Is it money or reforms they are after?

Yanis Varoufakis's latest article states that the Greek government should only cut about 2.5 billion euros, which is the nation's primary deficit at the moment, and then renegotiate the loan agreement with the Troika. Although it does sound like a good idea in theory, I am afraid that the only way to achieve what he proposes would be for the Greek government to exercise tremendous political on the ECB or the IMF.

In short, what Yanis proposes is for the Greeks to cut 2.5 billion, receive 31 billion and then renegotiate the loan agreement. Yet I am under the impression that if the "old-heads" of the IMF won't see the measures they have proposed, passed through the Parliament, they will not allow for the 31 billion tranche to reach Greece. As the stupidity that the EFSF-ESM will not directly recapitalize Greek banks remains then I am afraid that all Greece, Spain and Cyprus are doomed to forever move in a recessionary spiral.

Norwegian chocolate bar Troika. Too bad their measures are bitter. Source: Wikimedia Commons

It is impossible to understand why the Germans and many other Northerners are opposing the idea of a direct aid to the EU banks. If that was to occur, then the EU nations which opted for a bail-out would only have to receive half of the aid they are currently receiving, if not even less. And for those who do not remember, most (if not all) of the EU banks are facing troubles due to the decision to haircut the Greek bonds held by the private sector by essentially 79% (30% plus 70% on the remaining) and the equally irrational decision to raise Core Tier 1 capital adequacy ratios by 1% in the midst of the crisis. 

For those who fear that the "German taxpayer" would have to pay for bank recapitalization, I need not remind you that the ECB can just guarantee the adequacy of the EU banks, without spending a cent, forcing the banks to come up with the money in a number of years and not now. Nevertheless a money injection in the ailing banks could be good for the economy as a whole. And if you consider this to be greatly risky for taxpayer I repeat: money does not have to be spent to make the Union's wheels turning.

While Yanis's proposal is great in theory, I am afraid that the only way around the austerity measures proposed would be to pass them through the Parliament, receive the 31 billion and then annul some of them. This however, would not make the Greeks more credible, nevertheless it would make it more possible for them to get through 2013 without another severe recession. As a Kathimerini article states today, some fear that the recession will be closer to 9% than 4.5% in 2013.

What worries me more is that while the country is at the brink of disaster, the Troika or the EU does not seem to understand the effects the undertaken measures will have on the ordinary people. In the previous article I have stated that the measures affect the low- and medium-income families much more than the higher income ones. Given that the latter have much more elastic demand it is more than obvious that when their income is reduced, their consumption is reduced by a large factor. (the formal term is propensity to consume)

Thus, although eliminating the primary deficit and renegotiating the loan agreement would be a good idea, it would be nearly impossible, given the state of mind of the Troika and the EU officials. What we need is rational measures, implemented on a long time-frame, with structural reforms and mentality changes. Yet, all we see is spending cuts. What are the Troika objectives is really beyond me.

Incredible Threats?

Yesterday, Yanis Varoufakis presented an article over his concerns about the OMT (Outright Monetary Transactions) program announced by Mario Draghi almost two weeks ago. In the article, Yanis, after depicting the arguments in game theory style, states that if Mario Monti decides to take up Draghi's offer for OMT, then the former would be better off by not enforcing reforms and austerity measures in Italy, because the threat that Draghi will stop OMT operations in incredible. In essence, Draghi will be caught between a rock and a hard place.

Yanis states that it would be disastrous for Draghi to back out once he has agreed to fund Italy (or any other country for that matter) since the result would be that Italy would most likely exit the euro. However, I think that in his analysis, Yanis fails to state three points:
1. Money will not be given as a lump sum as soon as the agreement is signed. What should take place is an instalment-based assistance just like in the case of Greece.
2. Economic theory (and game theory) states that rational people will choose what is best for themselves under certain circumstances. However, behavioral economists have proven that people are not at all like the rational beasts economists perceive them to be. (Paradoxically, economists themselves are not as rational as they think they are)
3. The consequences for Italy if the country exits the Eurozone.

If game theory was right, it would mean that the Greek government would have an incentive to exit the Eurozone and declare bankruptcy as soon as

Persistence of Ideologies

I have been reading Yanis Varoufakis's blog post today and what has stricken me with amazement was how much ideology is affecting economists. As you may read from his post, he is criticizing the newly developed plan for purchasing EU bonds in the secondary market, called OMT (Outright Monetary Transactions), my comments about which you may find here.

In the article, Yanis states that the EU is currently facing a battle between Bundesbank and the private German banks which want to avoid banking integration and the EU leadership
who wants to promote an EU-wide banking regulatory system. The main advantage of this proposal is that "small" countries will not be taken down as soon as their banks face disaster. What is most important is that under a common regulatory framework, all banks of the EU should (at least in theory) be treated equally without any national prejudices.

I may be too optimistic, or too pro-European in comparison to Varoufakis. Truth be told, I do not believe that Greece is innocent of all its sins and the situation there should not amaze us:
If you happened to watch any news about Greece over the last 10-20 years you would see how little trust the Greeks had in their governments, no matter what the ruling party was. Add to this an ideology proposed
by the world's leading economists (i.e. Friedman, who I am sure is laughing gaily now since he did not believe a monetary Union could be achieved in Europe) and what we get

On Yanis Varoufakis's Modest Proposal

Yesterday, Yanis has posted a new article which contains some new Q&A over his modest proposal. Although he provides some clarifications he does not specify others. I still have three questions unanswered:

1. Why should the ECB issue Eurobonds and not move in directly to help a nation? A constraint Yanis uses it in his Modest Proposal pdf is: "The ECB will not be allowed to monetise sovereigns directly (i.e. no ECB guarantees of debt issues by member-states, no ECB purchases of government bonds in the primary market, no ECB leveraging of the EFSF-ESM in order to buy sovereign debt either from the primary or the secondary markets)". Nevertheless, the problem is exactly this. The ECB does not need to issue Eurobonds in order to aid ailing countries. This could happen simply, and more efficiently, by directly purchasing government bonds or guaranteeing them. Of course, this would be a difficult policy needing the unity of all the political leaders of the EU, however, it is the best solution for ending the current crisis. It is what should have been done in the first place (read An Alternative to the Greek Bailout for more) without resorting to the Greek haircut "solution".

The solution Yanis is proposing would mean that the ECB will basically act as an intermediary between investors and nations. The ECB would issue the bond, guarantee it and at its maturity the nation would (for Yanis's example) repay 2/3 of the debt while the ECB would repay the rest. What happens if the nation defaults one may ask. Yanis's solution is: 

"To safeguard the credibility of this conversion, and to provide a backstop (for the ECB-bonds) that requires no ECB monetisation,
(i) member-states agree to afford their ECB debit accounts super-seniority
status, and
(ii) the ECB’s conversion servicing loan mechanism is insured by the EFSF/ESM. E.g. if a member-state goes into a disorderly default before an ECB-bond issued on its behalf matures, that ECB-bond payment is covered by insurance purchased or provided by the EFSF/ESM."

Even if a nation agrees that this kind of debt would have super-seniority (i.e. it has to be repaid before anything else is repaid) it would not mean anything if the nation is nearing default. Seniority of debt only has meaning when there are enough money to repay the debt. If the nation cannot repay a single cent what difference (other than psychological for the debtors at the time of issuing) does having super-seniority make? Practically none! 

Then comes condition (ii): If the nation defaults then the EFSF/ESM covers the debt. If a nation reaches default then nothing differs from the current situation. The EFSF has to cover the nation's part, meaning that the EU is basically repaying for money used by the nation, which would make the nation accountable to them, which leads to the same result as if the ECB would directly move to guarantee or purchase the nation's bonds.

Besides, this scheme does not promote the Central Bank's independence and power. One of the main issues of the crisis is that the ECB cannot act as a real Central Bank. If it was allowed to function like that then TARP-like interventions would have taken place by now (at least I hope they would). Which means that this plan provides a non-stabilizing and non-permanent solution, which does not promote the ECB's power, independence and it's ability to act on its own discretion.

2. Question number two concerning the feasibility of Yanis's point 3 (the EIB expanding its projects in order to boost investment) is articulated in this article and is summarized as:

(i) If the EIB has lucrative projects in its arsenal, as Yanis states, then I would assume that the projects are spread all over the EU and not just focused in the South. Thus, it would mean that investment would not be focused in the EU-periphery.

(ii) If the EIB is forced to fund mostly projects in the South wouldn't that be unfair to the other countries in the EU and wouldn't that lead to investing in less and less profitable projects? (A suitable example for this would be a university forced to accept 10% of all applicants from nation A - let's say that this would amount to 50% of its student population - and the rest from other countries. If the university is forced to accept 20 or 30% of the applicants in nation A then more bad students would attend that university than before)

Most importantly:

3. None of these points have anything to do with the fact that the Periphery faces low productivity, is in the midst of the burst of a property bubble and what economists call "bad institutions" (i.e. bureaucracy, ineffectiveness, corruption, etc) nor do they have any way of altering the situation. (for more details read Do We Need a Crisis?)

Debate between Kantoos Economics and Yanis Varoufakis

Dear Kantoos and Yanis,

After reading your interesting debate which lasted (lasts?) several months I felt the need to comment on some issues that I thought to be quite intriguing. What worries me more about Yanis proposals is not their rationale as a thought experiment but the outcome of their actual implementation in the real world. While I couldn't agree more with Point 1 of his Modest Proposal, I have serious doubts concerning the feasibility of Point 3. Yanis states that: "the EIB has a sterling record of financing, through its own bond issues, profitable investments and has a long list of shovel-ready potentially lucrative projects that could realize Europe’s New Deal". 

First of all, if the EIB has that record it would be a shame to lose it due to an increase in investments of doubtful success just for the sake of increasing investment. If the EIB does indeed have those lucrative projects, as Yanis states, then I would assume that the projects are spread all over the EU and not just focused in the South. (The only reason the EIB would choose to have its majority of projects in the South would be increased returns on the funds invested, which, given the circumstances which currently affect the South, is not a very rational assumption). Of course I do acknowledge that even relatively small investments would be beneficial to the EU periphery. However, if the EIB is "obligated" to use more of its funds in periphery-based projects, the "sterling record" is bound to be lost and yet another institution within the EU will be under pressure. 

What I have not yet seen in your debates (although to be honest I may have missed such a point) is a mention to the actual problems and drawbacks the South currently faces: bad institutions, property bubbles and productivity. Even though I am a South European, currently living in a Southern European country, I do believe that at some point a crisis is necessary. (See my post on Do we need a Crisis? for more on the subject). Would any one disagree that the subject of productivity is of the utmost importance in the South? Or would Yanis disagree that the Greek government had been overspending over the last 10-15 years and its finances were in need of major corrective measures? Or is Kantoos of the opinion that rapid austerity measures would not wreck havoc over the economy?

The only point I think we would all be in agreement would be that Greece should not exit the Euro.