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Sunday, June 24, 2018

"The Greeks Can Now Smile!" - After Having Benefited From The "Biggest Solidarity The World Has Ever Seen.”

Government spokesman Dimitris Tzanakopoulos is credited with the promise that the Greeks can now smile following the successful settlement of Greece's exit from the 3rd program in August and ESM chief Klaus Regling reminded Greeks that they had been the beneficiary of the world's biggest solidarity effort ever. No better way for Alexis Tsipras to celebrate all this than by putting on a red tie.

It would be unfair to spoil the party by diminishing Greece's accomplishments. Only 3 years ago, the vast majority of politicians, commentators, analysts, etc. expected chaos for Greece's future: declaration of default and perhaps even repudiation of debt; exit from the Eurozone; breakdown of domestic stability; etc. It is unquestionably to the credit of Alexis Tsipras that all of this could be avoided and that now, 3 years later, the political establishment is celebrating Greece as a great success story. The fact that Tsipras accomplished this by essentially accepting just about everything, without resistance, that was put before him is a moot point. The end justified the means. I would further venture to say that no non-leftist government could have gotten away with accepting just about everything the creditors demanded.

If Tsipras celebrated with a red tie, the EU and Eurozone leaders celebrated with an effusion of self-praise. That, I think, was inappropriate, to say the least. The way the EU handled, beginning in the spring of 2010, the external payment crisis of Greece was a blunder of historical proportions and here is a compilation of articles I wrote about the subject back in 2012.

So how good is the new agreement which was reached a few days ago?

I propose that in any debt crisis, be it personal, corporate or sovereign, the borrower is faced with 2 principal issues: (a) the amount of interest he has to pay and (b) the amount of loan instalments he has to repay. The unique character of sovereign debt is that loan instalments never really get paid, i. e. nominal debt is hardly ever reduced. Instead, loan instalments are always refinanced. As a result, to offer an overindebted borrower like Greece an extension of maturities is nothing other than the recognition of reality. Those who consider this substantial debt relief should explain why they would prefer to waste time and effort every few months to renegotiate individual debt maturities.

So the crux of the matter is interest expense. Interest expense flows through the budget which means that it comes out of government revenues. Every Euro of interest payments is a Euro which is not available for other government expenditures. Pensions may have to be cut in order to pay interest. The point is: if one wants to give a sovereign borrower debt relief, one has to reduce his interest expense.

In 2016 and 2017, Greece's interest expense was stable at 5,6 BEUR. Back in 2011, Greece's interest expense had been 15,0 BEUR. The enormous reduction in interest expense, particularly when considering that debt was increased during this time, reflects that Greece has received substantial debt relief in recent years.

If the new agreement reduces Greece's interest expense below the 5,6 BEUR, then it is debt relief. If it doesn't, it is no relief at all.

The published information does not allow me to pass judgment on this. There are references about not applying the step-up interest margin on a certain portion of the debt which only means that interest expense would not increase; neither would it decrease. There are references about a further deferral of EFSF interest which would also hold interest expense stable but not reduce it. There are references about finally distributing to Greece SMP profits which had so far been held in an escrow account. This would be a significant reduction of interest expense. And there are references about replacing some expensive IMF debt with cheap ESM debt. This, too, would reduce interest expense.

At the same time, Greece is taking on quite a load of new debt for the primary purpose of building up a cash buffer. That cash buffer, of course, would increase interest expense.

In short, the principal benefit for Greece seems to be that its debt has now been regularized. That is in and by itself a very significant benefit because only if one's debt is regularized can one begin to commit time and resources to things other than debt negotiation. Whether or not Greece's budget will be relieved of interest expense as a result of the agreement remains to be seen.

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.