Today’s Greek Crisis: A Non-Platonic Dialogue: The Honest Broker for the Week of February 8, 2015
Readings:
- : Greek bond rout deepens as Syriza fears mount – fastFT
- : Greece: Think Flows, Not Stocks
- : Thinking About the New Greek Crisis
- : Greece, the EU and Aunt Agatha
- : Greek games and scenarios
- : Eurozone breakup would trigger the mother of all financial crises
Sokrates Son of Sophroniskos: You are out of your century, and out of your country…
Titus Pomponius Atticus: I claim this to be my country, and here by the docks of the Piraeus to be my place. I am not called “Atticus” for nothing, you know…
Axiothea: Why are you called “Atticus”? It doesn’t sound like a very Roman name…
Atticus: I made it up. My father had only two names–good old Titus Pomponius, no claims to triple-barreled noble senatorial-class names he, just an equestrian.
Sokrates: So you have a triple-barreled name because?
Atticus: My mother wanted it: Caecilia Metella–one of the Metelli. Her family was at the top in the years surrounding my birth, providing the Republic with seven consuls in the generation between 123 BC and 98 BC: Quintus Caecilius Metellus Balearicus, Lucius Caecilius Metellus Dalmaticus, Lucius Caecilius Metellus Diadematus, Marcus Caecilius Metellus, Gaius Caecilius Metellus Caprarius, Quintus Caecilius Metellus Numidicus, and Quintus Caecilius Metellus Nepos.
Hypatia: “BC”?
Atticus: So it’s an anachronism. Sue me?
Glaukon: “Caprarius”? “Goat”?
Atticus: Don’t ask. So, anyway, I had to have a triple-barreled name. So my mother insisted I choose one. And I chose Atticus…
Glaukon: But what are you doing out of your century?
Atticus: What are you doing out of yours? This isn’t the Piraeus of the fifth century BC: This is a twenty-first century AD container port.
Aristokles: So then why are we here?
Daniel Davies: Syriza has won the Greek elections. There has been a lot of rather contradictory comment on what the party’s negotiation strategy might actually be, but nevertheless, it certainly seems that the ‘ultimatum’ approach to debt reduction is very much on the table, and in any case, a dogmatic refusal to continue with past agreements on structural measures would end up having the same effect. It’s worth wargaming out what the various parties might be thinking and how their strategies might interact…
Sappho: Why has that man covered himself with blue paint?
Atticus: We are here not to have a Socratic debate, but to watch one.
Axiothea: And our role is to be a more-or-less MST3K to the situation?
Atticus: Less rude, and more informative. We will see how it develops.
Aristokles: Who put you in charge?
Atticus: That I own the time machine? That even though most of you know me only as the guy whom my friend Marcus Tullius Cicero ranted and vented to, and even though I spent a huge amount of my time trying to keep Cicero from getting himself killed either by his political enemies or by my sister, I did have a day job: I am a banker. This is my territory.
Thrasymakhos: Hush. A second interlocutor approaches.
Barry Eichengreen: The decision to join the Eurozone is effectively irreversible. The insurmountable obstacle to exit is procedural. Reintroducing the national currency would have to be preceded by very extensive discussion. In 1998, the founding members of the Eurozone agreed to lock their exchange rates at the then-prevailing levels to rule out depressing national currencies in order to steal a competitive advantage. In contrast, today the very motivation for leaving would be to change the parity. A system-wide bank run would follow. Investors anticipating that their claims on, say, the Italian government would be redenominated into lira would shift into claims on other Eurozone governments. It would be unlikely that the ECB would provide extensive lender-of-last-resort support. And the government would not be able to borrow to bail out the banks and buy back its debt. This would be the mother of all financial crises. What government invested in its own survival would contemplate this option? As soon as discussions of leaving the Eurozone become serious, it is those discussions, and not the area itself, that will end.
Glaukon: These people are long-winded.
Cnaeus Pompeius Magnus: Have people become more intelligent since our days? I remember how Marcus Porcius Cato, Cicero, and I agreed that we had Gaius Julius Caesar trapped–that for him to cross the Rubicon would be so disastrous as to be totally inconceivable. And so I wound up dead on a beach in Alexandria…
Hypatia: I know how that feels…
Sokrates: It is a disease of twenty-first century economists–that people will invariably walk down and examine the leaves of the game-theoretic strategy tree and so avoid disastrous branches. We see it often:
Daniel Davies: One thing it’s important to make clear is that the European policy makers aren’t stupid. I have lost count of the number of articles I’ve read where some opinion columnist or other acts as if the fact that Greece’s debt burden is unsustainable and cannot ever be repaid is some special insight available only to readers of his newspaper, and that the benighted fools of the Commission, ECB and Eurogroup are so ideologically blinkered that they can’t see this obvious fact. Often enough, this piece of pontificating is attached to some distinctly dodgy theorising about the peculiar national characteristics of ‘Germans’. The fact is, everyone knows that the total burden of Greek debt is too big to be serviced by the Greek GDP, and that if it isn’t written down, then Greece will always be reliant on an increasing stream of official financing to meet its roll-overs. Everyone also knows, although some of them might not be ready to admit it to themselves, that an indefinite commitment to financing the roll-over of an ever increasing debt burden is a fiscal transfer in all but name. The thing is, though, while the Eurosystem bureaucrats know this at least as well as anyone else, they have jobs in which they can’t simply bemoan the fact in print, then submit their copy and go off to think about something else.
Socrates: There, for example.
Axiothea: But not all of them:
Paul Krugman: Daniel Davies tells us that ‘European policy makers aren’t stupid.’ But they do say stupid things, still talking about expansionary austerity, still treating debt as a purely moral issue. Can and will they be realistic, accept that they can’t extract blood from a stone–at any rate not at the rate of 4.5 percent of [annual] GDP [per year]–in time to avert a spiral into disaster?
Axiothea: See?
Atticus: And Krugman believes we need to focus on the essentials:
Paul Krugman: Markets are panicking. It’s important to understand that this is not a verdict on the new Greek government, or at any rate only the new Greek government; it’s a judgment that the risk of no agreement, and a disorderly breakdown of the whole process, is high. I think it’s important to be as clear as we can about the stakes and the real interests here, lest players stumble into a disaster they could and should have avoided…
Aristokles: I am lost.
Atticus: Let’s back up:
Daniel Davies: Don’t think of the Greek debt burden, either in cash € terms or as a ratio to GDP, as an economic quantity. It isn’t an economically meaningful number any more. It is a political quantity–the means by which control is exercised over the Greek budget by the Eurosystem. The regular rituals are the way in which the solvent Euroland nations exercise the kind of political control that they feel they need to have if they are going to be fiscally responsible for the bills.
Aristokles: Can we go over that again?
Daniel Davies: Consider a young man–to make it concrete, let’s call him Jim–who is living rather beyond his means–every month, he has income of £5000 and expenses of £5500. He is maxed out on his credit card with £5,000 of debt. So his only source of funding is Aunt Agatha. Aunt Agatha makes Jim sign an IOU and pay interest, but the interest rate is pretty low compared to the credit card, and every time the debt comes due, she is content to extend the term and roll it over into a new loan. Jim has, over the last few years, amassed a balance of £50,000 in debt to his beloved aunt. Then disaster strikes and Jim’s income falls to £3000 a month. Aunt Agatha is prepared to increased her monthly loans from £500 to £2500, but she has a number of firm conditions attached. Some of these are things that Jim has been planning anyway, but some of them–like giving up on his foreign language course–seem counterproductive to him and he doesn’t really want to do them. What should he do? I hope everyone can see that the following piece of advice would be dreadful:
Well, the problem is your debt/income ratio, which is now around 153%. And Aunt Agatha is by far your biggest creditor. Tell her that you can’t pay her back and need her to write off half of your debt.
Thrasymakhos: Why is he named “Jim” rather than “Bertie Wooster”?
Glaukon: To explicitly compare Greece, its voters, and its politicians to a P.G. Wodehouse character would attract the scrutiny of the United Nations High Commissioner for Human Rights.
Aristokles: Why is it such bad advice, again?
Daniel Davies: Aunt Agatha is a very unusual kind of creditor. She is lending, at concessional rates, in circumstances where no other lender would be prepared to, and most importantly, she is the sole provider of finance to cover Jim’s deficit. If his relationship with her breaks down, he has no other sources of funding and would have to reduce his consumption, immediately, to equal his income…
Aristokles: So writing down the Greek debt actually makes Greece poorer because it comes at the cost of the end of current transfers to Greece?
Hypatia: Actually, I don’t think that is true…
Paul Krugman: The question is how much Greece will transfer to its creditors by running primary surpluses–and yes, at this point that’s the question, there’s no possibility that the creditors will transfer more resources to Greece. If Greece were to adhere totally to the previous terms, over the next five years it would make resource transfers of about 20 percent of one year’s GDP. From the point of view of the creditors, that’s a trivial sum. From the point of the Greeks, however, it’s crucial; the difference between a primary surplus of 4.5 percent of GDP and, say, 1.5 percent of GDP for the Greek economy and the welfare of its citizens is huge. There was modest de facto aid to Greece in 2010-2012, but no aid is currently flowing, nor will it.
Axiothea: Davies does admit that that word-picture was the past, not the present:
Daniel Davies: Things have moved on a bit. Jim gave in to Aunt Agatha’s demands and has stabilised his monthly situation, with income of £3500 and expenditure of £3500. But he has an interest bill on his credit card of £100 every month so he still needs to borrow a bit from Aunt Agatha. And he has got a new girlfriend who keeps telling him that he really ought to start the language course again if he is going to have any prospects. This is Greece now. Primary balance has been achieved and growth is positive again. Syriza wants to make more investment spending. But it seems clear to me that the following strategy is not going to help Jim.
If you stopped paying interest on Aunt Agatha’s IOUs and told her to write off half your debt, you could afford to take those language courses again.
Aristokles: Why not?
Daniel Davies: Because it’s not true–messing around with the debt interest on the EU debt doesn’t free up any material resources for the Greek state budget, unless the EU can be persuaded to advance more money. If you can persuade the EU to finance some deficit spending, then the problem is already solved. Negotiating with Aunt Agatha about the language course would be a sensible course of action, but not kicking off those negotiations with a load of demands that her to confront the reality that she is throwing good money after bad.
Thrasymakhos: So Greece should shape its negotiating strategy to avoid hurting the German government’s feelings?
Sokrates: I agree it does not fit with Davies’s earlier description of European policymakers as flint-eyed Machiavellian realists who do not let empty verbiage and meaningless accounting entries distract them.
Axiothea: But even that is wrong!
Paul Krugman: As both Daniel Davies and James Galbraith point out, at this point Greek debt, measured as a stock, is not a very meaningful number. The debt is an accounting fiction: whatever the governments trying to dictate terms to Greece decide to say it is. Focus on the aspect of the situation that isn’t a matter of definitions: Greece’s primary surplus, the difference between what it takes in via taxes and what it spends on things other than interest, the amount Greece is actually paying, in the form of real resources, to its creditors. Greece has been running a primary surplus since 2013, and according to its agreements with the troika it’s supposed to run a surplus of 4.5 percent of GDP for many years to come…
Atticus: The focus on real resource transfers is a very important point. And Davies does recognize that looking forward:
Daniel Davies: The EU program for Greece assumes large primary surpluses for the years 2016–2020. And that changes the dynamics significantly. In a couple of years’ time, Jim’s income has reached £4000 a month, but his expenditure is still £3500, per Aunt Agatha’s original budget. He’s paying down his credit card, and he really really wants to get back on that language course. At this point, the “Tell Aunt Agatha to get stuffed” advice is… well, I still wouldn’t regard it as prudent, even if one ignores the morality of short-changing a beloved aunt. But it’s no longer actively suicidal. If the language course helps Jim get a high flying job elsewhere, then it could kick-start his comeback to a state where he can pay all his debts and persuade the fair Cecilia to marry him. If Syriza think that diverting [future primary] surpluses into fiscal stimulus could kick-start a recovery, then it would make sense to ignore the troika and start playing real hardball.
Glaukon: “Cecilia”? “Caecilia”? Is someone going to run off with your mother, Atticus?
Sokrates: No, it’s just that the appearance of that name in Daniel Davies’s piece was what triggered this off. But that “beloved aunt” stuff–once again it doesn’t quite seem to fit the rhetorical pose of the down-to-earth Welshman who doesn’t trust flowery motives…
Glaukon: And what Daniel Davies sees as the future, in which Syriza might change its negotiating strategy without catastrophe, Paul Krugman sees as the present. For Paul, now is the time to figure out what to do with Greece’s 2015-2020 primary surpluses…
Atticus: There is a point to it:
Daniel Davies: I wouldn’t advise this though, for one very good reason, which the more cynical readers and afficionados of PG Wodehouse novels may already have skipped ahead to… One day, Aunt Agatha is going to die. When she does, it’s very likely that her will is going to release Jim from his IOUs; although she is much too straight-laced and Calvinist to admit any such awful thought. Wouldn’t it be a terrible shame to shut yourself off from such a generous aunt, particularly as the rosy future on the language course is far from assured? One day, fiscal union will happen in the EU and Greece’s debts will disappear into a common pool. Everyone knows this, but it’s not politically acceptable to say so at present. Given that, it makes little sense to risk the relationship for a short term gain. Syriza has a much more appealing strategy in a negotiated settlement, involving less primary surplus and more stimulus spending.
Thrasymakhos: Now I am lost. It seems to me that Daniel Davies is saying that the fact that even though the Euro Troika has done the wrong thing over the past seven years Syriza should still avoid trying to play hardball because the Troika are going to do the right thing in the future, any day now. I do not see where that confidence comes from.
Hypatia: Say, rather, that Daniel Davies believes that being inside the charmed circle of the European Union as a member in good standing is going to be an enormous source of wealth for Greece over the next two generations:
Daniel Davies: Seeing the peripheral Eurozone debt in isolation from the politics of European integration is a sure way to lead yourself up blind alleys. It is, therefore, totally inimical to the Eurosystem to hold out any hope of the kind of debt writedown that Syriza wants. Syriza wants to get a major up-front reduction in the debt number is to create political space to execute the rest of their program. The people who don’t understand it are the ones writing editorials in the business press which support the debt reduction but don’t think that Syriza should be given carte blanche to do everything it wants.
Hypatia: In Daniel Davies’s mind, not calling for a large writedown of Greece’s formal debt is a way for Greece to demonstrate that it is playing by the rules in the game of European unification–and that it is in Greece’s long-run interest to do so:
Daniel Davies: There’s more than a couple of Germans I’ve spoken to over the last few years who have pointed out that although Germany got massive debt relief in the twentieth century, it got it in the context of an equally massive national admission that the entire political system was rotten and needed to be totally restructured with foreign help.
Thrasymakhos: But the cost of playing by the rules and running large primary budget surpluses over the next six years as long as Germany keeps ECB monetary policy inappropriately tight is absolutely enormous:
Paul Krugman: Relax[ing] that [primary surplus] target would not mean demanding that creditors throw good money after bad; everyone has already implicitly acknowledged that the debt will never be fully paid. [If] Greece stopped running a primary surplus at all, you might think that this would let the Greeks spend an additional 4.5 percent of GDP–but the benefits to Greece would actually be much bigger. The extra spending would mean a stronger economy, which means more revenue. Suppose that the multiplier is 1.3 and that Greece can collect 40 percent of a rise in GDP in revenue. Then an additional billion euros in spending should generate around 0.5 billion euros in revenue, reducing the primary surplus by only 0.5 billion euros. Dropping the requirement that Greece run a primary surplus of 4.5 percent of GDP would allow spending to rise by 9 percent of GDP and raise GDP by 12 percent relative to what it would have been otherwise. Unemployment would fall by around 10 percentage points relative to no relief. The question of how large a primary surplus Greece runs is real and has powerful implications for the economic outlook. Keep your eyes on that ball.
Thrasymakhos: Can Aunt Agatha’s will be generous enough to make up for that!?
Atticus: You got me.
Sokrates: There are dangers for the rest of Europe from walking down the no-resolution branches of this strategy tree as well:
Paul Krugman: The consequences of playing hardball with Greece over its banks could very easily be immense. Up until now, the euro has proved very durable, largely thanks to the point Barry Eichengreen emphasized: any country that even hinted at the possibility of leaving would face the mother of all bank runs. But as I worried some time ago, this argument becomes moot if the banking system has already collapsed. If it turns out that the single currency is not irreversible, do you really think there would be no contagion? At the moment, Germany is talking as if it intends to follow the Michael Corleone strategy. But do we really think that Syriza will or even can retreat with its tail between its legs immediately after winning a dramatic election victory? Again, wanna bet on it? Wanna bet on it?
Atticus: Daniel Davies really disagrees:
Daniel Davies: Tsipras’ strategy is… cute. I think it might even have worked if tried three years ago; as far as I can tell, something like it was the unspoken threat under the table which led to the restructuring of the Irish bailout liability. It’s a blackmail game that is best played by a left-wing populist, because in order for the threat to be credible, it needs to be made by someone who is not susceptible to apocalyptic warnings and who is even prepared to dice with the prospect of actual bank runs. I can entirely see why it’s attractive to Syriza and Tsipras. But this isn’t three years ago. I think that if faced with this sort of behaviour by a Syriza government, the ECB would definitely decide to call the bluff. Euroland had a real, credible stress test and it wasn’t the one that we were all looking at. The real stress test in 2014 was the restructuring of Banco Espirito Santo. Stress tests are not a test of the banking system; they’re a test of the bailout system. The purpose of a stress test isn’t to bore the pants off us with megabytes of accounting data telling us things we already knew. The purpose is always to put the weakest banks in the system into a position where they need to be recapitalised, and thereby to demonstrate that the system is capable of dealing with capital shortages, and doing so without an unreasonable fiscal burden. The quick and brutal treatment of BES demonstrated that even in a comparatively large European bank, and even in one of peripheral Europe’s shakiest fiscal systems, it was possible to carry out a refinancing and resolution over a weekend, with legal certainty and without contagion to other banks or interruption of vital services. The successful outcome from BES must surely encourage the Eurosystem policy makers to think that Greek euro exit, if it happens, could be contained…
Thrasymakhos: So how is all this likely to end?
Atticus: Let’s listen:
Daniel Davies: Syriza plays the ‘madman strategy’ and gets given meaningful concessions to keep it in the Euro. One would expect this to be associated with a lot of self-congratulation from the ECB and repetition of ‘whatever it takes’ speeches, and the end result would be to either monetise or mutualise a load of the Greek debt burden. This would be very bullish.
Hypatia: That would seem to be the usual way that Eurozone crises have been dealt with over the past seven years…
Sokrates: Although very inadequately, from the standpoint of recovery of employment. Good for banks and capital holders, not so good for…
Atticus: Hush!
Daniel Davies: If Syriza plays the ‘madman strategy’ and Greece leaves the euro, this would be the mother of all buying opportunities as it would surely be associated with a massive risk-off trade, but the market would be quick to subsequently realise that the actual effect on the Eurozone was heavily quarantined.
Hypatia: And then?
Thrasymakhos: Davies’s implicit view is that Greece is then in trouble–cast out of the European Union into the status of a Belarus or a Turkey or an Algeria–and loses big long-term…
Sokrates: But the Eurozone recovers..
Atticus: Hush!
Daniel Davies: So my view is, I guess, that if you can close your eyes and open them again in January 2016, you buy Eurozone risk and hold it. The best trading strategy would be to keep some powder dry. Mon-Greek peripheral credit looks like it could be cheap, and potentially a way of parking cash somewhere without equity downside but some share in the upside when things get resolved and the market snaps back.