3 Comments on the SGP3

I would like to contribute three comments regarding the recent Franco-German agreement arrived at recently. This post is a poor contribution to more enlightened commentators’ criticisms of the proposed SGP3.

The first, is a criticism to the article from Charlemagne, which completely fails to mention what I think is probably the most important part of the agreement. The last four paragraphs describe the issues both countries want to see changed that require treaty changes. It fascinates me how the Economist would fail to mention that apparently France has come on board with Germany in terms of cancelling council voting rights. This isn't the most intelligent proposal that's ever come out of a Franco-German agreement, and is offensive to the intellect of anyone reading it and makes a mockery of European solidarity and democracy. It's an insult to the intellect, because anyone who expects every single country in the Euro-zone (much less in the EU) to approve a treaty change denying any given Member state of the EU the right to representation is either disconnected from reality or seriously thinks the rulers of small countries are stupid and their citizens inert.

If we have learned anything since the creation of the Eurozone and the misfit application of the SGP, is that indeed we are not at all equal. Several countries have failed their SGP obligations. Portugal in 2002, Germany and France in 2003, Italy and the Netherlands in 2004 and finally Greece in 2005 all failed to live up to the SGP. The only country that ever came close to being punished was Greece. When the problem hurt France and Germany they decided to change the rules. That's why we are now talking of the SGP3 rather than SGP2. As Caballero, Cababllero and Losada 2006 and Chang 2005 describe, Germany and France are clearly more equal than the rest of the Member states. Call them primus inter pares. As Thornhallson 2006 explains this is understandable. However, it is morally highly objectionable. It should be clear to anyone dedicating even a minute of their time to the ongoing debate about the reform of the SGP, that although France is endorsing a German proposal to withdraw votes from countries not fulfilling their obligations under the SGP, neither France nor Germany will ever let other countries do that to themselves. This is a policy for others and shamefully so.

SGP 3 Update: The Franco-German Compromise

France and Germany seem to have reached a compromise over the SGP3. As Charlemagne describes it, the Germans seem to have dropped their "hawkish" demands about the semi-automaticity of fines at the preventive stage and in return got the French to accept supporting the German ideas of creating a debt restructuring mechanism for the Euro-zone and extending the EFSF forever. According to the communiqué, only the later of these proposals would require a treaty change. This was all agreed over the week end and came to light in the last day or so. The German press was not amused, and I am certainly not impressed. However, I leave more comments for later.

Bailing out Greece: A great business deal!!

This note was posted as a comment on the FT, Brussels Blog at http://blogs.ft.com/brusselsblog/2010/05/mother-of-all-rescue-plans-buys-europe-time-but-can-it-work/#comments:

"Germany is all “abuzzing” about the costs of bailing out “lazy” Greeks. But how much did it cost Germany to bail out Greece? Well apparently letting Greece scare the markets and then bailing it out is a good business model. As it turns out, Germany made at least a €8.6Bn profit off it. May be even as much as €25.4Bn. How? Let’s see:

The cost of bailing out Greece was €22.4 Bn over 3 years, according to Der Spiegel. (http://www.spiegel.de/international/europe/0,1518,693579,00.html)

However this saved German banks from a balance sheet hole of as much as €33Bn, due to their exposure to Greek sovereign debt. (http://www.spiegel.de/international/europe/0,1518,693579,00.html)

It also turns out that a weak Euro, caused by Greek fiscal profligacy probably helped German exports. It is hard to say by how much, but given that exports had grown by 1% on average over the last year or so, and that they grew by 21% in March, I have generously considered that 14.81Bn out of the total 85.6Bn of German Export may have been caused by the low value of the Euro. (http://www.ft.com/cms/s/0/f6e35528-5c1f-11df-95f9-00144feab49a.html ) Finally it seems that the DAXX regained all the losses it incurred last week. (http://markets.ft.com/ft/tearsheets/performance.asp?s=569857&ss=WSODIssue)

So I propose two estimates of the German economic profit from rescuing Greece:

If you think that my estimated effect of the low Euro is exaggerated, which it probably is, then at worse, the bail out saved German banks from incurring those losses. As such Germany made an economic profit of as much as €8.6Bn from saving Greece.

None the less the low value of the Euro must have had some impact on Germany’s. Although the effect might not have been as high as to account for a whole €14.8 Bn worth of added exports, I guess one could establish that as a decent ceiling of how good the devalued Euro might have been for Germany. If that’s so, then we have to accept that Germany might have made a total of up to €25.4Bn from rescuing Greece.

Not such a bad deal after all… "

Greece will be bailed out before it defaults or restructures

So it seems that Greece will actually need to be bailed out. Wolfgang Munchau offers a good explanation of the underlying dynamics and mechanisms, while Jean Quatremer provides a more accessible version, for those who speak French. Its particularly relevant in terms of the accounting and maths of it all. Please read them if you have a chance. I must say I identify more with the optimistic perspective of M. Quatremer, in that Greece will be bailed out. I'm not saying it won't default. I'm just saying it will be bailed out and if that's not enough, then it will default. My hope for the bailout is that it will save Greece from falling further into a debt deflation dynamic such as the one described by Jacques Depla, which would then create real lasting problems. If this proves true, then we end up in Wolfgang Munchau's scenario number two, where the EU and the IMF bail out Greece. Contrarily to him I assume that member states can bail each other out, within the limits of some set out by article 103a of the Maastricht Treaty(in page 13), which reads as follows:

"ARTICLE 103 a 1. Without prejudice to any other procedures provided for in this Treaty, the Council may, acting unanimously on a proposal from the Commission, decide upon the measures appropriate to the economic situation, in particular if severe difficulties arise in the supply of certain products. 2. Where a Member State is in difficulties or is seriously threatened with severe difficulties caused by exceptional occurrences beyond its control, the Council may, acting unanimously on a proposal from the Commission, grant, under certain conditions, Community financial assistance to the Member State concerned. Where the severe difficulties are caused by natural disasters, the Council shall act by qualified majority. The President of the Council shall inform the European Parliament of the decision taken."

Granted that all of Greece's problems are not motivated by "difficulties caused by exceptional occurences beyond it control", but they are partially. As long as it is possible to determine that an economic shock is not purely endogenous, this article allows for the intervention of the Council upon a unanimous decision of its members. Given that economics is not an exact science, and that we are unlikely to create a European Court of Macroeconomic Justice, it is fair to say that as long as an economic shock is symmetrical(meaning as long as everyone else is also experiencing a recession), those who are suffering less will always be able to bail out those suffering more, even if everyone is suffering.

I also disagree with Munchau on his last comment that "the message from the EU, and from Germany in particular, is that member states are not ready to co-ordinate economic policy in the short run, and move towards a minimally sufficient fiscal union in the long run, and that as a result EMU is doomed". To me this is a syllogism. I think that the EU is more than the sum of its parts, particularly in terms of institutional reform, which is what is relevant from the point of view of fiscal

Also, if common sense is not a good enough explanation for German self interest in dealing with its neighbours, here is a fairly comprehensive review of all the possible reasons why Germany does not want to offer Greece any outrageous bailout.

This is why we need European independent revenue, ie EU taxes. This way there will be another level of government whose preferences are the result of an aggregation of the preferences of the populations of all EU member states, weighted by the machanics of the European parliament's electoral system.

This way, the greeks won't complain about Germany. They'll complain about Europe. And if Europe does not help them with structural funds, they'll burn EU flags or vote for more leftist representatives in the EP, who will be more generous with how they spend EU funds.

On a final note, this issue of the bail out from the EU has been a controversial topic since the beginning of the financial crisis, before it expanded to the rest of the economy. There's an interesting distinction that must be made. States can, under some circumstances bail each other out, the ECB cannot. Both the member states and the ECB can bail out the private sector. The explanation for this can be found in Article 104 of the Maastricht Treaty:

"ARTICLE 104

1. Overdraft facilities or any other type of credit facility with the ECB or with the central banks of the Member States (hereinafter referred to as ‘national central banks’)in favour of Community institutions or bodies, central governments, regional, local orother public authorities, other bodies governed by public law, or public undertakings of Member States shall be prohibited, as shall the purchase directly from them by the ECB or national central banks of debt instruments.

2. Paragraph 1 shall not apply to publicly-owned credit institutions which, in the context of the supply of reserves by central banks, shall be given the same treatment by national central banks and the ECB as private credit institutions."

So if you are wondering why people talk about the help that the ECB gave to businesses during the financial crisis, it did so through paragraph 2. It provided credid facilities to "private and publicly owned credit institutions." In conclusion, member states can bail eachother and their private sector out. The ECB can also bail out the private sector but not country. The ECB can increase its credit lines to private institutions all over the Euro-zone, which may then buy credit from the state. So in principle, the ECB could bail a state out. However, it is rather unlikely that the ECB will provide a credit line exclusively to one bank of a specific country, which would serve as a proxy of the state, as this would be highly frowned upon. Alternatively, it could provide that credit line to everybody, but it seems very unlikely that all those banks would then flock to a troubled country and just hand that money to it.

EMF, German economy and EU procurement reform

In the following article, Tony barber of the FT asks Two questions. First, whether it is possible for Germany to

: 1) "no longer to be, in the broadest sense of the term, the EU’s paymaster", 2) "impose strict budget deficits in the Eurozone" 3)"remain the EU’s champion exporter and a model of business competitiveness, piling up vast current surpluses as a result"

and secondly, whether this is compatible with European (Economic, I assume) Stability.

Regarding the first question, I believe that this is a coherently proposed set of goals. Again, I go back to the basic open economics: Y=C+I+G+NX, and Y=C+S+T implies that I-S + X-M = T-G. Therefore it is not just possible, but in the absence of a short term disequilibrium between Investment and Savings, if Germany wants to be a big exporter it needs to have a low deficit. What better way to do that than to stop being the EU "paymaster". But is it really the pay master?

Now, the second question is much more tricky. As I said, I'm assuming that he is referring to economic stability. Now the thing one needs to keep in mind is the EU's procurement system. At the moment EU revenue has 4 main sources: VAT, customs and agricultural duties and direct country contributions, based on some GNP proportionality formula. Then there are some other smaller adhoc contributions, but nothing more tha 5-10%. This means that whoever consumes more, whoever participates in more external trade, and whoever has the largest GNP, will always be the EU's paymaster. So Germany is stuck. Even if the EU was to levy some income tax, it would still be germans paying the largest piece of the cake.

Ultimately the point is still that the whole story is a bit inflated. There is no problem with Germany not wanting to pay for greek debt. Moreover, just because it decides that the idea of a EMF is good because it spreads the monetary cost of rescue to everyone, it does not mean that suddenly Germany wants to decrease the bill it pays. I guess it only means it does not want it to increase! Germany is the biggest payer of EU but it is not the majority. It's not worth making a fuss

Government run Ponzi Schemes - Call the IMF!!

So, aside from the brief and recent comment posted yesterday, I haven't written much lately, which is good. It means I have a life. :) However, I think I ought to write something about this whole Greek mess, so as to at least have a reminder of these troubling times for the future. I have five comments about this mess:

First, why on earth is any country allowed to finance the payment of debt itself with more debt? Greece is (today) struggling to pay its debts, so it borrows to pay the debts. Why do markets even lend it the money, given the rather poor growth prospects that Greece is faced with?... It's likely that they have lent some money to Greece at lower interests in the past which now require more lending to get paid. Therefore the idea is that high interest yielding debts pay for low yielding debts. As long as lenders believe that Greece will pay, they keep on lending. So the risk really is to get to a point where Greece loses credibility, because then it will no longer be able to borrow. (this is a bit messy...). As a friend of mine reminded me, this cannot technically qualify as a Ponzi Scheme, because there are no asymmetries of information as the people purchasing Greek bonds are aware of the state of Greek finances and the implications. Indeed it is possible that the Greek government might be the one being defrauded…

Secondly, it is interesting to see the aggressive comments coming out of Greece, about German WWII reparation payments and about Anglo-Saxon media and financial conspiracies... It’s evident that the first two are political manoeuvres to confuse the electorate and shift the blame from the present government to other people. Nonetheless, I must say that the financial conspiracy does carry some weight. I’m not saying that there was any wrong doing. I’m just saying that there is enough evidence to make me believe that it would have been interesting to investigate whether there was collusion between the major lenders to Greece, the last time that it issued its debt. This idea is motivated by the fact that someone recently brought to my attention the fact that although the German bund spreads on Greek debt went up massively the last time they issued debt, the demand for it was massive. This would imply that lenders had estimated an increase in the risk of Greek defaults, but still found them to be attractive enough to want to purchase them. Because the Greek government really needed the money, its demand was rather flat, and inelastic. If there was collusion between the major financial players, then in real terms they would have behaved like a monopolist, supplying cash at an interest equal to their marginal revenue, not their marginal cost. So to go back to the beginning of this paragraph, I’m not saying that there was any wrong doing. I just think its natural to investigate whether the collusion that seems to have taken place was natural, tacit and logical or whether there was some type of explicit agreement between some of the financial actors. Both situations are possible, but only the first is legal.

Thirdly, it was interesting to read Eichengreen's article about why the Euro will not collapse, due to market arbitrage (ie: if Greece was to leave the Eurozone, firms would know that it would devalue its currency, and as such would move their assets abroad before this, so as to not have them devalued) and to practical concerns of paying machines and cash dispensers, as well as the cost and time of producing the new currency itself.

Fourthly, one thing that is becoming more talked about is the consequence of the default for other EU member states as the interdependencies in the EU financial sectors might mean that Greece defaulting on its debt would destroy the assets of some other member states financial institutions. (As illustrated in that article: This in turn would freeze lending in EU markets as markets once more become unable to distinguish between good assets and bad ones, as they did when Lehman fell. This might cause companies to go bankrupt, because they are dependent on some type of lending from the financial sector, and to consequently fire more people. Depending on the size of these interdependencies, we could either have a little glitch or another financial crisis on our hands. Lovely...

I must say that in light of all this, and particularly in light of the stupidity of some greek politicians it might actually be better to bring in the IMF. At least that way the Greeks will stop blaming other Europeans. Moreover I don't think Germany is in the mood to help a country where a government official says something like what the Greek deputy prime minister said and the government does nothing. (Actually I wouldn't be surprised if on the eve of a German led bail out, he would be fired or retire for “personal reasons”, that most political of euphemisms…) "Let the IMF let loose the Washington consensus dogs of war"

A less interesting situation, but one which takes me back to my Varieties of Capitalism days, is the understanding of why people are protesting in the streets of Athens. On this issue, there are two interesting paths to explore here. The first one is that Greece probably lacks a substantial export sector other than its shipyards (which is not little, but probably not overwhelming). This in relation to other insights on labour force reactions to economic policy and industrial relations makes me feel that the default position for labour is protest, not refrain. If it was, then Greek workers from exporting industries would protest against the protestors (for that sake the same would apply to Danish workers when Denmark joined the Deutschmark area). The other thing is that myopic self interest really is a strong force. I mean, Greece is really in a mess. If it does not tighten its belt, it will really have to default on interest payments of its debt. This would bring about a number of painful consequences, where the little business existing in Greece would leave, thus increasing unemployment, and decreasing wages, which is basically what the EU is asking Greece to do. The difference is that business would not leave if Greece did it without defaulting on its debt. However, public functionaries don't really seem to care much about that... I may sound cruel and cold, but the truth is that Greece has no alternative. One way or another it will have to decrease wages. The choice is between the process, ie whether it wants to be coerced into doing that by basic economic mechanisms or whether it decides to do so voluntarily.