An email exchange with Eleni Tsigante

I frequently have private email exchanges with readers of this blog. There, I formulate my thoughts a bit more bluntly than I do in the blog. One of my readers, Eleni Tsigante, sent me this article by Martin Wolf of the Financial Times. I responded to it and this triggered the following response from Eleni: "A magnificent summary economically and politically that brings us exactly to the present and this moment. I urge this (to publish it in my blog) because I know - for sure! -  that others will benefit too in the same way as I have". Well, I feel flattered, particularly since I have been saying similar things over and over again in my articles. But I am not above vanity and when told that others might benefit from my ideas, I only too willingly oblige...

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Eleni, I am most familiar with the arguments of Wolf, de Grauwe, Münchau, Varoufakis et.al. They write in a very sophisticated manner. Krugman is more down to earth and states: “My expense is somebody else’s income. When I cut my expense, I cut somebody else’ income”. I guess even a teenager can understand that.

The intellectual arrogance displayed by some of the above often defies description. Wolf writes: “Because of its (ECB) refusal to act as lender of last resort to governments, they suffered liquidity risk”. Sounds great. But what he does not say is that lending directly to governments would be an outright violation of the ECBs statutes.

Now, the ECB and the EU have ‘bent’ statutes and treaties several times so far but they have only bent them, sometimes in an extreme way. But not so extreme that someone could sue them before the European Court (please note that the German Court has ruled the OMT as violating EU treaties!). An outright violation of statutes or treaties would immediately trigger law suits before the European Court.

When I suggested  a couple of years ago that Greece should implement import taxes and capital controls, Varoufakis immediately (and correctly) pointed out that this would lead to law suits before the European Court. When it suits his fancy, he sees the point. When not, he downplays its significance. That is not intellectually valid.

The OMT IS NOT a lending of last resort! It is a buying/selling in the secondary market to hold interest rates down (i. e. bending the rules). Yes, an earlier OMT could have made life easier for some countries, not for Greece, though!

For Greece, it is absolutely irrelevant what happens to its bonds in the secondary market. Rates there might as well go to 20% and more (as they have done). Why?

Because Greece has essentially been taken off the market since May 2010. Greece did not borrow in the market (with a few exceptions); Greece borrowed from the Troika. Admittedly, the Troika interest rates were far too high in the beginning and even a blind man could have spotted this (Bill Rhodes had hammered this into the microphones whenever he talked). They are now very low. Still, I would argue that they should be put to zero for, say, up to ten years. That would be a ‘haircut in disguise’.

In fact, debt and debt service have been absolutely irrelevant for Greece so far. Every cent of principal and interest was not paid by Greece out of its own resources. Principal and interest were paid by foreign lenders so that Greece could repay other foreign lenders (and Greek holders of bonds). This is now changing as Greece enters into the phase of a primary surplus. Now it will indeed become a question of what Greece does (or rather: has to to) with that surplus: pay interest or invest in the economy. I have written this and that about that. You won’t be surprised to hear that I suggested that the surplus should be invested in the economy.

Bank liquidity was never a real problem in Greece. Why? Because all liquidity which the banks lost (such as deposit flight) was replaced by the ECB. Greek banks don’t lend for the same reason why banks in other countries don’t lend in the midst of a crisis --- they don’t want to increase their risk. In fact, they actually do everything to reduce risk. That is in the nature of bankers everywhere. Bankers always act pro-cyclically (and, I hasten to add, Basel-2 reinforces that!): when the sun is out, they sell umbrellas. When the first raindrops fall, they chase for the exit door. What is true is that foreign banks no longer accepted the risk of Greek banks for trade credit as they had done before. That clearly was/is a problem, and I hear of not counter-measures for that…

The ONLY THING which mattered for Greece were the terms of the Fresh Money which Greece required to finance its primary deficit. Greece had no choice but to ask for and take this money. The ONLY VALID ARGUMENT is whether Greece had a choice in the terms/conditions for that money. Mr. Papandreou coined the phrase that Greece had no choice; that Greece simply had to do what was required of it by foreign lenders. I say that this was his greatest mistake. Greece would have had a choice. I am the first one to agree that Alexis Tsipras would have negotiated better terms.

I have been involved with IMF programs in Chile and Argentina. Their program has been standard for decades, namely: cut government expenses, reform and the free market forces will take care of everything else. They have been criticized for that for decades, too, but they insist.

In the case of Greece, the IMF – with undoubtedly a lot of prodding from the EU – went overboard with their conditions. My sense is that there was a notion of ‘setting an example with Greece’ and Greece was such an obvious case for setting an example. Except, the whole thing should not have been about ‘setting examples’ but, instead, about curing an economy.

Either way, whether austerity targets are overshot or not, if they are not accompanied by growth measures, then Krugman’s simple law of cutting somebody’s income when somebody else cuts his expense comes into full force. Remember that about half of Greece’s austerity came via cutting investments!!!

Where I disagree with Varoufakis & Co. is where they say that growth measures should have come from the government. I say that they should have come primarily through the private sector. A few large, government-financed infrastructure projects would, of course, help (they would also increase the deposits in Swiss banks of many of the people involved). But I think you would agree that the Greek economy will only turn for the better once the Greek private sector becomes the cash cow which the state needs. Don’t you? Still, this is a guessing game: Varoufakis & Co. may be right; I may be right. Probably we are both right in a way. The middle road would be to do both. But it is totally wrong to ignore one of the two!

Where I really start blaming the EU is that the thought of searching for ways how to increase private sector investments in Greece never even crossed their minds (and, I should add, I don’t remember journalists proposing that, either). That was/is unforgiveable and stupid. Stupid because they didn’t/don’t want to understand that the only way to get your money back from a weak borrower is by making him strong again. Of course, Greece, too, could have done quite a bit in that direction but if not even the EU comes up with that idea, one can forgive Greece for not doing it, either.

Having said all this, I agree that the OMT is, in the short term, good for countries which are not ‘on the program’ yet. It lowers their cost of borrowing which, as I said above, is one of the key factors. It doesn’t solve longer term problems, though. The key issue is that there are 17 countries which have made themselves dependent on a foreign currency which they can’t print, and their Central Bank has been given a statute where it can only act as a monetary and not as a political authority (which I think is good!). The only reason why the ECB has been pushed so much into political functions is because those who get paid for being politicians have failed in their job.

Maybe the good news is that Italy may fall apart. Italy can’t be saved by the Troika; there nature will take its course. If Italy falls apart, the damage will finally land where it belongs --- the banks. Confidence in a financial sector will only return once the market feels that the banks have valued their assets correctly. If Italy forces banks to value their assets correctly (resulting in giant losses), then we will see a moment of truth and then one will finally attack the debt problem at its source.

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