Troika Wrong? Estimates of the Cyprus Debt

Source: IIF publication "Cyprus:Just the Facts"

According to an IIF publication of about a week ago, Cyprus had about €15.6bn of government debt, or about 87% of GDP. Of it, €6.6bn were held by non-residents, leaving about €9bn to residents. Of the €6.6bn of non-resident claims, €3.9bn were held by official creditors (mostly the €2.5bn loan from Russia and another €1.1bn from the EIB and the Council of Europe Development Bank). The rest (or €2.7bn) represent medium- and long-term bonds. It also appears that these are almost exclusively Euro Medium Term Notes (EMTN) issued under British Law.

Of the remaining €8.4bn debt, €1.4bn represent medium- and long-term bonds and €1.9bn represent bank recapitalization bonds for Laiki bank in May 2012. Of the whole €7bn held by domestic creditors one-third or about €2.35bn of them is short-term.

When first reading about the Cypriot bail-out (bail-in would indeed be a better term) I thought the amount would be approximately €10bn for both financing government debt as well as recapitalizing the banks. However, it appears that under the last deal "achieved" by the Eurogroup €10bn are to be given just for government needs and not for recapitalization. 

Now, let us add the numbers presented above: €3.9bn of short-term, non-resident claims in addition to €1.9bn for the Laiki recapitalization and €2.35bn held by residents. This adds up to €8.15bn. Yet, hold on for a second: if we exclude the €1.9bn for Laiki, (which will not be of use since the bank is to be liquidated) then the amount is about €6.25bn. Then, the question becomes on whether the short-term claims could have been rolled-over. Russia has explicitly stated that it would be willing to do so, yet we will not even consider that scenario for now. We will just consider the fact that residents would, which decreases the amount to €3.9bn.

It appears that the Troika is not considering rolling-over loans: it is just thinking about changing the identity of the creditors, from residents to the EU or the IMF. 

Under the Troika scenario of €8.15bn, the Cypriot state has to produce minimal deficits in every year to come, even with private consumption and GDP contracting. The hole is government finances is about 4% or approximately €720m. Under the Troika scenario just two years of the same amount of deficit would force the Cypriots to ask for more money (improving government finances when GDP is shrinking is a midsummer day's dream. Greece can indicate more details on that), thus perpetuating the situation.

Even if Russia would not roll-over its loan (which it probably would), it would meant that the EU would not have to give more than €10bn to Cyprus. As the bank recapitalization costs are now less than €6bn, the whole €17bn package seems way in excess. Why government officials, with every inside information available to them could not see this is beyond my understanding.

Does the Troika undermine sovereignty?

The first experiment is Greece. Cyprus is about to become the second. Wherever the Troika has gone it has left nothing less than a trail of ashes behind them and a whole nation blaming them for the harsh measures their governments are forced to implement. A recent article in Spiegel states that the Cypriot government has taken up measures which will make the current recession last at least 2 more years.

Yet, the most important aspect of this story is that the Troika is actually trying to undermine sovereignty in the small island. Cyprus is expected to have a major source of income from gas deposits discovered in the area. Although the first income from the exploitation of these natural resources is not expected to come until the next 5 years, the Troikans have specifically requested that they should have the first say to what the Cypriots will do with the money; a request that the Cyprus government has so far rejected. In addition, the Troika has asked for the yearly budget to be presented to them first and then, if they approve it, it should move for a parliamentary approval; which reminds me of what they are doing with Greece. The idea is the same as the preposterous initiative to have a Commisioner veto national budgets, discussed in depth by Protesilaos here.

The problem is not that they are merely trying to control these issues for a specific period of time. It appears that a new, technocratic system is eager to impose itself in the world. A system which will be based on the knowledge that people with PhD's have obtained in the course of their studies. A system which always put quantity over quality. A system which would tolerate irregularities or breaches of regulations just for higher profits. (for a small sample of what I mean have a look at this article: a Ryanair pilot dropped the plane so rapidly that he had to lift it up again so it wouldn't hit the ground. What is most frustrating is that none of the passengers complained.)

It appears that people are becoming more and more passive (fortunately with some notable exceptions) and that the leaders are slowly shaping the world, and especially the EU, as they would wish. In another article by Protesilaos Stavrou, an important comment may be found (commenting on the "blueprint for a deep and genuine economic and monetary union" found here): 

"... will realize that a sovereign state with an independent budget and with powers to tax and to force elected governments and entire peoples into specific forms of action, or to place them in various straitjackets, is already being contemplated. In this new ideological type of "integration", genuine democracy is secondary in importance, if it can be considered important at all, for the technocratic elite of Europe already agrees that such democratic 'complications' will be discussed over the longer-term, long after all important fiscal, banking and economic powers have been forever withdrawn from elected governments and centralized at the Euro-area level. As a matter of fact the Commission's blueprint envisages "discussions" for some fig leaf of democracy after 5 years from now and once all the technocratic aspects of the Euro-state have been set in place and become fully functional." 

I can safely say for myself that I am not against solidarity in Europe. On the contrary I am a huge supporter of the issue. Nevertheless, integration and solidarity should occur without forcing the participating nation to comply with what the EU elite has designated. The EU motto is "United in Diversity" and not just "United". Although a banking union is an excellent idea, removing almost any power a national government has is not. 

What nationalism with Hitler and Mussolini did 80 years ago technocracy is trying to do now: nations which are dissatisfied with their current leaders, governments and politicians are given the "opportunity" to allow foreigners to run things for them; what is essentially happening in Greece and Cyprus at the moment. Nationalists told the citizens of their country that they would be a better alternative. All they had to do was give them the power to do as they pleased; the technocrats are merely trying to remove that power and tell us that we should not have to assume any responsibilities as they will take care of things for us. And as the Greek experiment has shown, the short-term and medium-term consequences of their actions are horrendous. One can only wait and see how long the supposed long-term benefits will take.

I have stated it before and I will state this again: I am not a conspiracy theorist. Nevertheless, what has been presented in this article are not mere figments of my imagination. They are presented in official EU blueprints and in almost every media source in the world as what the Troika demands from sovereign nations in order to assist them.

We are indeed at the crossroads of history. Either nations will revolt and demand greater democracy and less external manipulation or they will do nothing and end up in a much worse place than we are now. This is not the case for merely Cyprus and Greece. It has to start from somewhere and the crisis has given this opportunity. If we let is flourish then almost nothing can stop it.

Martin Niemöller, originally a Nazist and then a concentration camp prisoner, wrote the following on the inactivity of the German intellectuals during the first years of Hitler's chancellorship:

First they came for the communists,
and I didn't speak out because I wasn't a communist.
Then they came for the socialists,
and I didn't speak out because I wasn't a socialist.
Then they came for the trade unionists,
and I didn't speak out because I wasn't a trade unionist.
Then they came for me,
and there was no one left to speak for me.

Questions on the Crisis

Source: council-tvnewsroom.eu

After observing the outcome of the latest Eurogroup meeting (you may find a commentary on that here and here) and thinking about what led us to where we got not, there are still parts which do not make sense. Things that could have easily been avoided and yet nothing was done to safeguard growth and stability in the EU. The 2 major questions which spring to mind when considering past and present decisions are:

1. Why did European Finance Ministers agree for a nominal haircut of 53.5% on Greek bonds held by private investors?

We can all understand that the European leaders all wanted to find a fast solution for the enormous amount of Greek debt. That time was of the essence and a clear plan was in need. Nevertheless, the fact that Finance Ministers in Cyprus, Spain and other nations who had large exposures to Greek debt failed to oppose such a plan still amazes me. What happened? They did not know what the consequences would be? If most newspapers around Europe knew how much government debt each bank had they how could they have not known? The mathematics of calculating the results are more than straightforward: a 9-year-old could have done them without the use of a calculator. Even if we do accept that the German Finance Minister Wolfgang Schäuble pushed for the deal to go through, given that German banks were large enough to take their losses without causing any problems to the economy, and even if he had support from other Ministers, why did the Southern Ministers not oppose or veto his proposal? There are only 2 rational explanations for this: either Finance Ministers are incompetent and did not think of what the effects would have been, or that they are parts of dark plan to bring the EU to an end. Given that they are now trying to solve the problems they themselves have created we can easily assume that the latter does not hold. So that leaves us with option 1...

2. If the IMF and the EU both know that growth is more important than austerity when trying to cope with a large debt burden, why are they imposing harsh austerity measures on any country who asks for a bail-out?

To quote IMF Chief Economist Olivier Blanchard's Ten Commandments for Fiscal Adjustment in Advanced Economies article, "a one percentage point increase in potential growth—assuming a tax ratio of 40 percent—lowers the debt ratio by 10 percentage points within 5 years and by 30 percentage points within 10 years, if the resulting higher revenues are saved." We can easily assume that if the Chief Economist knows and writes about such an issue, then everybody in the IMF should know this as a fact too. If this is true, and by the way if one studies the aforementioned article more arguments against extreme austerity can be found, then why is the IMF so bent on imposing so harsh measures? Nobody can agree more than me that reforms are needed in all EU-periphery countries; even if they are harsh and difficult to be implemented. Yet, a reform is a much different thing than just slashing pensions and wages. I can understand abolishing most (if not all) of allowances paid by the state to civil servants. I can even understand a reduction in social allowances like unemployment benefits and support allowances due to the fact that state expenses have to be reduced. Yet I cannot see any possible rationale for slashing wages and pensions by large amounts, especially during a crisis period where the state is supposed to help boost consumption and not further reduce it. What makes things even worse is that even though the "Greek experiment" yielded terrible results over the 1.5 years that the Troika has been involved in it, they are pushing the same "reforms" in Cyprus. If Spain and Italy follow, then France and Germany will be next in line, until they finally decide to do as they preach.

The above have been puzzling me for some time now. If any one can assist me in understanding the rationale behind these decisions please do. I, and the rest of Europe will be forever grateful.

Short-term lessons to be remembered

I have been so far bewildered by the Troika's proposals, although to be fair we should all be waiting for the actual proposals and not base our comments on the policies several media sources are surfacing. It has happened before to witness that the actual measures were much less severe than the ones presented by the media. (One wonders how the media got those excessively inflated stories in times where information is so widely available).

If however, what the media are stating is true, then Troika is pushing for a reform in Cypriot legislation which would allow banks to confiscate and sell the real estate fortune of those who cannot meet the needs of their mortgages. Given that Cyprus has a population of 838,000 people according to Wikipedia, the outcome of even 1000-2000 confiscations would be disastrous. What would happen would be analogous to the late 2000's recession in the US, where a large portion of the population could not repay their mortgage, banks confiscated their properties and then could not sell them in a falling economy. What then happened was the worse drop in real estate value since the Great Depression of 1929 and the banks were left with thousands of unwanted real estate in their balance sheets and no liquidity.

The same situation would happen in Spain as well had Mariano Rajoy's government not proposed a 2-year moratorium on evictions (for more details and an alternative solution read this). As banks become loaded with "useless" real estate, what usually occurs is what is called as a Minsky Moment. The Minsky Moment is in simple words, the wanting of investors (or banks in this case) to get cash for their illiquid assets, which results in a sharp decline in the value of the goods. The late 2000's recession was also coined as a Minsky Moment.

An increase in illiquid assets in addition to falling prices will wreck havoc to balance sheets. The simple case is that banks do not need houses or apartments or commercial blocks. They need cash

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.

Unemployment Update in the EU

Source: Eurostat

Well, the figures give more or less the same story as last month. Unemployment is roughly the same in the EA17 or the EU27 (up just 0.1% in the EA17), Greece and Spain are champions both in youth as well as in overall unemployment, Italy, Ireland and Cyprus saw their unemployment rate rise while Austria's, Netherlands's, Luxemburg's and Germany's remained the countries with the lowest figures.

What I am eagerly waiting for some time now, is for the Eurostat announcement that EU27 and EA17 GDP has contracted over the last quarter thus officially throwing the Union into recession. I am not doing this out of hate towards the Union; just because I hope that this will be a wake-up call for politicians and policymakers all through Europe that what they have been doing up to now is erroneous. What the reader may ask is whether they have the common sense to admit their mistakes, which unfortunately I cannot answer now. Time will show and hopefully after that time we will still be part of a Union. Better late than never.

Change can only come from within as Protesilaos states in his latest article. Here's the part that I liked the most:

"The troika's "expertise", or in general the technocratic, "objective" knowledge of the various bureaucrats that make crucial decisions on the citizens' behalf (e.g. the preposterous proposal to have a Commissioner veto national budgets), is in effect nothing more than the facade which conceals an apocryphal desire or rather a specific strategy for the redesign of the Euro area along the lines of a corporatist-neoliberal economic system that will realize economies of scale for a selective corporate elite at the expense of suppressing the standard of living of most people across Europe; while also rendering any spontaneous entrepreneurial initiative practically unprofitable or near-impossible due to the complexity of legislation and entry criteria, which always operate as means of insulating big business from the powerful forces of real competition (neoliberalism should never be confused with genuine free markets)" 

I do not know whether there is a plan or strategy behind Troika's decisions. Nevertheless, it seems that the measures they are proposing are damaging the middle and lower class and leave the upper class unaffected. This basically means that people pay for the faults of their governments and/or banks without the latter assuming anything of the blame. Now I do not know how do you call such a regime but exploitism sounds like a good name.

Poor Greece... (Literally)

At last, the outline for the new austerity measures has been agreed with Troika and presented yesterday... Good news for Troika, horrible news for the Greek people. 

Greece's next economic model. So unfortunately true... Source: Wikimedia Commons

With the announcement of the austerity package came the announcement for a 48-hour general strike next week, when the measures are expected to be voted on the Parliament. The total monetary value of the austerity package is expected to be about €13.5 billion, the majority of which (€9.2 billion to be exact) is expected to be implemented in 2013. The package consists of a two-year increase in retirement age (from a current 65), pension cuts and even greater taxation. Greece is now waiting for the additional installment of €31 billion from the IMF and EU, without which the country will run out of money on November 16th.

As for the latest forecasts for Greece's indicators: unemployment will rise to 22.8%, government debt to 189.1% of GDP, deficit will grow from 4.2% to 5.2%, primary surplus of a mere 0.4% and an economic contraction of 4.5%! One cannot help but wonder what the outcome would have been, had the measures been lighter and Greece received the €31 billion installment. I guess things would have been better wouldn't they?

Now, pessimism will prevail in all issues of the economy, uncertainty will rule everyday life and with this, economic activity will take a larger tumble. One cannot understand the rapidity of movements concerning budget cuts. If the country was not already in a recession, then effects would not have been that great and rapid, harsh reforms could have been pushed through faster and will less implications. Yet, this is not the case.

Greece's lenders want their money back. That makes sense, but why do they need it now? When banks invest in government bonds, they either stick to their investment until maturity or try to sell it through the secondary market. It seems like Greece's lenders do not want either of these! Using the same rationale, banks should be allowed to force a man who has a contract for a 20-year housing loan, to repay them in 5 years! Now that seems to be a bit odd doesn't it? They say that markets know better. Well they do, and when a person goes to a bank and says "I cannot pay the remainder of my housing loan with the monthly installment this high" the bank does not force that person to take severe cuts in his life to repay it. Instead it refinances the loan for a longer period of time, with less monthly installments, making them both happier: the person can pay less per month and live better than before, and the bank receives more cumulative interest. 

Truth or Lies? Your choice. Source: Wikimedia Commons

The same idiotic reasoning holds with Schäuble's proposal for an all-powerful Commissioner to have veto rights over countries' national budgets. Really? Then why not have an all-powerful Commissioner to dictate policy in all matters of the EU? Or why not have that Commissioner draft the budgets himself? (for a great discussion on Schäuble's proposal read Protesilaos's article here)

Let's focus again on Greece: rapid solutions, especially in times of recession, cause extreme trouble. The US, after the collapse of Lehman Brothers in 2008 injected 3 Quantitative Easing packages in the economy. And the economy has only now started to grow. In comparison, Greece has only made budget cuts and reforms. I do not know whether the Troika has a "long-run plan" but the "short-term" consequences are horrid. And any recession which is expected to last for 6 years is not "short-term" any more. Remember Keynes: "In the long-run we are all dead"

A €13.5 billion package could have been easily broken up to fit a 3- or 4-year horizon. That way, the consequences from it would have been much softer. What difference does it make to Troika if a pensioner in Greece earns €600 or €700 a month? None. It only cares whether the country can repay its debt and that its lenders do not lose any money. Thus, why not have a longer horizon? If GDP rises, then it would make sense that income from taxes will rise too. Then, the debt-to-GDP ratio would have been lower and the country would be able to continue paying its interest and even imposing more reforms, tax increases or budget cuts GRADUALLY!

I guess the above plan was too difficult for the IMF, EU and EC "experts" to understand. If they can understand this then I would ask the Troika to let us know whether or not they are interested in destroying just specific economies (e.g. Spain, Cyprus, Greece) or the EU in general. Worst of all, the Germans, usually (supposedly?) people with patience and common sense, agree with them.

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Troika's Strange Ideas

Talks about the new Greek austerity measures have been raging for over a month and a half now. It was the end of August when negotiations between Greek authorities and the Troika had began, and although things has come a long way since then, nothing has been formally agreed yet. It is said that the Troika wants the Greeks to proceed into slashing more wages, benefits and allowances. Yet, even though the Greek economy has been on life support over the duration of these negotiations and things can only get worse without the additional aid they have been promised, these talks do not seem to reach an end.

One cannot help but wonder whether it is the Troika's or the Greek's fault for this. Prolonged negotiations may be good for an organization already earning a substantial amount of money, nevertheless, they are not for a nation whose economy is getting weaker by the month. It is my understanding that the Troika has arguments on whether the allowance cuts proposed on this budget can be considered as new measures or they should be considered as part of earlier agreements. My question is what difference does it make? The point of the austerity measures is to make the Greek economy more competitive and eliminate the chance of bankruptcy. The important part is not whether allowance cuts are new or old, it is whether they are implemented or not. The Greek government has so far slashed everything: wages, salaries, pensions, allowances, benefits. The Troikans even wanted to slash allowances for people with disabilities. What the? Who proposes something like that? What are these people? Some kind of economic machines and they think only in €? I thought people like those only existed in movies. 

The Troika is missing it's target if it is just focusing on numbers and not reforms. In a country ridden by unemployment, (reaching 24.4% last quarter) you do not propose a lay-off of 3,000 government employees. Sure the government sector needs less people. Yet it does not have to happen now, it can be done gradually until 2020. Obviously, someone needs to keep an eye on them. Nevertheless, with the Greek accounts expected to reach a primary surplus over the next year, unless in a case of severe recession, the Troika does not need to cause that recession itself!

The idea of sticking to numbers and not having a look at what the consequences will be is like looking at a tree and missing the forest. The Troika is so focused on getting budget cuts that it does not see what changes need to be done. For example, the Cypriot government has issued counter-proposals, which, although they include severe wage cuts, they do not take into consideration the need for fiscal reform in the island. Not even one. And yet in pure monetary terms, the measures proposed by the Cypriot policymakers are harsher than the Troika ones. If the Troika representatives are really willing to assist a nation then they should insist on reforms and not just cuts. I am curious about their answer and I really hope that it doesn't take them a month to let us know.

P.S. Have a look at the unemployment rate in Spain over the last 37 years:

Source: Eurostat

Does something appear strange? Exactly. Unemployment in Spain had never been lower than 8% (and only lower than 10% in 3 years) and it has been growing rapidly since 2008. Now the million-euro question is this: Why wasn't anything done about unemployment since 2008? Or even 2010 when it reached 20%? I will let you decide on that.

Terrible Calculations and Crisis History

In Thursday's article I gave some of the views Nobel laureate Joseph Stiglitz had on Europe. Notably, that austerity measures are causing the crisis and not the other way around. Who could disagree with that? A simple logical deduction will lead us to that. Let's see now the order things happened in the EU:

1. Sub-prime lending crisis in 2008, led by US banking and investment firms, and marked by the Lehman Brothers collapse in North America and the Northern Rock bankruptcy in the UK. (other financial institutions also failed in the EU, yet no-one was large in size). The sub-prime lending crisis had nothing to do with the now sovereign debt crisis. (it may have been the thing that pushed Greece over the cliff but this was not the cause that brought the Greeks at the brink of disaster. The Greek economy was unstable for years)

2. Greek scandal concerning the size of debt, deficit and GDP of the nation. (debt and deficit had been deflated while GDP inflated. Curiously, nobody was ever sentenced for this fraud) Greece opts for a bail-out from the EU and the IMF and the first austerity measures were put forward in the country.

3. Seeing that the debt-to-GDP ratio of Greece climbed even higher, regardless of the austerity measures (again, think about this: €100 debt with €100 GDP makes a 100% debt-to-GDP ratio. €100 debt with €80 GDP makes a 125% debt-to-GDP ratio. Unfortunately this was too much mathematics for the Troika and the expert economists to understand) the EU policymakers and Troika decided to give the Greek debt a haircut. The haircut consisted of 30% of the face value at first (i.e. for every euro the borrowers held they were going to get 70 cents) and then another 70% of the remaining later (i.e. instead of the 70 cents they were holding they were going to get just 21 cents).

4. This led to a significant shrinking of assets for the banks exposed to Greek debt (many of the Cypriot, Spanish and Italian banks as well as many German ones which curiously managed to sell most of their bonds), and with the new regulation raising capital reserves from 8% to 9%, banks were is serious need for money. 

5. Since many banks did not have sufficient capital reserves to allow them to function, they opted for a government bail-out. As banks are not really like any other firm (look here for more details) the nations had little option but to try and save them. However, the banks' needs being large, and the nations' debt being high made it more difficult for them to refinance. Thus, nations themselves needed to opt for a bail-out since their banks were dragging them along to the bottom.

Had the Greek haircut not occurred in such extremity (for an alternative read here), banking needs would have been lower and nations would not be in such a difficult state. Thus, the rough austerity measures could have been milder and with a longer time-span than now. This would have allowed nations to increase their GDP slowly, while simultaneously reducing their deficit and debt, which would mean that none of the current events would be happening. Although I am an advocate of the austerity measures in order to rationalize the budget, having too much too rapidly will only cause trouble in an already troubled economy.

P.S. The new idea now is that politicians and policymakers will offer more austerity with different measures than the ones the Troikans are proposing. Case study: Cyprus. The counter-measures proposed by the Cypriot government include a 9-11% cut in public servants wages (nothing of the kind was mentioned in Troika documents) in order for the Troikans to agree for the non-abolishment of the 13th salary (a bonus salary paid at the end of each year). Again simple maths: €1000 monthly salary is €12000 a year. A 9% cut would mean that €1080 euros are cut from the worker's salary each year. (provided that the 13th salary does not suffer the 9% cut as well). So in essence, the worker is giving up €1080 to receive €1000. (€1170 if the 13th salary suffers cuts as well). You may imagine what happens at the 11% level. 

Clear case of stupidity and obsession with an idea: the 13th salary should not be abolished, thus we are offering extra cuts, so that the 13th salary will remain but the overall hit would be larger than the one proposed by Troika. Hmm, one wonders who it is the officials work for. Troika would be much better in running Cyprus than its politicians.

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.

Austerity Measures and Reforms in Cyprus

The first thing I read today were the austerity and reforms guideline plans prepared by Troika for the island of Cyprus, which has requested a bail-out in the summer. According to them, the country's fiscal deficit has to be reduced to about 4% of GDP in 2012, 2.5% in 2013 and in the realm of 1% in the next two years. 

Austerity measures for 2012 include:

1. Freezing of the Cost-of-living-adjustment (COLA), extension of the special contribution

2. Freezing of wages and filling of vacancies in the public sector for another 2 years (until 2015). Extend this regulation for all state officials and Members of the Parliament who will now see their allowances taxed (the law for the state officials has already been passed as I have seen)

3. Introduce an immediate early retirement penalty of 6% of the Government Employee Pension Scheme (GEPS)

4. Introduce a permanent contribution towards pension entitlements for all government employees

5. Abolish the 13th salary of the broader public sector employees and state officials, reduce 13th pension by 50% in the 1000-1500 bracket and 75% in the above 1500 bracket.

6. Increases in the excise duties for tobacco, alcoholic drinks, and motor fuel

7. Increase tax on dividends by 1% and to deposits by 0.015%

If one takes a good look in the above measures, the fact is that rough and rapid changes (like the ones in Greece) are proposed. The only measures which would be considered rough would be the abolishment of the 13th salary of all state officials and pensioners. However, we are talking about the 13th salary, an additional one which should not have been calculated in e.g. bank loan repayment installments. Granted, a 13th salary in Cyprus is part of the gross yearly salary and people are taxed on that, however, this is much better than actually reducing the rest 12 wages. As far as dividend tax is concerned, from what I understand, Cyprus has a fixed tax of 20% - which is rather odd since people who are earning 1 million euros a year and 50 euros a years end up paying the same rate. I would like to see the Troikans propose a new dividend tax scheme based on the tax bracket one belongs instead of a fixed rate (that is, for individual dividend-receivers). 

The 2013 cuts will include:

1. Abolishment of obsolete allowances as well as general government wages and salaries with a target reduction of 15% in the government bill (hopefully, they will be wise enough to focus on abolish allowances instead of reducing wages and salaries by 15%)

2. Reduction in social transfers by 10%

3. Reduction in the Easter, Christmas and Dietary allowance as well as abolishing heating allowance

4. Consolidate housing-related schemes

5. Reduce the number of government employees by 250 per year (1250 in total)

6. Reform shift-work system to reduce overtime remunerations by 20% in 2013, an additional 10% in 2014 and keeping the amount paid stable for 2015

Even in 2013, although Cyprus will still be in recession, austerity measures will not be so harsh as they have been anticipated. To compare in 2011 the Cypriot government had taken measures of 500 million euros compared to the 360 million of permanent measures the Troikans ask for 2012. Things will obviously get worse before they get better, however, the measures are much more conservative than those originally expected by the press and public. In addition, these measures were very much needed by the country, but just like any other nation in the world, politicians and policymakers did not want to make any reforms until the final hour. In any case, what I have been saying for over 2 months now, has finally been understood by the Troikans. Harsh and rapid changes are not a good solution for an economy. We have Greece to thank for that lesson (the country has paid a rough price for it though). Cyprus will have a much smoother bail-out period, provided of course that nothing extreme occurs!

A Good Day For Europe

At last, after months of discussions and speculation, the German Federal Constitutional Court has given the green light towards the creation of the European Stability Fund (ESM). This means that the Fund can give up to €500 billion of loans to Member-States in need. In addition to Draghi's announced bond-buying program, this is expected to bring a new era of calm in the markets. However, what is more important is that they are giving out the signal that both the EU and the common currency are here to stay.

In essence, this would mean that all rumors and speculation concerning the fall of the euro, the Union, a sovereign exit or bankruptcy are unfounded. Thus, after these are refuted, stability and calmness is expected to appear on the markets, in contrast to the panic which lasted for almost a year. Nevertheless, not to be forgotten is that individual nations are still struggling to survive
, and for some (Cyprus, Italy and Spain), the worst is yet to come.

Tomorrow, in Nicosia, Cyprus, the Greek Prime Minister, Antonis Samaras, is expected to announce the new austerity measures at the Eurozone finance ministers meeting. Although the flow of cash to Greece is not expected to halt as none of the decision-makers has ever stated such an interest, the Troikans will issue their next report in October where the Greek government is expected to come short of its targets. In the same meeting the situation in Spain is expected to be discussed. Even though a package of €100 billion has been made available

Cyprus Bailout and Austerity Measures

Having written an opinion on austerity measures in South Europe I think it is time to focus on the current problems faced by Cyprus. Although its government states that it has money to hold until September (other sources state that it has money to make it until the end of the year) it is common knowledge that the island is bankrupt. For more information on the situation read this article by Wolf Richter where the nation's current situation is outlined. Prospects appear as dark as they can get while the Troikans believe that the island will need about 10 billion euros to cover it's needs (both for the fragile banking system as well as for a black hole in it's finances). 

The Cypriot government is headed by a President whose communist views have spurred controversy even amongst its European Allies and who seems unable to commit to actions that will alter the situation. The only moves that have been made towards fixing public finances were done in September and December 2011, by a Finance Minister (Kikis Kazamias) who resigned in March stating "medical reasons". However, the Cypriot President, Demetris Christofias, despite his growing unpopularity even amongst its own party, has requested that the structural changes that need to be done in the Cypriot economy should span over the next 6 years and not over the next one.

For once, I do believe he has the right idea, although for the wrong reasons. His reasons are strictly political as he must think, and many others in his place would have thought the same, that the effect of strict fiscal discipline will be devastating for the future of his party. With elections coming on February 2013 he has every reason to be worried. (However, I don't think that this will do much more harm to his reputation than he has already caused to himself by his inability to face reality).

My reasons are strictly economic. Changing fiscal policy so rapidly will cause a wave of new issues to the already problem-ridden island. Cyprus has one of the highest private debt ratios in the world of about 300% of the GDP. Add to that an exposure of about 40% of the Cypriot banks' loan portfolio to Greece and an economic confidence level at its lowest since they have started compiling one, and you get an explosive package. So, if one may ask, what happens when to a country with a 300% of GDP private debt when fiscal policy is abruptly tightened without an expansion of credit? Well, I guess (the troikans can verify this if they can) that foreclosures, bankruptcies, a confidence level even lower and unemployment levels reaching 15-20%  are the logical consequences. After that, you can understand that the next victims are the banks themselves.

Cyprus Popular Bank, the second largest bank on the island has led already agreed with 185 employees on a "voluntary" retirement scheme. This would help it fulfill a target of reducing employees by 7% this year. The rapid and rather stupid expansion of Cypriot banks in both Cyprus (Bank of Cyprus, the leading bank of the island has about 120 branches in a nation where the total area is less than 6,000 square kilometers. The same numbers more or less hold for Laiki Bank. However the exaggerations in both banking and fiscal policies must not be revoked immediately as this would not bring the island to the brink of destruction - it will push it over the cliff.

If the austerity measures are pursued with severity and results are expected from the first year of imposition the island will need another group of Troikans until next year to hand over several billion more to save them.

Impressions from a Southern European Country

After watching that Cyprus has also applied for a bailout from the EFSF/ESM fund (following Greece, Ireland, Spain and Italy) I decided to to watch a bit more carefully on how the situation will be handled this time. From what I can see in the news, the group of experts (or technocrats if you prefer) of the International Monetary Fund, the European Commission and the European Central Bank (the so-called troika) have reached the same conclusions as they had done before for the case of Greece, Ireland, Spain and Italy: Austerity Measures. Surprise, Surprise! As if any European citizen was expecting anything else.

News stories of what they intend to propose specify things like large cuts on government expenses, decreases in civil servant wages and benefits and increases in direct and indirect taxes. Although I am positive that the Cypriot state needs to perform some sort of rationalization over its expenses (the Southern European states have a much deserved reputation of not being very logical when it comes to government spending. An excellent example of such irrationalities is Greek government's allowance to the civil workers who arrived at work on time) this sort of thinking and acting will not ease the burden of a sovereign debt crisis. Judging however of the ease at which the troikans believe that austerity measures are a panacea I would propose that the next country that will need a bailout ship its accounting books to them and spare the EU some money on traveling!

As one may observe, austerity measures have not so far helped in easing the effects of the near-bankruptcy of Greece. In Spain, unemployment has reached 25% amongst the population and about one out of two youths under 25 is jobless. And yet, Mariano Rajoy's government announced huge cuts in the nation's budget which will only worsen the situation. Mario Monti's government of technocrats in Italy (in my opinion the best leader in the EU at the moment) has only taken 30bn euros worth of measures, and those in December 2011. In comparing the two states it would now seem that prospects seem slightly brighter for the Italians as per the spring 2012 European Commission forecasts. (for more details read the European Commission Economic Forecast. Be warned it is 190 pages long!)

As one may observe the Commission states that after 2012, a bright future awaits the Union.However I do not believe that such a comeback will be feasible so easily. In an already depressed economy the cost of slashing government spending is going to be more than the amount of money not spend.

As one may see from Google's public data Spain had negative growth only twice in the last 50 years while the more politically unstable Greece and Italy have had more ups and downs. On the other hand Cyprus's only year of negative growth since 1961 was 2009 (wouldn't it be nice if they could just keep it up? Damned bank exposure to Greece!). However, if you exclude the 1974 change in Greek authorities after the 1967 coup d'état, a year which was marked by a 6,44% Greece had not faced major economic downturns. The same holds for the Italians whose worst year was 1975 with a 2,09% drop.

According to the Debt-Deflation Theory of the Great Depression by Irving Fisher and the academics who have studied and written about it over the years (one of which in the Governor of the Bank of England Mervyn King) a large government sector has stabilizing consequences to an economy. In Hyman Minsky's Stabilizing an Unstable Economy (you can find it here) this idea is revisited and it is once again shown that a large government (up to a point obviously) is beneficial for the financial stability of a nation. (I am under the impression that the troika will not especially enjoy this paragraph) Thus the danger that may arise from an excess of austerity measures is to make the already fragile system more prone to future crises.

Following this ideas it is more essential to provide incentives for growth and then impose austerity measures. The logic behind the EFSF so far has been: we give you money if you promise to be frugal with them. Well gee EFSF thanks a lot! What would actually make sense would a be a policy of ''we give you money, spend them to boost the economy, and then impose some austerity measures". (If you are one of those who like to derive examples from economic history you may use the one of Theodore Roosevelt and the Great Depression) I once again state that I am not against the rationalization of government expenses. However, this should be done after the economy stabilizes and not before! If the economy does not grow how is the nation going to pay back it's lenders?

I guess that following the traditional German logic of keeping inflation low and finances tight at all costs led us to where we are now (a note on the solution of the Greek debt haircut on posts to come) and will keep us there until the Germans realize that the hyperinflation of the 1920's will not occur if the let the ECB act as regular central bank and print money. It would even make the value of the dollar fall which would help German exports! 

(Mrs Merkel please listen to reason! Most Europeans are bored of the same meetings with the same conclusions!)