Sunday, February 2, 2014

Emerging Markets - Greece On A Larger Scale?

Having lived in Chile/Argentina from 1980-87, the current outflow of capital from emerging markets feels like the re-run of a movie seen a long time ago. Today's story is virtually the same as it was then, namely:

First, something happens in an emerging market which conveys to foreign capital the confidence that risks are low and returns are high (in Chile, at the time, it was the Chicago-Boys taking over economic management; in Argentina, it was their mental relatives; and in both countries the exchange rate was fixed to the USD). Next step: an avalanche of foreign capital hits the emerging market. Next step: incomes and asset prices in the emerging market go up. Next step: much of the increased (artificial) wealth is spent on consumption of imported goods instead of investment, driving the current account balance into dangerous, negative levels. Next step: something happens (like the discovery of the negative current account balance; or the fear of Fed tapering) which makes foreign capital doubt that risks are still low and returns still high. Final step: foreign capital is withdrawn but, regrettably, much of it is no longer there.

This is the story of Greece! In Greece, it was the EU membership but, much more dangerously, the EZ membership which gave foreign capital the confidence that risks were low and returns high. What happened was the reverse of a personal depression. In a personal depression, the road into it is like a highway to hell but the road out of it is like a trip to heaven. Greece experienced the capital-inflow-period as a trip to heaven and is now experiencing the deep depression.

Is the above development like a universal law which cannot be escaped? Of course not. The easiest way to escape is for a government to control capital flows, on the way in as well as on the way out. However, capital controls are perceived as the Greatest Sin in today's world.

One might want to look at Switzerland. That country, relative to its size, has probably the largest capital inflows in the entire world. And yet --- the Swiss don't go berserk with that capital. Perhaps that is because the Swiss are boring people. Or perhaps that is because the Swiss know that nothing comes from nothing.

So perhaps that is the choice: either control the amount of food which comes on the table or educate the guests in the restaurant that, at the end of the day, there is no such thing as a free lunch.


  1. The money that flows into Switzerland mostly goes to SNB and we still not know how this story will end.

    Yes, some Swiss are boring people and voters there do instinctively know that nothing comes from nothing.

    Also they quite often know that they must vote against their government and the majority of well established parties :O


  2. Klaus: you have mentioned Switzerland several times in your posts, usually with a positive comment. I have to confess that I am not particularly well informed on Switzerland, having only once in 2008 examined some specfic policy issues. However, i think there are some general comments that shoujld be made.

    First, is that the Swiss capital inflows are (at least historically) legally very dubious with much criminal investment in the Swiss banking system. This is of a very different character to K inflows into Greece, and clearly could NOT have been used for consumption in the country.

    Second is that the Swiss K inflows went into banks and not to the State. Most of the K inflows into Greece involved state institutions, as I recall -- even if some of these were state banks. The Greek state has always been a disaster and operates quite differently from the Swiss federal and canton system.

    Thirdly, CH has a long history of dealing with money. It has an institutional framework that knows well what is prudent, what is slightly risky and what is reckless. The Greeks have no idea at all, and if anything have a short history of reckless consumer consumption of all capital, not to mention corruption. This fact is known from the 1960-70s record of utilisation of workers' remittances to Greece -- none spent on capital investment or anything useful; some went on essential consumption but an enormous amount went on luxury consumption goods. That was why import controls and taxes etc were needed and were not abolished until 1989.

    So, all of Greece's problems with the euro were 100% predictable. The fact that they were not predicted indicates the very shoddy management of the entire eurozone project.

    1. I mention Switzerland not because I know it so well but, instead, because its external accounts are so interesting, even for a layman. Judge for yourself (if you are interested); the tables below shows Switzerland’s foreign assets/liabilities position as well as the Central Bank's balance sheet.

      I used Switzerland as a case in point in the above article because Switzerland shows that a country can have a lot of capital inflows and still do well if that capital is invested wisely.

    2. I agree, and of course the data show a very prudent management of K inflows. We know from modern comparative research that cultural factors are crucial in how "money" is managed. For example, comparison of two villages in the same African country show one that spent all of its migrant remittances on consumption goods, and another that had a philosophy of investment and used the money to create new businesses and production. Guess which village had the best economic development after a decade!

      Similarly, I was looking a decade ago at firms' utilisation of profits in terms of R&D and technical training of staff. I discovered that Greek companies spent almost zero on these, and Greece was the lowest in the entire EU. BY low, I mean not even comparable; whereas the figure for Turkey was identical to two decimal places. This looks to be a cultural parameter -- that SMEs in Turkey and Greece see their profits as a cashcow to be spent on luxury goods and often also on property (which they see as an investment). From an economic perspective, investing in property is counterproductive because it diverts assets from productive sectors to a non-productive one and forces up the price of land or housing. This is why Greece remains a rent-seeking economy and has problems producing anything.

      These cultural parameters indicate how ordinary people think. it is up to state and private institutions to influence and reshape those incorrect attitudes to capital inflows. They did nothing with the arrival of the euro, and the state behaved as recklessly as any ignorant peasant. They continue to do so to this very day.

    3. Klaus, how do you think that capital inflow has been (wisely) invested?


    4. @Xenos:

      >"with much criminal investment in the Swiss banking system"

      This is a never ending myth. For many years Switzerland has very strict laws against money laundering etc.

      The money inflow is for speculative reasons and because CHF is thought to be more safe than EUR.


    5. @Trickler
      Touché. I obviously don't know whether that money is wisely invested but if it had been wasted like in Greece, we all would know about it by now. My prejudice is that Switzerland could be a prototype for other countries in many aspects: excellent infrastructure, excellent public services, excellent social services, good employment opportunities, good incomes, budget in balance --- and all of that with very low taxes. And a decentralized democracy. Not bad; not bad at all.

      Probably the most exciting place these days is the Swiss National Bank (SNB). What they are doing with their exchange rate policy is quite chancy. That could easily lead to a moment of truth...

    6. Plus, the Swiss are very capable politicians, knowing to adapt to the circumstances. For instance. Do you remember the deal about taxing the german deposits in Switzerland? Greece thought to do the same. The reply of the Swiss goverment was "the model applied with Germany and Britain is obsolete". This, to justify why they refuse to retroactively tax the greek deposits in Switzerland.

    7. I always laugh when the Swiss inform me about their "strict money-laundering laws". Of course, there are legal statutes -- and that is it. To do more than that would be like shooting yourself in both feet, and really rather silly.

      As far as the concessions of the swiss to the US and Germany are concerned, the USA was pushing for full disclosure of all bank account holders and their assets. Maybe they are still pushing for this, as they should. Germany and the UK accepted a compromise of a levy of taxes on accounts held by their nationals -- as better than nothing.

      If the Swiss really wanted to stamp out money laundering then they could do it overnight through disclosure to other states in confidence. They would also bankrupt all the Swiss banks overnight.

      And the reason that Greece gets nothing? Simple: Greece has no political clout in the world. And even less economic clout. The Swiss know when to be neutral, when to be partisan, when to compromise, and when to turn a blind eye to organised crime. Very pragmatic, although completely hypocritical.

    8. @Guest(xenos)February 4, 2014 at 6:10 PM

      Your comment makes _me_ laugh. With this broad view of prejudices you will happily live forever ;)


    9. @Anonymous February 4, 2014 at 1:46 PM

      The Swiss government had been quite competent during WW 1+2 which culminated in the small country becoming rich...

      However, in modern times when the Swiss government engaged in a submissive contract to EU and the voters did not accept it, the government said that this was a black day for the future (!!)

      From then on, quality has been very mixed to say it politely...

      H. Trickler

    10. Switzerland, like Greece, is a country short of raw materials. Thus, it comes as no surprise that Switzerland runs an annual trade deficit of 8-9 BCHF out of ordinary exports/imports. However, Switzerland runs a trade surplus of about 23 BCHF out of special exports/imports (2012: exports of 201 BCHF; imports of 176 BCHF!). Much of that is transit trade where Swiss residents buy abroad and sell abroad (including foreign companies which use Switzerland for re-invoicing exports). Some of that is the export of finished products for which semi-finished products have previously been imported (i. e. value-added in Switzerland).

      The business of transit trade is extremely profitable for Swiss residents. It’s not just a matter of buying/selling. Instead, it involves a very large support structure (banks, accountants, lawyers, insurance companies, etc. etc.).

      A friend once told me that, in the late 1970s, Greece implemented laws favoring Athens as a place for trading/holding companies and such companies (many of them traders from the Near and Middle East) blossomed and contributed significantly to Greece’s GDP. The old Papandreou apparently did away with that and the trading companies disappeared.

      If one exchanged the Swiss and Greek populations, within probably one generation Greece would do as well as Switzerland is doing now. Except, Greece would no longer be Greece (and Switzerland no longer Switzerland). Thus, it is futile to attempt that the Greeks should become like the Swiss (or the Germans). However, everyone is invited to look at what others are doing well and to adapt some of these tricks to their own culture and mentality.

    11. Having just read the full SNB report, I must correct the above.

      Transit trade IS NOT included in 'special exports/imports'. The latter are true commercial exports/imports crossing the Swiss border (transit trade does not cross the Swiss border). Thus, the commercial strength of the Swiss economy outside its borders is clearly evidenced by these figures (what I called 'ordiinary exports/imports' are precious metals, art, etc.).

      Incidentally, the transit trade (whose volumens are not included in the trade statistics) has an annual volume of about 800 BCHF (more than the Swiss GDP!). Fees from transit trade (about 20 BCHF) have replaced fees from the financial sector as the largest service revenue item.

  3. Klaus, many thanks for explaining those numbers I never tried digging through... Certainly Marc Rich group, Nestle and other multinationals also contribute to the wealth of the country.

    >"Thus, it is futile to attempt that the Greeks should become like the Swiss."

    For me this is evident. But for more than 2 years I now try to find out what reasonable change could be possible for Greece. I come to the sad conclusion that most probably the only way out will be through chaos and hell. Hopefully Greece might after that rise like a phoenix...


  4. For interested readers, I link below the SNBs full report on the Swiss Balance of Payments for 2011 and 2012. They make for interesting reading! The 2011 has a long section on transit trade ('Merchanting' it is called there).

    The strength of Switzerland's international position, particularly the trade, is extremely impressive. Exports and trade surplus keep going up like there was no 25% devaluation at all during the last couple of years.

    The only weak spot that I can see is the SNB itself. Central Banks like the Fed or ECB are being criticized because their balance sheets have grown to about 25-30% of GDP. The SNBs foreign currency assets alone are about 2/3 of Switzerland's GDP!!!

    Since Greeks are a bit traders by nature, I would seem to make eminent sense to attempt to attract trading companies. A bit like a HongKong for South Eastern Europe.

    1. Of course I meant a "25% revaluation".

    2. And another thing: I am a great fan of using a country's Balance of Payments as a point of departure in any analysis and within that BoP - as readers of my blog undoubtedly know - I think the current account is crucial for any economy.

      The crux of the matter are a country's borders. What happens within its borders is subject to the country's legislation. If Greece had all its sovereign debt placed within Greece, hardly anyone outside Greece would worry about it.

      What happens outside its borders is beyond a country's direct control and the BoP shows all the cross-border money flows. The current account works exactly like a family budget: if expenses exceed incomes, a family needs to borrow and/or make an inheritance. If a country's foreign expenses exceed its foreign revenues, the country, too, needs to either borrow and/or attract foreign investment (equivalent of an inheritance) and/or have guestworkers abroad send their earnings back and/or get grants from abraod. Or even better: increase foreign revenues, reduce foreign expenses or a combination thereof.