the situation will be worse afterwards than before because the darting flame will have burnt whatever there was left of small pieces.

There are many economic examples for both scenarios. The postwar German campfire was very well built and the Marshall Plan, actually a relatively small stimulus, provided the darting flame which turned into a lasting fire. Forty years later, the former East Germany was not a well-built campfire. The West did not throw a cup of gasoline on that campfire. Instead, the West threw (and still throws) truckloads of gasoline on that campfire (roughly 100 BEUR annually) and it still hasn't really developed its own strength.

How can one explain the difference between postwar Germany and the East Germany of the 1990s? Well, it certainly can't have been racial and/or cultural reasons: the East and the West were ethnically the same Germans. The answer must be found elsewhere.

Is the Greek economy today more akin to the postwar Germany of the 1950s or East Germany of the 1990's? One thing is certain: post-1953 Germany was a tremendous economy to invest in, both for Germans as well as foreigners (particularly Americans made huge investments in Germany). Greece, in contrast, ranks as one of the least attractive countries of the Eurozone, of the EU and of Europe in total to invest in (Doing Business Report 2018).

Statistics since 1981 show that as money flows into the Greek economy, as growth occurs, as purchasing power increases --- much of that purchasing power goes into consumption instead of investment. Since the Greek economy cannot satisfy, by far, the desires of Greek consumers, the increased purchasing power goes into imported products. All the reforms discussed/implemented since 2010 had as their declared objective to change/improve the structure of the Greek economy: more productive output and less services; more exports and less imports; more private and less public activity; etc. A distant observer cannot see that much has changed in that regard.

On the other hand, there are some positive examples. My favorite one is Cosco which I have described in many articles since 2012 as the prototype of a desirable foreign investor. Cosco proves a couple of important points to me: (a) there are investment opportunities in Greece which are of great interest to major foreign players; (b) there are major foreign players who are willing to invest even during risky times; (c) there are major foreign players who take a long-term view on Greece instead of eyeing only quick profits; and (d) when such major foreign players who take a long-term view on Greece make their investments, the results for the Greek economy can be miraculous.

Cosco had encountered a lot of criticism/objection in its early years. Reactions to my positive articles about Cosco pointed out inhumane working conditions in Chinese sweat shops. The announcement around 2013/14 that Cosco was projected to add about 1-1/2 - 2% to Greece's GDP by 2018 did not catch much attention. Today, it seems that actual results have persuaded the critics.

So is the Greek economy now akin to a well-built campfire waiting for the initial darting flame or not?

My gut feeling is that there is no major change/improvement in Greece's overall attractiveness as an economy to invest in. The truly important changes/improvement in the structure of the Greek economy have not taken place. At the same time, I believe that there could be new 'Cosco's' and the Greek government should make every effort to look for them and find them. If only there were a dozen 'Cosco's' in the Greek economy, their presence would probably do more to change/improve the structure of the Greek economy than all the Troika's, Task Forces, etc. put together.

Tuesday, May 8, 2018

Surprise, Surprise - Germany Not A Model Pupil!

The English edition of the German Handelsblatt published an article showing that Germany was, by the end of 2016, the leading breaker of EU rules:


The German author of the article concludes: "The country, which has lectured debt sinners like Greece, performs worst in complying with European Union legislation. Physician, heal thyself!"