Last Greek thoughts

A few salient points that don't seem to be on the top of the outpouring of Greece commentary.

1. Greece seems to be coming to a standstill.  Kerin Hope at FT  (HT Marginal Revolution):

... many [Greeks] have simply stopped making payments altogether, virtually freezing economic activity.

Tax revenues for May, for example, fell €1bn short of the budget target, with so many Greek citizens balking at filing returns. 

The government, itself, has contributed to the chain of non-payment by freezing payments due to suppliers. That has had a knock-on effect, stifling the small businesses that dominate the economy and building up a mountain of arrears that will take months, if not years, to settle.

“Business-to-business payments have almost been paused,” one Athens businessman says. “They are just rolling over postdated cheques.”

 Around 70 per cent of restructured mortgage loans aren’t being serviced because people think foreclosures will only be applied to big villa owners,” one banker said.

2.  If a Greek goes to the ATM and takes out a load of cash, where does that cash come from? The answer is, basically, that the Greek central bank prints up the cash. Then, the Greek central bank owes the amount to the ECB. The ECB treats this as a loan, with the Greek central bank taking the credit risk. If the Greek government defaults, the Greek central bank is supposed to make the ECB good on all the ECB's lending to Greece.  It's pretty clear what that promise is worth.

Some observations on what these stories mean.

1.  The argument is not about "lending" to Greece, i.e. covering this year's primary surplus. The argument is whether the IMF, ECB, and rest of Europe will lend Greece money to... pay back the IMF, ECB, and the rest of Europe. This is a roll over negotiation, not a lending negotiation.

The loans were not intended to be paid back now. The loans were intended to go on for decades. But with conditions. The negotiation is about enforcing or modifying the conditions for a roll-over.

Rolling over short term debt with periodic reviews is a nice incentive mechanism. Foreign policy should try it.

2. The latest proposed agreement includes sharp increases in tax rates.  Now? Are you kidding?

Source: theguardian.com

I am reminded of the story of a town, that had a bridge, that had a 50 mph speed limit. A drunk driver, going 85, caused  horrific crash. The town lowered the speed limit to 25.

What Greece needs is to get going again. That is, to persuade anyone that this is a good country to start a business, invest, hire people, and so forth.  In particular, if Greece is to pay back debts, it has to become an export-oriented growth economy, and run trade surpluses Higher VAT, higher corporate taxes, and higher taxes on successful entrepreneurs are hardly the way to go about attracting investment.

I think of taxes in terms of incentives. Keynesians look at aggregate demand. Either way, raising tax rates, now, in an economy where nobody is paying much of anything because they see the big explosion ahead seems destined, pragmatically, to raise no revenue. And, incidentally and humanely, to further crater the economy.

Despite cuts, the Greek government is still spending north of 50% of GDP. If you want to get primary surpluses, that seems the place to cut.

But with an economy at a standstill, major structural reform (like, go back and put back in the structural reforms that Syriza scuttled on arrival) seems like a more promising short-term set of conditions. And we'll see you on the next big roll-over.

3. Rolling over post-dated checks is a fascinating story to a monetary economist. Money is created when needed, apparently.

4. The bank run, or "jog." Remember, the big Greek bailout already happened. Private investors, largely European banks, who held Greek government debt got to sell their debt to government and IMF. Bailouts are creditor bailouts.

One way of viewing the current slow motion crisis is an invitation for ordinary Greeks to join these investors. Take euros out of the bank. The government default will happen, possibly with bank closures, capital controls, currency exit, and expropriation. But lending to Greek banks is now bailed out, with the losses sent to Europe via the ECB, just as German bank's lending to Greek banks was bailed out in the first round. Too clever, maybe, but that is the effect.

Too clever, really, to describe the situation. It only works if the government actually does exit, and soon. Getting money out of the banks and then defaulting is one thing. But a frozen economy can't go on long.

I repeat: the run and non-payment, freezing the economy, happen largely because people see capital controls, bank account expropriation, grand all-around default (your mortgage might get redenominated to Drachmas too, and forgiven once the bank goes under, so why pay now) and Grexit in the future.  The simplest way to stop the run and economic cratering would be a solid commitment from both sides that government default will not mean Grexit,  capital controls, etc.

5. Without the banks, this would all be simple. Greece could default, stay in the Euro (unilaterally if need be) and Euro zone. One government defaulting on debts to other governments is not a crisis.
All along though, the involvement of the Greek banking system makes it much harder.

Greece has 11 million people, $242 billion GDP and 51,000 square miles. That's as many people as Ohio, the GDP and land area of Louisiana. Why does Greece need its own banking system in a common currency and free market zone?

Think how much easier this would all be if Europe had gotten around to integrating its banking system. In any city in the US, the major banks are all national. If California defaults on state bonds, your Chase bank account is safe, and not because of Federal deposit insurance. Because the bank has no exposure to California bonds.

Imagine if Greeks deposited money in a local branch of a large pan-European bank, backed by assets spread throughout Europe. Imagine if Greeks borrowed money from the same bank, funded by deposits spread throughout Europe. Imagine if, when a remaining Greek bank defaults, the European equivalent of Chase could sweep in, and take over loans and deposits seamlessly. A default by the Greek government on its bonds would be inconsequential to Greek banking.

Why not? Well, such banks would not hold vast amounts of Greek government debt. Such banks would not have Greek ownership, or be controlled by the Greek regulatory system. Such banks would not be available targets of Greek capital controls, or a currency change.

Greece needs an independent, national, banking system about as much as Ohio or Louisiana need independent, state banking systems.

6. And currency. Many economists keep saying how wonderful it is for tiny countries to have their own monetary policy, so they can devalue their way out of crises like these. They advocate "capital controls" (English translation: expropriation of savings). That's how Argentina, say, is such a success story. We may be about to see.