Monday, September 26, 2022

Greece On The Rebound?

An American friend recently asked me for my opinion on the current status of Greece. Below is the original mail which I sent him with 2 follow-up's. 

Original mail

News about Greece? Well, I think I said before that Nea Demokratia (Mitsotakis’ party) should erect a monument honoring Alexis Tsipras in downtown Athens! That man was to the Greek economy what Paul Volcker was to the American one. Except that Volcker did it out of conviction to wring inflation out of the US economy whereas Tsipras had signed everything the Troika had laid on his desk only to be loved by international leaders. No non-leftist leader could have done what Tsipras did - there would have been a rebellion. Sometimes I think that, in approaching the negotiations, the Troika had started with extreme austerity scenarios only to be prepared to negotiate them down but Tsipras didn’t do any negotiating. So screws were really put on EVERYTHING (wages, pensions, benefits, state employees, etc.) and taxes were increased like mad. And the result? A balanced budget and a wonderful trampoline for a new government - fresh leeway to lower taxes and increase benefits!

The really smart thing of Tsipras was that he did not agree to the Troika’s pressure so sign a standby-agreement for the time after the program. That would have again required memoranda with financial targets, reviews and so forth. Instead he opted for the option of a cash reserve (actually, at the time I argued that he should go for the standby-facility) and the Troika started with a dowry of 15 BEUR. 

But the smartest thing of all was that Tsipras had learned the lesson - „borrow when you don’t need the money so that you don’t have to borrow when you need it“. Mitsotakis subsequently took that lesson to the extreme. Greece borrowed and borrowed because markets were so eager to find yields and before you knew it, Greece was sitting on cash reserves of 40 BEUR+ without having any significant debt maturities until the early 2030s and very low interest expense. So here you have it - markets were lending to Greece because the risk looked so good with so much cash reserves and the more Greece borrowed, the more cash reserves it had and the better it looked. Investment grade is around the corner. Greece spent tons of money on Corona and, now, energy and under normal circumstances that might have led to a liquidity squeeze. As it was/is, it just made a small dent into cash reserves only to be filled quickly again with funds from the EU Recovery Fund.

Greece is swimming in cash and more cash is on the way out of the EU Recovery Fund. In theory, most of this cash is earmarked for certain growth projects and if Greece, for once, manages to spend borrowed money on sensible investments, that could really lead to a phenomenal future. But that is - as always - the big „if“ with Greece. I would be cautious.

And against the above background, enter Kiriakos Mitsotakis, a superbly smooth operator with cosmopolitan flair who is more eloquent and fluent in English than most native English speakers. The ideal interviewee for the global networks. The perfect pitcher for foreign investments. A man who managed to give back to Greece, in the eyes of the world, some of its greatness and that, of course, has an impact on the perceived creditworthiness of the country. Mitsotakis dances on the world stage like it is his home. When he visits Washington DC, he - naturally - is given a chance to address both Houses of Congress where he gets innumerable standing ovations. All this leads to a situation which was beautifully described by a recent NYT commentator:

"It is, rather, the unsustainable contradiction between the country Mr. Mitsotakis insists on pitching abroad — an unimpeachably democratic state whose respect for the rule of law and liberal bona fides ought to be rewarded with corporate investments and tourism dollars — and the one he actually presides over.“

Mitsotakis has managed to get the world who loves him to disregard the Greek shadows (of which there have always been many and which have not disappeared). In some ways, he is running the country Orban-style while portraying himself as Thomas Jefferson. The media are pretty much under control and Greece went from #58 to #108 on the Freedom of Press Index. No one seemed to care. If Orban had done to refugees what Mitsotakis is doing (push-back’s, etc.), he would probably have been kicked out of the EU by now. And then it turns out that Mitsotakis' government is wiretapping political opponents! So far, Mitsotakis has managed to keep all these serious issues under control but if and when they explode, they will explode in a nasty way. 

And here is the greatest risk - just like Ikarus became over-confident when he saw that he could fly, Mitsotakis is getting a bit over-confident, too. Quite cocky, I would say. When the honor of addressing both Houses of Congress is awarded to you, you live up to that distinction and you don’t use that opportunity to trash your neighbor (regardless how justified Turkey-trashing would be; and it is!). When you sit in the European parliament and listen absent-mindedly to serious criticism from a parliamentarian who quotes from the EU report on Greek push-back’s, everyone would expect you to respond in a serious way to those accusations (which, incidentally, are not accusations but proven facts). When you then get up and say not much more than „Greece is honoring all international treaties and conventions“ - full stop, well, that’s really kind of cocky. 

All of this is a very long way of saying that not everything is as shiny in Greece as it presently seems. Yes, Mitsotakis is a serious leader and he has some serious people in his government. Notably the Minister for Digitalization who is a genius and who has already introduced incredible reforms in public administration. But the sad fact is that underneath the surface are Greece and the Greeks and I am very cautious before I jump to the conclusion that Greeks will really change. Our mutual friend David would tell you that they never will.

The economy is booming. No surprise with all that cash and all those tourists coming in. Unemployment is down to 12% (!) and growth this year will be over 5%! But whenever Greece booms, Greeks discover that the products for which they now have money and which they want to buy are not produced in Greece. The money immediately goes into imports. Tsipras’ austerity had brought the current account deficit down to almost zero. This year, it will be at least 20 BEUR despite all the tourism records. That’s a little over 10% of GDP. Back in 2009, just before Greece had hit sudden stop, the current account deficit was about 15%. I think there is a real chance that Greece will return to its traditional role of being a turntable for money - money coming into the country as debt and leaving it as current account deficit and capital flight. And with everything booming, inflation is going through the roof not only because of energy costs. Simply put - Greece is getting expensive again. Not too bad yet but well under way. And we all remember what happens when Greece becomes more expensive than competitor countries. 

One of the greatest risks that I can see is that Greece faces no serious financial constraints for a number of years. Existing cash reserves are high enough to carry the country through several years and more cash is on its way. Not having financial constraints while cash is flowing into the county is a very dangerous combination for Greece.

Addendum #1

Of course I was being facetious about Tsipras. I agree with those many people who say that Tsipras’ IQ is not very high. It doesn’t appear like he really understood what was happening around him. He was the man with the megaphone and he had great talent to hit on good soundbites. As for the „Volcker of Greece“, the Troika was the Volcker and Tsipras was their proxy. He would shout into the megaphone that he would reject the latest Troika demands only to sign them the following day. He is really a bit of a tragic figure because he took the beating so that his successor could shine (and he was not aware that he was doing it!).

Tsipras is not history yet! The wiretapping scandal has really damaged Mitsotakis credibility and strengthened Tsipras’ megaphone. The new election system makes it virtually impossible for anyone to rule alone, so Mitsotakis will need to find a coalition partner next year. Tsipras will also look for coalition partners. So Greece will face interesting times (again). The only thing which seems certain is that Greece will be less stable going forward (after the election).

Addendum #2

Back in the summer of 2018, Greece was heading for the exit from the Troika program. There was really no way of telling at the time what would happen once Greece stood on its own feet again. Most people were cautious and felt Greece shouldn’t take any risks and, therefore, opt for a Troika standby facility. That also made a lot of sense to me because, that way, Greece would pay only a small commitment fee and nothing more. The alternative (the cash reserve) would mean that Greece would pay interest and receive less interest on the re-investment of those funds. 

Tsipras was the lone wolf. His objective was to go into the 2019 elections with the claim that he personally had freed Greece of all foreign shackles and a standby facility would have required him to sign another memorandum. That was a no-go for Tsipras. In retrospect one can say that entirely for political reasons he took a decision which turned out brilliant for economic reasons. No one at the time would have foreseen how easy it would be for Greece to borrow new money in the markets at near-zero rates.

I love to browse around in the statistics of the Greek Central Bank and Treasury (as well as those of other countries). It is quite surprising what one can find there. For example, since 2010, during more than a decade where everyone thought Greece was excluded from foreign funding, Greece managed to increase its external debt by 195 BEUR (!) to 565 BEUR! That now represents almost 3 times GDP. Argentina is looking good in comparison… Of that 195 BEUR increase, roughly 120 BEUR alone came in during the last 3 years of Mitsotakis’ government!

Greece now has a negative net international investment position of 325 BEUR (i. e. negative international net worth). Since external debt alone is 565 BEUR, I figured that there must be somewhere at least 240 BEUR in foreign assets. As it turns out, the Greek economy reports total foreign assets of 302 BEUR against foreign liabilities of 627 BEUR. I was extremely surprised that the Greek economy would have so many foreign assets. Regrettably, from the Central Bank lingo, I can’t tell what assets those are and who owns them. That would be an interesting area to research!

Whichever way you slice it, those figures - albeit not nominally as large as Italy’s - are huge figures for a country the size of Greece. Wouldn’t you agree? I know one shouldn’t look at such macro figures with a bookkeeper’s mind but my bookkeeper’s mind tells me that, cross borderwise, Greece has a negative net worth of 302 BEUR. And if the foreign assets do not serve as collateral for the foreign liabilities (which I am sure they don’t), foreigners have 627 BEUR at stake in Greece. Not bad for a small country which doesn’t even have a complete land registry yet and where the state is not able to produce a list of all real estate it owns!

That brings me to my favorite subject of Target2. In the spring of 2011, the German economist Hans-Werner Sinn wrote an article that he had discovered an amount of 325 BEUR among the assets of the Bundesbank and had researched what they were. It turned out they were socalled Target2 claims. And since then there has been a debate what Target2 claims are. Are they overdrafts? Loans? Or simply hot air? Well, they are undocumented balances in a clearing system. If Germany has 325 BEUR in claims (the claims are against the ECB), someone else has 325 BEUR in liabilities against the ECB. If the clearing system breaks down (i. e. if the Euro fails), Germany is out of 325 BEUR.

Except, Germany would now be out of over 1,2 trillion Euro because that’s the current level of Bundesbank Target2 claims! Well, that’s like one-thousand-two-hundred-billion-Euros. Or more than a quarter of Germany’s GDP! This come on top of the rescue financing which Germany has been part of in the last decade. If there were no Euro-clearing system called Target2, the deficit national central banks would have to borrow that money in the market (if they could indeed borrow it) and pay interest on it instead of the interest-free ECB liabilities. According to the gospel, any Target2 liabilities were supposed to be secured by first-class securities. Well, they have become unsecured by now.

Returning to Greece. Greece had scared the world because by 2010, their Target2 liabilities had reached almost 150 BEUR. That was the net outflow of money which could not be financed by normal credit. It was again under their proxy Tsipras that the Troika could reduce the Target2 liabilities to 25 BEUR by 2019. An achievement which I would never have thought possible. And where have they gone since then under Mitsotakis? They are currently around 110 BEUR again. If you want to look into Target2 balances in more detail, here is a good link.

What am I trying to get at? Well, if one were to look at Greece with the same critical mind as one looked about 10 years ago, one should really get scared. Budget deep in the red, current account deep in the red, sovereign and foreign debt rising at enormous speed. But no one is worried at the moment. After all, Mitsotakis is a good looking cosmopolitan man who is fluent and extremely eloquent in English. He has a great pitch and he pitches all the time. But one should always remember what the commentator wrote in the NYT recently: "It is the unsustainable contradiction between the country Mr. Mitsotakis insists on pitching abroad — an unimpeachably democratic state whose respect for the rule of law and liberal bona fides ought to be rewarded with corporate investments and tourism dollars — and the one he actually presides over.“

If you look at the above figures of Greece and bear Italy’s figures in the back of your mind (and some other countries), you know that there is only one way for the Euro to survive longer-term and that is the mutualization of all national debts (i. e. Eurobonds). Otherwise, this whole system is going to blow up sooner or later. Which reminds me of a biography I once read about Alexander Hamilton. His point was that there are 2 key prerequisites for a union to stay together: a common army and a common currency with a central bank. Well, he got both. The EU still needs both (whether you like it or not).