Monday, February 8, 2010

Greek financial crisis: Panic, bad policies and conflicts of interest

In one of Prime Minister George Papandreou's recent brainstorming session, Joseph Stiglitz apparently told him that the IMF is the only way out for Greece. He does not think that the EU will do the job properly.

In the meantime, the Papandreou government seems to be in a panic to raise money and Finance Minister Papaconstantinou is preparing a new draconian tax code. The result is that there is already a sizeable flight of capital leaving Greece.

I fear that these measures will result in killing what little exists in the private sector. Years of socialist government in Greece have resulted an oversized government that has systematically crowded out the private sector and driven large parts of it underground. The Greek government expanded entitlements, which they financed by deficits and public debt. Privatization always met considerable resistance, of which the recent wild cat Piraeus Port Authority strikes encouraged by the pre-election rhetoric of the now ruling Socialist party, is a vivid example.

The Socialists denounced the COSCO port privatization for a container transshipment facility as neo-colonialism and called renegotiation and rescission of the agreement. As soon as elected to office, they faced a nasty strike by Communist party-controlled unions in an attempt to frustrate the government privatization agreement. The strike created considerable consequential damages in the Greek private sector as well as revenue losses to the Greek state in port dues. Despite empty public coffers, the socialist government ended the strike by conceding to the Communist party-controlled unions with generous pay terms that have no relation to market reality. Whilst nearly defaulting on the terms with COSCO for the use of the port facilities in Piraeus, the Greek government turned unsuccessfully to the Chinese government for public loans.....

The government is now targeting those who declare low incomes. Whilst a few in this category are hiding larger incomes, most of them are self employed and small businesses as well as black market labor who are living very marginally. Forcing them to pay taxes when they are just surviving in a recessionary environment will result in putting them in abject poverty. Many more shops and small businesses will be forced to close. They are also preparing a new onslaught of heavy property taxes. The construction industry will largely fold. Already property values are falling. The Athens area is vastly overbuilt in both commercial and private residential construction. The Conservative party told them that they are spreading panic in the market place and this risks provoking general economic collapse.

The Greek banks are in trouble because of 1.) flight of capital from Greece to safer havens and 2.) the potentially toxic debt that they hold in the way of Greek government obligations and 3.) risks of non-performing loans from consumer finance and housing as the economy collapses.

Within the EU, there is considerable politics over Greece. The Greek government seems to be hoping for new loans from France and Germany as a bailout, albeit they are worried about the tough conditions. The EU does not want Greece to go to the IMF. Partly they fear the contagion to the Euro system and pressure on the Euro with the bad money (Greece) in the system driving out the good money (France, Germany). No currency union without fiscal and political union has ever survived and EU system was badly flawed from inception as many economists like Milton Friedman and lately even his adversary Robert Mundell have pointed out. Already some are discussing a two-currency system in the EU.

The heart of the matter is the potentially toxic Greek debt. Whilst the Italians and Spanish have public debt problems, too; a lot of their debt is held domestically. It appears that in the case of Greece, the largest share of their debt is held in other EU countries. A Greek default will result in sizeable losses in unexpected places such as German pension funds. For this reason, the EU commission prefers the ‘pound of flesh’ method forcing Greece into high taxes and permanent recession rather than an IMF workout that would result in partial default and losses on Greek debt holders.

Greece never really met conditions for EU participation but the EU authorities winked for political reasons, wanting as many countries to participate as possible. Ironically a few of the sounder countries like the UK, Sweden and Denmark passed but the weak countries such as the PIIGS all jumped for it.

Greece has had public debt problems for years due the socialist politics of entitlements and consumption as opposed to productivity and investment. Greek politicians latched on to the Euro as a means of credit enhancement, obtaining a defacto subsidized interest rate to lower their public debt interest costs. This allowed them to borrow even more.

A lot of the EU transfer money was used for political show projects of which the Olympic Games was an example, but the now empty athletic halls did not prove sustainable, productive investments to build a sound economy. The socialist mentality in Greece always favored state-sponsored capitalism rather than private investment, which they saw as an affront to their dignity and a threat to their strategy of captive voters totally dependent on the state bureaucracy. The EU tolerated this (looking the other way with the false accounting and dubious statistics and now feigning false indignation) because the transfer money opened infrastructure projects for European firms and Greece became a vast dumping ground for EU and other exporting countries like Germany and China, with an ever widening commercial deficit now 14% GDP - reputedly the largest in the EU. The global financial crisis ended the party!

The result of these policies today is the present financial nightmare. The Greek government has to turnover debt and borrow even more every money to cover ever-widening deficits. The deficits are exploding because of a rapidly shrinking tax base as the economy implodes and ever rising interest costs due the increasing default risk. In these circumstances, more EU money even on soft terms, is really only making the longer term situation worse.

Without productive private investment, Greece will never be able to repay its debts or survive in the future. No one will invest in Greece under the present circumstances. The public sector needs to be downsized. Entitlements must be reformed. Public debt needs to be renegotiated and partially written down. Good to have the stigma on the political system that created the mess in hope of future credibility. Prolonging the agony will only increase the losses. Better to take the losses now and focus on changing the rules for a sound economy for tomorrow.

I believe that the EU Commission approach is tantamount to permanent loss of Greek sovereignty and will result in years of recession and economic stagnation, whereas the IMF approach will allow Greece more leverage with the EU in view of these conflicts of interest and a speedier turnaround.


  1. In and of itself a Greek bankruptcy or bond default should -in theory- not affect the Euro as such very much, Greece being maybe 3% of the total. However, just as a Californian bankruptcy (probably inevitable, large US cities at least are already contemplating insolvency, ten idividual states may well follow) would reflect badly on the "state of the Union" as a whole so would the default of on EU country, coupled with the rising interest rates and thus further destabilisation of the remaining over-leveraged member states, make investors wonder when sovereign default across the board is likely. Thus they wouldn't commit themseves to bonds of longer maturity and that's the beginning of the end.

  2. True, but the US has a much sounder system with the Fed to deal with these problems. No monetary union has ever survived without fiscal and political union. The Euro system is badly constructed and needs major reforms. They have no mechanism to deal with crises.
    Greece qualitatively is in much weaker position than California because these is so little productive base to support the high debt levels that are a result of years of unbridled entitlements and cronyism. There is no incentive for private investment with the tax burdens/ heavy bureacracy and there is hopeless loss of competitiveness locked into the Eurozone.