Friday, June 17, 2011

Letter to Mr. George Papakonstantinou, Finance Minister of Greece

Dear Sir:
I would like to make some suggestions regarding possible future actions on the part of the Greek government in the context of the present crisis.
1) Greece needs to make a case that the foreign money it needs is an investment in the country’s future (instead of throwing good money after bad). That case is presently not being made in credible fashion.
2) Just by looking at statistics of the Bank of Greece, one can easily determine that the net cash inflow from abroad in the last 2 years (particularly the ECB-funding of the Greek banking system!) has served primarily the following purposes: (a) servicing foreign debt and refinancing short term credit lines of the banking sector (which were cancelled by foreign lenders); (b) capital flight; and (c) imports. That money is now in bank accounts of private parties abroad.
3) One cannot expect tax payers of Central/North European countries to spend their money on such purposes! Neither is it in the interest of Greece to do that!
4) One can certainly expect tax payers of these countries to invest in Greece’s future because that is of primary interest for the “European Project”!
5) Greece should hold on to the Euro but SIMULATE A SITUATION AS THOUGH IT HAD THE DRACHMAE! That will violate certain EU freedoms (like the freedom of transferring goods and capital) but this is a state of emergency and requires emergency measures (not to mention the fact that France/Germany were the first countries which violated EU contracts).
6) The structure of the Greek economy is such (“developing economy” with 80% in services) that Greece will for a long time to come need the savings of other countries in order to achieve the necessary growth because it cannot generate enough savings domestically (current account deficit). Those foreign savings are unlikely to come in the form of voluntary foreign loans for quite some time.
8) There is a huge pool of funds which would at least partially quickly flow to Greece if the investment framework were right. I am referring to the hundreds of billion EUR which Greeks hold in foreign bank accounts. Why would a Greek prefer earning 2% in Switzerland if he could earn a multiple thereof in Greece? For that, however, the Greek investment framework needs to be “right” (security, low costs, tax incentives, etc.).
9) One cannot change a whole country in a short time frame. However, one can change parts of the country very quickly. China is still being ruled by communism but in parts of the Chinese economy, capitalism-pure reigns.
10) Greece should establish selected Free Trade Zones where the foreign investor is offered everything which he desires. The simple question to the foreign investor (the wealthy Greeks) would be: “What would you like to have so that you invest your capital in Greece?”
11) What should be produced in those FTZ? To start with, all those products which are presently being imported but which could just as well be produced in Greece if Greece were competitive. Greece needs a manufacturing sector badly, something which is called “Mittelstand” in Germany and Austria. Those are companies with 5-500 employees who produce goods which someone else needs in good quality and at a fair price, and where the employees pay taxes (as well as the companies and their owners!).
12) Greece should take the following short-term measures to control foreign cash flows: (a) taxes on imports (up to 100% on luxury goods) and (b) a stop on capital transfers abroad unless they are economically justified. This would have to be accompanied by a temporary freeze on bank deposits with only minimal withdrawals for personal use.
13) These measures would simulate a situation where Greece had returned to the Drachmae. If Greece returned to the drachmae, the new currency would immediately devalue by at least 30%. Imports would decline and “official” capital flight (i. e. via bank accounts) would come to a halt because the banks would not have enough foreign currency (and there would be a run on banks). Exports would become competitive with a devalued drachmae but they would also become competitive in a FTZ which works with internationally competitive costs.
14) If implemented well, this would quickly translate into increased domestic economic activity. More importantly: the “story” alone, if presented well, would immediately demonstrate to foreign tax payers that their money is being spent well.

1) First of all, Greece must arrange a creditors’ meeting and organize a Steering Committee of creditor institutions with which one can negotiate. That is the only way to keep private creditors “on the hook”!
2) Greece should stop talking about the sovereign debt only. The real issue is the gross foreign debt of the entire country which stood at 431 billion EUR in mid-2010 (according to the Bank of Greece). That is the amount of money which has to “stay in the country” for some time to come.
3) Greece must NEVER request a “haircut” from foreign lenders! Only countries of the 3rd world have been forgiven sovereign debt and Greece does not want to belong to that group!
4) Greece’s position must be: “We will pay our foreign debt in full! However, since we don’t have the necessary cash right now, we will pay in a different form".
5) We will offer the owners of the 431 billion EUR the following (just an example): 20-year bonds for 50% thereof; 10-year bonds for 30% thereof; and 5-year bonds for 20% thereof.
6) During the first 5 years we will accrue interest on 2/3 of those bonds.
7) We will need Fresh Money which will be in a senior position to those bonds.
8) What do we offer in exchange? The above-described National Recovery Plan (obviously, the above is only a “quick-and-dirty” starting point. A real “plan” would need to be developed and would require the best brains not only from Greece but also from Europe). If this plan works, Greece will be able to pay these bonds in full upon their respective maturities.
9) In the meantime, there will be a secondary market for those bonds which will trade at significant discounts. New EU regulations will have to allow the banks which have long-term viability to make the necessary “mark-to-market” adjustments over time. The other banks will be liquidated in orderly fashion. This also applies to Greek banks which become holders of such bonds.

1) At issue are countries which presently pride themselves in arrogant fashion that they are “helping Greece” in the interest of the European Project while, in actual fact, they are using Greece’s balance sheet (and tax payers’ money!) in order to bail-out their own banks.
2) Greece should call that bluff.
3) Greece should say: “By implementing the above, we will impose on Greeks enormous adjustment pains for a number of years but at the end of this process Greece will be a value-generating member of the EU. That will be Greece’s contribution to the European Project. In exchange we request the following: when the above bonds become due and if we can pay them, the lenders can reverse their write-downs and will have windfall profits. We ask that the governments tax those profits at 100% and give that money to Greece as a grant, as reward for having saved the European Project.


  1. Great post Klaus! Any chance the Minister will listen to your advice? Let's hope he at least reads the letter. Maybe a newspaper would publish it?

  2. Dear Mr.Klaus,
    its a very interesting proposal even though i think it is not a realistic one any more considering the entrance of the IMF in the country. There are companies and countries that are becoming richer from this situation and they won't change this. The prosperous years in Greece started in the 80s suddenly and in the same way they are 1974(its the period of dictatorship in Greece) our external debt was almost zero and it took as few decades to arrive in this astronomic number that you mentioned and i am wondering is it only our politicians that brought us in this situation? I believe not because if you consider the thousand we were obliged to spend buying from Germany France etc military equipment that we will never learn if we really needed it, if you think that the exports of Germany are increasing since last year and the "Greek situation" has contributed to this, if you think that Greece when it joined the European Union in 1981 (official entrance) did not fulfill the economic conditions but it was a strategic movement in order to diminish other influences (such as Russia) in Europe all these leads me to the conclusion that “the problem of Greece” its something that it was not created by us exclusively ... even if every European and American citizen/politician/giornalist treat it like this and even if once again European union its shows its weakness to act as a union. Because if it wanted to act as a Union I believe that the solution would be much easier. Considering the former I wish to give you an alternative proposal that i have read and i wish to have your opinion on that (see this link :
    I believed in European Union but I see lately that its just a mechanism used by the leading countries to use the pro and avoid the con at any costs. Thank you for your time. Despina

  3. Hi Despina, I was familiar with the "Modest Proposal" and the open letter which Varoufakis wrote to Papandreou (

    Their principal point is the same as mine, namely: in the midst of a crisis of the entire economy, one cannot just focus on state debt. With the same effort one needs to attack the crisis of the domestic banking sector and - most importantly!!! - get the economy going again through investment. They just express it in a very sophisticated way while I use the simple language of a retiree...

    Their proposal regarding Eurobonds etc. is so sophisticated that I would have to spend a weekend trying to understand it. Let's assume the proposal is good. That is not the kind of thing which one can implement in a short time. It would actually be a new EU-treaty. Something like that takes a long time of preparation and you can't accomplish that in the midst of chaos which exists now.

    They are wrong as regards Roosevelt's New Deal and its impact on the depressive US economy. It was not the New Deal which got the US economy going again. Instead, it was WWII which did that (and any war is, economically, deficit spending). At the end of the war, the US had a sovereign debt ratio of about 140% (if not more). Ten years later it was at a historic low point (I believe even below 40%). Had they repayed debt? No, but the economy had grown rapidly and certainly much faster than the debt.

    Even if Greece were forgiven her entire sovereign debt and even if the government managed to have a balanced budget, Greece would still need a lot of money from abroad every year. Let me explain:

    In 2008 (the last "good" year before the crisis), Greece imported goods in the amount of 64 billion EUR. In other words, they needed 64 billion EUR from somewhere else in order to pay for these imports. They exported 20 billion EUR which still left a hole of 44 billion (64-20). Through services (mostly tourism), Greece obtained another 17 billion EUR which reduced the hole to 27 billion EUR (44-17). And that's a big hole, isn't it?

    In 2010, that hole was "only" 15 billion EUR. Why? Because in a recession you import a lot less (19 billion EUR less than in 2008). But there is no reason why exports should go down because of a domestic recession (instead, exports increased by 2 billion EUR versus 2008). As soon as the economy gets going again, imports (and the hole) will also increase again (unless Greece manages to substitute imports with domestic production; i. e. my "industrial development plan").

    Until Greece reaches a per-capital GNP similar to core countries, she will always need money from abroad. Why? Because the domestic savings are not big enough to finance the necessary growth.

    Needing money from abroad (the technical term is "current account deficit") is not necessarily a bad thing. It all depends on what the money is used for. If it is used for investment, it will generate future returns and lead to a Golden Age. If it is spent on consumption (which is what happened in Greece in the last ten years), it leads to a bust. Just as simple as that.

    I hope I could make myself understood. Regards, Klaus

  4. Thank you very much for your answer Mr. Klaous! It was very clear! I agree that the proposal is very ambitious but i think that europe has to start working on this or a similar proposal because in an international arena its not possible for the european countries to survive alternativle don't you think ? Regarding your answer i have one more question considering that i am not an economist why you think greece imported goods in the amount of 64 billions if it did not have the money to pay for them and we needed 64 billions from abroad for these imports? considering your important experience i would like to ask what you think it will really happen now? as u see the europeans are looking for private creditors to "help" us restructuring and the greek government is preparing new taxation measurements pushing all small and medium companies to close or to transfer in balkans.

  5. It is not so that Greece decides to import goods for 64 billion EUR and then asks foreign banks to finance that. You have to see it in the context of time.

    Until 3 years ago, foreign banks were lending to the Greek state, to the banking sector and even to some large corporations as though it was going out of style. Greek banks would regularly be contacted by their forein correspondent banks to see how they could "intensify the business relationship". The Greek banks would explain that the economy is booming and that they could always use trade financing. The foreign banks would happily establish credit lines for that purpose. When the banks then had to transfer money abroad for the payment of imports, they would simply draw down under those credit lines. Everybody would be very happy.

    The whole world of finance would be happy today if no one had started asking 3 years ago how much those sub-prime papers were really worth. Once they asked, the whole thing blew up. Or, as Warren Buffett once said: "Only when the tide is out can you see who is naked".

    Almost 3 years ago, foreign banks started asking how well the Greek state and the Greek banks were really doing. And that was the beginning of the end.

    Banks behave like herds. When the "leading steers" pump money into Greece, the others start doing the same. When the leading steers turn around, they others will also quickly look for the exit door and hope to get through it before it closes.

    What will happen to imports when there is no longer financing available. Well, Greeks will continue to import until there are import controls. Think of the Greek car dealer who has 10 million EUR in his bank acccount, goes to the bank and orders them to transfer 10 million EUR to Korea for the import of cars. No bank can refuse a customer's order when there is sufficient money in his account. So the bank has to make the transfer and then scramble to get the financing. So far, they have been able to get it from the ECB as a lender of last resort, but that well will dry up soon. So, when the bank cannot balance its books at the end of the day, the bank has to be shut down. That is what the law says.

    This is why the new financial package must not only include financing for the state but it must also include finaning for the banks (because the banks will also need money in the future to finance more trade). Otherwise, all the Greek banks will become insolvent in the near future and then you really have a problem!

    What happens if Greece gets no new financing at all? Some Greeks are even saying that the government should refuse to accept new financing even if it is offered. Well, that would be a soreign default which means that the whole country would financially go down the tube. In practice, all banks would have to be closed for a week or so to give the government time to pass new legislation for the crisis. They would definitely have to freeze all deposits and reduce imports to the minimum (only in the amount that cash still comes in from exports and tourism). If the government really decides to default, then I see no alternative other than returning to the Drachmae because the country needs a currency in order to transact business and when you no longer have Euro, then you have to print your own money.

    The only comforting thought for the Greeks would be that not only their country goes financially down the tube but the whole world of finance will experience something which will make Lehman look as harmless.

  6. very good post- gpolitica from twitter