Thursday, January 19, 2012

Hedge funds as the ultimate decision-makers over the fate of national economies?

If this article is not sickening, then I don't know what is! Hedge funds, allegedly, are thinking about sueing Greece in the European Court of Human Rights for violating bondholder rights in the event that Greece passes a new law affecting debt instruments which are subject to Greek law (the CAC).

And here is the cute (legally probably correct) rationale: changes in the terms of a debt instrument could be viewed as a property rights violation and in Europe, property rights are human rights. Now thank God that there is a European Court of Human Rights to protect the property rights of hedge funds. Of hedge funds whose only reason for having this property (the Greek debt instruments) is to use them as blackmail for taking (legally, of course) property away from someone else - from tax payers!

This is just one more reason why one should hope that we will see, next March, closing time to this charade of the last 2 years by allowing default to happen. The existing debt would be separated from the Fresh Money requirements. The latter would come from EU/IMF (for budget deficit) and from the ECB (for current account deficit). And the holders of existing debt would be invited to form a Steering Committee which has the mandate of all creditors to negotiate with Greece a rescheduling of maturities. No haircut; new evergreen bonds instead!

Obviously, at this point Greece has to start being serious about serious things. No more games about promises which are not kept, etc. Much more pain will have to come over Greece's public sector and public administration. But there should be a carrot for all of this.

That carrot should be a giant investment program for the Greek economy financed by foreign investors, EIB, EU Structural Funds, etc. (but not the Greek tax payers). So giant and so well thought out that one could expect hitting bottom of this crisis and returning to growth already in 2012.

The above Fresh Money for budget and current account deficits will be about 3 BN EUR per month. After hearing about 3-digit BN EUR figures for so long, European tax payers will find that amount to be quite reasonable, particularly since it would now serve a positive purpose (instead of throwing good money after bad). For once, there would be light at the end of the tunnel.


  1. Dear Sir,
    I discovered your blog recently and read a few of your articles outlining your rationale regarding the default of Greece. In broad terms I agree with you on a series of issues and am glad that have found your blog.

    As far as the above article is concerned, I would only like to add the following thoughts.

    First is a massive investment programme feasible given the increasing economic pressures on other EU/Euro countries? Also assuming that it is can it be politically acceptable and can there be a credible way of preventing a "contagion" of this phenomenon - a repetition of this programme in other countries mired in recession, who can potentially reach a Greek-like situation (though not of the same magnitutde)?

    Indeed Greece will have to default on its debt obligations and reschedule its debt, instead of contuining along the failed memorandum/PSI path, without exiting the euro of course. The point is can the rest of Europe handle a Greek default, not so economically but mostly politically?

    Given the inability of European policy-makers to devise a rational strategy since the very beggining, to address the crisis systematically, I doubt they will be able to recover currently, especially since things have deteriotaed further.

    Those are just some initial thoughts.


  2. Hi Protesilaos, this is part 1 of 2.

    The main issue is the huge amount of cross-border debt of the whole country (not to be confused with the sovereign debt of the state). This cross-border (foreign) debt is the symptom and not the cause (Greece as a country presently owes around 500 BN EUR cross-border debt to foreigners. In the Central Bank terminology, this is the “gross external debt”). If the Greek state had twice the amount of debt which it has today (everyone seems to say that sovereign debt is around 350 BN EUR; so we would be talking about 700 BN EUR), but if all that debt were domestic (i. e. with Greek savers and investors), you can rest assured that there would be very little hectic between Paris-Brussels-Berlin these days. They would coolly state that this is really a domestic Greek problem. The reason why there is so much hectic is that the cross-border debt of the country is about 500 BN EUR (and about 250 BN EUR of that is debt of the state). Should Greece fall into the Aegean and if all the sovereign debt were domestic, borrower and lenders would both fall into the Aegean (note that borrower and lenders are the same when sovereign debt is domestic) and no one between Paris-Brussels-Berlin would be hectic. There is only one reason why they are hectic: because if Greece fell into the Aegean, about 500 BN EUR of savings of other countries which are presently invested in Greece would go down the Aegean with Greece.

    Having said this, one now has to understand how cross-border debt comes into existence. A country’s Balance of Payments must mathematically balance just like total assets of a company must mathematically balance with liabilities+equity. The Balance of Payment is composed of the current account and of the capital account. If you have a deficit in one, you must have a surplus in the other. Again, that’s mathematics and not economics.

    THUS: there can only be a need for cross-border financing if there is a deficit in the current account (exports plus services/tourism minus imports). If Greece had a balanced current account, she would not need any “savings of other countries” (no foreign debt)!!! If you don’t want to be dependent on foreign money, you need to have a balanced current account. If you have a current account deficit, the dependence on foreign money (debt) is automatically the consequence. To solve that debt problem, you must solve the current account problem.

  3. Part 2 of 2.

    Greece has a huge structural current account deficit: a record high of 35 BN EUR in 2008 and, despite the recession, it will still be about 20 BN EUR for 2011. So, mathematics tells us that Greece must have a surplus in the capital account. In other words, Greece can only continue her way of life and standard of living if capital is sent to Greece either as loans or as equity. The moment the capital inflow is stopped, the economy comes to a screeching halt and the standard of living (which so far has been financed with ever new money from abroad) is out the window.

    What applies to Greece, applies to the entire Periphery (to a lesser degree than Greece, though). If the producers are in the North and the consumers in the South (extreme example!), the North will have to transfer money to the South so that the South can buy products from the North. If the North stops sending money, it won’t send products to the South any longer (unless the North wants to make gifts). So the North (say, Germany) will have to pay one way or another: either by continuing to send money to the South or through lower growth in the North because of lower exports to the South.

    As Warren Buffett wrote so nicely in his piece about Thriftville and Squanderville: if the North knows it has to send money to the South, it might prefer to send the money in the form of equity (foreign investment) instead of debt. Debt is interest-bearing and must be repaid; foreign investment carries no interest and does not need to be repaid.

    This is why I say that it is in the greatest interest of the North to start a giant investment program in the South. When a banker has lent money to a company which is getting into dire straits, the first thought is what can be done to make the borrower strong again. Only a strong borrower can service his debt. With Greece, incompetent EU-elites have done exactly the opposite: they have sent more money Greece so that Greece could buy more imports (and continue de-industrialization of her own economy) and – believe it or not – so that wealthy Greeks could transfer their money to, say, Switzerland. Does that sound smart to you?

    Will there be contagion in the sense that other countries will also want to have “giant investment programs”? Of course! As I said before, if the North/South imbalances of trade and services are not evened out, things will get just as bad for the North as for the South.

    My personal recommendation what Greece should do is in the paper “Endgame for Greece”. Maybe the other links below help to explain in more detail what I have tried to say. Klaus

  4. Thank you for you response sir. I agree with your points. Indeed Greece needs to reduce its structural deficits and of course implement all necessary measures that will remove the obstacles to free market that currently exist. In short there must definitely be an investment plan from the North, ultimately for their own benefit. I shall examine the links you provided me with in part 2 of your comment.
    Thank you.