Politics vs Economics: The South Combat

It looks like the Troika has changed their plans for Greece, as now the budget cuts and reforms have to reach €14 billion instead of the €11,9 which was the number about 2-3 weeks ago. (sigh) What will ever happen to those Greeks? It appears that even after chances for a Grexit has been significantly reduced (to the fact that almost no-one is considering this as a possible scenario) the probability of a Greek bankruptcy has not yet been diminished.

Der Spiegel reports that the Troikans are unimpressed by the progress Greece has undergone over the last year. Why would they be impressed need I ask? Except some budget cuts and reduction of wages and pensions, (of peculiar allowances, i.e. a benefit for arriving on time or a benefit for washing your hands!) nothing of importance has taken place in the country. No reforms whatsoever. The only positive is that the public sector is gradually shrinking in numbers, as it has become less attractive to the Greeks (well obviously if you cannot get an allowance for arriving on time why bother be in the public sector?!).

Greece is not the only nation which has similar problems. From what I hear, the leaders of Cyprus are proposing a plan under which they propose an increase in taxation instead of a reduction of public benefits. Really guys? So the solution, according to Cyprus's authorities is: "We are overspending. We know it. Why bother reducing expenses when this will make people turn against us? Why not just increase taxes which will not?" Really? 

I do not know how the Cypriots think about this, but in my opinion, every rational man would prefer to have benefits cut instead of ending up paying more in taxes. What should be done is better control of expenses and a taxation aimed specifically at the richer caste. A general increase in taxes would not benefit the public even if they maintain their benefits. 

Tax evasion is another thing: both countries (especially Greece) see their incomes reduced every year due to several well-off individuals who manage to somehow hide what they are earning. Although many steps have been made so far in this subject, and even more arrests have occurred (especially in Greece, I have not heard anything similar for Cyprus) the hole in public finances still looms. And this is one of the reforms that the South has to deal with.

The same situation more-or-less holds in Italy. Anti-tax evasion measures and reforms have not been implemented as of now, and thus many Italians are still dissatisfied with their government. Although Mario Monti is doing whatever he can to keep Italy from failing, he has not done anything in order to boost the public's confidence to their government, or to reduce tax evasion. 

Spain on the other hand, is worried that Mariano Rajoy's proclamations are merely theory and lack of action. While the government is trying to push through more austerity measures, the general public, fed up with increasing unemployment and no sign of their troubles ending, is protesting (quite rightly at times) for their lack of employment and in more severe cases their lack of money. 

Although the politicians are trying to implement mild budget and benefit cuts, in order not to lose the public's liking (which has been lost during the summer for most governments in the South) no-one has even tried to reduce unemployment in the region. With focus on austerity measures, no politician or policymaker seems to realize that an increase in the number of employed people would mean higher consumption, more taxes and even more savings so that the banks could lend. Yet it seems that the simple equation of how GDP is calculated and the simple logic of what a decrease in unemployment may do eludes the authorities of the South.

A week to know about Greek Bankruptcy

Greek Prime Minister Antonis Samaras has a planned visit to Germany next week, during which he will meet with Angela Merkel to discuss a two-year extension to his country's austerity measures. 

On one hand Samaras's plea makes sense: The austerity measures taken so far have paralyzed the country and made it go through one of the worst recessions in history. Next year is expected to be better for the Greeks as a recent IMF forecast expects GDP to be stable for the whole of 2013. (more on Greece's Progress here). It is more than reasonable to assume that both his popularity and his country's GDP will face a sharp drop if any more austerity measures are rapidly implemented. Even now, due to lack of money, Greece has to resolve to creative emergency loans in order to avoid default.

On the other hand Merkel's hard opposition makes sense as well: If the leader of one of the strongest economies in the EU accepts Samaras's terms then what would stop the Greek Prime Minister from asking for longer and longer time frames at the end of the two-year period? Let us not forget that the Greeks are to blame for their mishaps, although they may be suffering more than enough for them. €4 billion in savings from austerity measures are still missing, a prerequisite for the additional €31.5 billion the IMF and EU will disburse under the second bail-out package.

It seems like the two have reached an impasse: None of them is willing to fully accept what the other has to propose. The situation might look like a Gordian knot, however, like Alexander the Great (or Solomon if you prefer) I would suggest something simple: Compromise at a one-year extension of austerity measures, in order for the Greeks to have a smoother adjustment to them. In essence this would ease the consequences of hard austerity measures as their effect would be smoothed out over a year. 

Nevertheless, for the Germans and other Greek creditors to be sure that the reforms will take place, and their hard-earned money are safe, Samaras will have to formally present the reforms to be undertaken on a given date. On that date, (maybe in late 2012 or early 2013) the reforms would be presented to the public in a press conference, and the exact date of their implementation will then be set. 

In a compromise like the one described above, Greece's creditors would have an easy way of checking whether the Greeks have kept their word, while at the same time allowing the country to ease the pressure of rapid austerity measures. This would allow markets to believe that the odds of a Grexit scenario are declining. 

However, even if they disagree on everything, the Greeks should still receive the €31.5 billion package. Failure to do that would bring the EU down until the end of the year.

Grexit is not an option

Yesterday, Antonis Samaras, Greece's Prime Minister stated that a return to drachma would mean another 5 years of recession for his country, unemployment reaching 40% and could potentially be the end of democracy for the nation. What Samaras did not mention, however, were the effects this might have on every other European country.

First of all, a large Europe-wide economic downturn would occur, given that banks which still have money in Greek bonds will find out that their investments have vanished into thin air. This would mean that governments may have to bail-out several banking institutions. In countries like Spain, Italy, Portugal and Cyprus this would break them down, and it might even be a severe blow in "strong" nations like Germany (Deutsche Bank's balance sheet is about 80% of Germany's GDP. You may imagine what would happen if another 1 or 2 German banks face problems). This would lead to countries asking for financial assistance from the ECB/EFSF/ESM or basically anyone who is willing to lend them. As individual investors would be too terrified to lend, EU officials will face two options:

(i) let all countries which cannot help themselves fail

(ii) bail-out all EU nations in need for help

If option (i) is chosen, then what would happen next would be the death of both the European Union as well as the Euro (for consequences around the world if this occurs read The Effects of a Euro Collapse). Option (ii) would mean that the EU and the Euro will survive, but with a longer and harder recession than the one Greece is now facing. Thinking backwards, if the EU officials enjoy their jobs and were to choose option (ii) why not keep bailing-out Greece, especially now that the worse is gone and all they ask is time (fine maybe and a couple of billion as well)?

A recent poll in Finland indicated that 66% of Finns want their country to avoid shouldering more financial responsibility, even if it would save the euro. Hmm since when does asking people with no apparent knowledge on economics what to do has become a good policy? Of course the Finns have their Grexit scenarios. Every country should. What they should not be thinking is exiting the euro. If the situation is bad now, what do you think would happen if a country changes currency? First of all inflation would hit them so hard, it would take years before they can be competitive again.

What the Finns are saying is that they do not want to pay for other peoples' messes. True, why should they? Nobody would want that. That is why the ECB should make a direct intervention to prevent fragile economies from breaking down. ECB money is neither Finnish, nor German nor Greek. It's ECB money. It's EU money. Money that should have been in the system from before and not wait until now. At least now is still not too late.

German Government doesn't fear about Grexit. How about Itexit, Spexit or Cyexit?

While the Bundesbank states that a return to national currencies would not make economies better off, the German Vice Chancellor Philipp Rösler has stated earlier this week that the horror of a Greek exit has worn off I felt that he was trying to play tough cop when there was no criminal around. Otherwise, he was just really ignoring the economic reality of the EU (that is the polite way to say that he was being stupid silly).

What he seems to be forgetting here are the interconnections between the EU nations. If Greece fails and returns to drachma, then the next ones to fail will be Cyprus and Spain. And then Italy. Then maybe England if they decide not to print any more pounds. What then? Should Cyprus bring back the pound, Spain the peseta and Italy the lira just to save themselves if Germany will not is not afraid of them fleeing and will not aid them? Well then how about we just have a good north-euro? Great way to increase faith in the currency Philipp!

If Greece exits, the domino consequences will be catastrophic for the union. Euro is now the second most circulated currency in the world (after the almighty dollar of course!). 332 million people in the Eurozone use it daily and another 175 million worldwide have currencies pegged to it. Just imagine the consequences if the currency is destroyed. Great depression would seem like joyful period after such a case.

By the way Philipp I know you were only born in 1973 (errr you didn't want to say your age? Sorry!) but if you had studied German economic history you would have seen that immediately after WWI when the Allies demanded reparations paid by Germany to repay the damages and debt they had obtained during the war it was the German president of Reichsbank Hjalmar Schacht who had fought the idea most of them all. Indeed, even Maynard Keynes was against reparations as he believed that they would be a burden on the German economy which was just barely alive after the war. The allies did not want to adhere to the two economists, but the combination of a horrible inflationary period (during which Schacht was not in the Reichsbank) and the 1929 Depression made the Allies see that it would be economically irrational to pursue the policy of reparations. (which would last for more than 50 years) I do not know if Philipp can see the resemblance here which is quite obvious if you just substitute Germany with Greece and Allies with Germany. It is true that history repeats itself but I would hate for us to reach the brink of destruction just to realize that what we had been doing was wrong.

Although I am quite pro-German in several areas of the economy and society I cannot really understand this obsession with not helping the countries in need. What are they afraid of? Yesterday, Mario Draghi had an idea similar to what I had proposed here. This made me go to bed happy but today I learned that the Bundesbank has objected to such a plan. One wonders what their reasons might be! ''This seems like a good idea for the European economy so lets just say no!" While ECB seems all powerful, they will just not let it use this power. It is not acting as a real Central Bank the way the Federal Reserve acts in the US. I repeat once again: buy government bonds, expand credit in the Eurozone and let inflation rise for a year. Then go back to listening to stubborn German politics if you desire. Just do this now before it is too late.

P.S. I do not understand why we need to have IMF experts checking up economies in the Eurozone. (Well OK I do if the ECB does not want to act like a Central Bank) Don't we have enough technocrats here? Or are 4-5 troikans the only people in the world who can understand public finances?