Saturday, November 12, 2016

Ross Perot's "Giant Sucking Sound" Revisited

Ross Perot was my hero in America's 1992 Presidential campaign. As a common sense Texan businessman, he could explain complicated things is a way that people could easily understand them. Such as trade agreements.

Perot explained, in a rather convincing way, that manufacturing jobs are where manufacturing takes place. If a country makes trade agreements where it starts importing manufacturings which it previously manufactured domestically, there will be that 'giant sucking sound of jobs being shipped abroad'.

Warren Buffett, another American who can explain complicated things in a simple way, described the same phenomena in his story about Thriftville and Squanderville.

"If the Japanese want to work 18 hours a day in exchange for us signing promissory notes, that's fine with me", a young American told me back in 1974 when I asked him whether he wasn't concerned about the rapidly increasing American trade deficit. That, too, sounded convincing to me except that he didn't tell me about the consequences thereof, i. e. the giant sucking sound on one hand and the foreign indebtedness on the other.

I have written time and again about the overriding importance of current account balances in this blog. There are intra-border financial crises, i. e. crises which can be contained within the borders of a country and there are cross-border financial crises. Greece started out as a cross-border financial crisis (when the country lost access to capital markets) and it subsequently evolved into an intra-country financial crisis (when the banks had to be recapitalized on more than one occasion and when still more than half the loans of domestic banks are non-performing).

The external accounts of a country are summarized in the Balance of Payments (BoP). The BoP consists of a Current Account and a Capital Account. The critical formula is:

Current Account + Capital Account = Zero.

The current account measures a country's revenues from abroad and its expenses abroad. When foreign revenues exceed foreign expenses (current account surplus), the country is accumulating a surplus abroad. Vice versa, when foreign expenses exceed foreign revenues (current account deficit), the country is accumulating a cross-border deficit. Just like when a family spends more money than it earns, it has to cover the difference either with debt of with proceeds from the sale of assets or with proceeds from an inheritance. Spending more than earning is generally called 'living beyond one's means'. However, when some or most of the spending represents investment, it is actually good to spend more than one earns because the excess spending will, hopefully, lead to good returns on investments.

The point is, when you spend more than you earn, you have to get funding for it. It is a matter of arithmetic (and not economics!) that a current account deficit must have, in compensation, a surplus in the capital account. The latter means money flowing into the country. It can flow as debt or equity (foreign investment) or as gifts (EU subsidies). If it flows mostly in the form of debt, there will be trouble in the future.

Since the Vietnam war, the world has seen tectonic shifts in current account balances; gigantic centrifugal movements between manufacturing jobs and consumers. The consumers have contributed to the creation of jobs and wealth elsewhere. The price they paid for that is indebtedness to people elsewhere.

How does all this relate to Greece? Greece has 'exported' a lot of jobs by importing products which could just as well be made in Greece. And, in exchange, Greece has signed a lot of promissory notes...


  1. As long as you never pay back the promisory notes - such is the case of the current EU loans - you could actually sign unlimited amount of them.

    1. You can sign then as long as foreigner accept/buy them... Thereafter, what happens is what Warren Buffett calls "intergenerational challenges".

    2. Kleingut:

      As you have freely admitted before the Greek sovereign debt was replaced with EU in an effort to save the euro. This is a very cheap bargain deal for the EU resulting in saving the euro for only 320 BEUR.

      There are no intergenerational challenges here because none of this phony debt is the responsibility of this and future Greek generations.

      I don't think Greece wants or needs any new debt. It only needs a recognized deal on the existing debt so that Draghi includes Greece in the QE as every other eurozone country.

    3. Well, I guess you are right: if the debt of the older generation is wiped out then there will not be intragenerational conflicts.

      Whether debt or foreign investment, Greece will need foreign capital, in my opinion. How else would Greece finance the growth it requires?

      I have never understood what benefits QE would have for Greece but perhaps you can educate me on that.

    4. The way I understand it the QE inclusion deal is the elimination of ELA lending rates which make Greek banks both less profitable and uncompetitive. With QE inclsusion the cost of funds for Greek banks would propable drop by 150 basis points or more. This would set the stage for financing new growth among other things.

    5. Here is some partial picture on the QE deal.

    6. My understanding was as follows: when the ECB buys, say, German bonds under QE from a bank, that bank gets first of all liquidity. The interest which Germany pays then ends up at the ECB and increases ECB profitability. And ECB profitability is paid out to shareholders such as Germany. So the idea would be that as soon as the bonds end up at the ECB, the country no longer has interest expense on them because what it pays in interest it gets back in dividends. But I am not quite sure about that.

      Now if Greece still has 30 BEUR with private banks and pays, say, 6% interest, saving that interest would be a lot of money. That, of course, assumes that the banks are prepared to sell those bonds. Why would they, actually?

      What the article says about issuing new bonds doesn't make sense to me. Neither does it make sense what they write about debt service. So I really wonder whether they all understand QE or whether perhaps everyone repeats what he has heard elsewhere.

    7. I don't think ELA and QE are related. Greece has to borrow expensive ELA until the ECB can make available cheaper normal financing. The latter requires Greece to fulfill certain requirements.

    8. Kleingut:

      The cumulative ELA funding for Greece is around 71 BEUR so it gets quite expensive and renders Greek banks uncompetitive. So it has to be eliminated ASAP.

      From what I understand the only source of profitability for Greek banks at the moment is this constant recycling a 3-month and 6-month paper at roughly 2%. There is about 25 BEUR of such sort term debt that Greek banks handle exclussively. Each month Greece raises roughly 1.2-1.5 BEUR of this type of debt which uses to pay off old bonds of the same duration as they mature.

      As far as the QE inclusion let's hear what Stournaras says:

      "Propped up by three successive bailouts, Greece hopes to emerge from a long recession next year. But much of its outlook depends on getting a long-sought reduction of its huge debt pile, easing capital restrictions and inclusion in the ECB's 1.74 trillion asset buying scheme.

      "We gradually lift capital controls and the next step will take place soon," Stournaras, a European Central Bank Governing Council member, told Reuters in an interview. "The full lifting of capital controls is the end of the road."

      "To get there we need the finishing off of the second (bailout program) evaluation, discussion on debt measures and quantitative easing inclusion. Above everything else, it depends on how quickly full confidence returns."

      Stournaras expects the government to quickly conclude the second bailout review, opening the way for talks on debt possibly in December, setting the stage for the ECB to include Greece in its quantitative easing asset purchase scheme.

      Debt relief has been one of the key sticking points. Germany opposes a move now, while the ECB and the IMF are both calling for an easing of the burden, possibly through longer maturities, lower rates on some bonds, and a smoother repayment schedule.

      Stournaras made it clear that unless a serious discussion starts on debt, Greece will not be included in the ECB's sovereign bond-buying program. Inclusion could give the recovery a major boost.

      "QE depends on debt being sustainable. The ECB needs to have something concrete on debt measures before it performs its own debt sustainability analysis," Stournaras said.

      Although the ECB could only buy relatively few Greek bonds, inclusion in its asset purchases would underpin confidence and help Greece eventually return to the bond market.

      "The secondary effects (of QE), which are confidence and symbolism, are more important than the buying itself. It's a passport for us to enter markets again," Stournaras said.

      Cut off from global debt markets since 2014, Greece is anxious to regain market access before its current 86 billion euro bailout program expires in 2018.

      "The government could try a test bond issue next year. All elements of improvement are conducive to testing markets at some point not so far away," Stournaras said. "We need inclusion in QE for this as a precondition."

      The International Monetary Fund has so far refused to put money into Greece's third bailout on the grounds that financial targets are unrealistic without major debt relief. But Stournaras said it was unlikely that the Fund would part ways with Greece.

      "Everybody realizes the importance of the IMF staying in the program and the IMF realizes it too," he said in response to a question. "The IMF is close to our proposal at the Bank of Greece on debt measures and relaxing fiscal targets somewhat after the expiry of the current program."

      Stournaras said the central bank's ambitious target for Greek banks to reduce their huge overhang of bad loans by 40 percent by 2019 is "realistic" and would be helped by the economy's expected recovery next year.


    9. (continued)

      Greek lenders are saddled with about 109 billion euros ($119.4 billion) of non-performing exposures (NPEs), which at 45 percent of their loan books is the second highest ratio in Europe after Cyprus.

      Reducing the load is key to the recovery of credit growth.

      "The (bank) CEOs must devote more time and energy to NPL reduction and they understand it. With recovery, part of the non-performing loans will be corrected but we do not believe in auto-pilots," Stournaras said.

      He said the Bank of Greece has received a good number of applications from companies interested in administering or buying NPEs and which have experience tackling similar problems in Spain, Cyprus, Ireland and Italy.

      "We are ready to grant about six licenses and there are more in the pipeline. These funds will also bring their own liquidity in the Greek market. I am optimistic that the NPL targets will be achieved," Stournaras said.


    10. Successive Greek Governments have directly or indirectly destroyed the Greek industrial base. Furthermore, Globalization has shifted the world's manufacturing to Chine and outsourced the world's services to India. So, it will not be economically feasible to shift manufacturing back to Greece even IF (in CAPS) Greek Governments, local administrations and Greek society were willing to do so. So in my view, the only way for Greece to improve its BoP is to focus on certain localized Services such as tourism and entertainment.

    11. KK:

      The future for any country - noy only Greece - is no longer based on industrial production. Industrial production is a relic of the 19th and 20th centuries. The future belongs to other technologies of which Greece could adopt as many as it wishes and excel in them.

    12. Sure, could you enlighten us with a list of specific technologies where Greece has an (any) advantage (market size, educational specialties and excellence, tax breaks, overall manpower cost, infrastructure, ...) vs the other industrialized and emerging (India, Eastern Block, ...) countries?

    13. KK:

      Perhaps the Google CEO could enlighten you better:

    14. Great article. Wake me up on the first high-tech investment by Google in Greece.

    15. I think some people are making the mistake to think that basically Greece is good for nothing. A couple of years ago, I looked into Greece's "champions" and I was surprised what I found there. Where does Greece have advantages? I cannot give a professional answer to that but the following comes to mind off the bat.

      I have seen great talents in the areas of IT, design, advertising and all sorts of other creative things.

      Pharma seems to be an area of strength. Perhaps other niche technologies.

      Now above all trading. There was a time when Beirut was called the Switzerland of the Near & Middle East. Why couldn't Greece be a trading center for the entire area?

      Greeks can never make up their minds whether they belong to the East or West. Well, the answer to that is to assume the role of a bridge between the West and the Eastern Mediterranean, Near & Middle East.

      And so forth.

    16. Kleingut:

      I agree on pharma and other areas where Greeks could excel.

      The East vs. West argument for Greece is false and it's based on an imperfect definion of the term "west" by northern europe. Accoring to the Holly Roman Empire the outmost eastern border of europe ended in Croatia. According to such faulty definition then Greece could never be part of the West. In reality the center of the West is Greece and part of Turkey where the Greek cities of Asia Minor flourished. So to taunt Greeks about making up their minds of whether they belong in the west, the best reply is that it is you the europeans who need to be educated as to what constitutes the West. Because without Greece the remainder West is nothing but a superflous nonsense based on despotism and ugly european monachies (in other words nothing to do with the ideals of the West).

  2. Good, so now you understand why Trump will bring german trade surpluses to zero. Numbers don't lie:

  3. As regards trade, and business in general, many of the things Trump is discussing remind me of what Perot said at the time.

    1. @kleingut
      I think Ross Perot and Donald J. Trump play in different leagues when it comes to business. To cite a very ungreek "Greek": ‘The easiest short sales I’ve ever had in my life were the stocks and bonds of Donald J. Trump’s companies. ... It was like numerous ocean liners hitting many icebergs repeatedly.’
      Jim Chanos, Kynikos Associates
      (Jim Chanos is for me a kind of Warren Buffett for shortists)

  4. I wish I could agree with your views on Greece's possibility of becoming the traders of the past, no luck. The traders, middlemen, go-between or distributors, are a discontinued model without future in our globalized world. Increasingly the manufacturer is selling directly to the end consumer or a retailer. Lidl or H&M don't buy from whole sellers, but from manufacturers. You don't buy your air tickets from the local travel agency but from Expedia, or one of the other internet sellers where you have a huge selection and a clear price/value comparison. The day where the middle man could convince both parties they got the best deal on the market are over, even in Greece, people want an added value.Even the venerable Lloyds of London changes to electronic transactions, and they represented a sector where you would have a multitude of unknown middle men.
    Middle men are only used in deals where the manufacturer and/or end user do not want to "know" each other. Guns, stolen or smuggled merchandise and blockade running. The only way that picture could change is if free and fast information is seriously limited.

    1. You just described the influence network which Germany built in Greece over the years after WWII. There are so many Greek middlemen who depend for a living in selling german products and who have no shame or concern in selling out their country in the process. All the Greek middlemen invariably belong in the corrupt party of Nea Tromokratia. And they can'y wait for Nea TRomokratia to be in power again so that they use the same consumption model for Greece; the same model which brought the overborrowing bing and extreme reliance on DB to finance the so damaging Greek consumption without any restraint.

    2. @Lennard,
      there is a spot market for nearly all commodities in the world from metalls to grain and cattle which in turn means there are middlemen involved. There is even a spot market for electronic chips. Many supply chains still rely heavily on wholesale distributors because many manufacturers abandoned stockkeeping.

  5. @Urs.
    Yes, I forgot one function of the middle man, he can sometimes give you, not only the best, but the only deal on the market.
    Of cause there is a spot market and some whole sale distributors, and there will always be, but diminishing. The general trend is towards "just in time" supply chains, i.e. nobody has anything on stock. As the spot market diminishes it's becoming more lucrative, but it is a market for individuals, not something nations can live from.
    Those of us, who have had to go to the spot market, scream and shout about the prices, forgetting how cheap our daily supply chain has become.

    1. @Lennard
      In principle I share your sceptical view regarding trade in general and Greece as a hub for trade in particular. If one looks at a successfull trade hub like say Hongkong and compare it with Greece with regard to ease of doing business, tax, infrastructure etc. etc. I can not envision Greece being very successful in this field in the near future. Having said that, it may be easier to trade than to build a competative industry of any sort.

  6. Next stop in the rapid fragmantation of the EU: The Italian referendum of December 4th.

  7. President Obama just concluded his speech in Athens by saying "Long Live Greece" - Zito i Ellas. Nothing more to add.