Behind the Hype over Greece

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Since the beginning of the year 2010, the Anglo-American and also continental European mainstream media have been indulging in the financial and fiscal woes of Greece. If we believe the media, Greece is tottering at the brink of state bankruptcy and might detonate the European Monetary Union (EMU). Moreover, we are told, not only Greece but the whole southern belt of the Eurozone – Portugal, Spain and Italy – has become a financial and fiscal disaster area.
One should add however that the hype over Greece is accompanied by massive currency speculation against the euro and by a massive speculation drive with respect to “credit default swaps” (CDS). The “global players” of international finance are back to the very speculation practices which caused the 2007/08 financial crisis. If there’s one sensible conclusion from the “Greek affair”: States must finally get tough on financial regulation. This is as important for their credibility as fiscal discipline.
By Michael Liebig


Greece’s Debt Problem – and What about the Rest?

In order to avoid a misunderstanding, Greece, Portugal, Spain and Italy do have very serious financial and fiscal problems. And, the Euro single currency system does have design faults. However, let’s keep the problems of Greece and other Mediterranean countries in perspective.

On February, 12-13, 2010, the Reserve Bank of India held its International Research Conference „Challenges to Central Banking in the context of Financial Crisis“ in Mumbai. At the event, three economists of the Bank for International Settlements (BIS), Stephen G. Cecchetti, M. S. Mohanty and Fabrizio Zampolli, delivered a paper, titled “The Future of Public Debt: Prospects and Implications. In the introduction, they write: “The financial crisis that erupted in mid-2008 led to an explosion of public debt in many advanced economies. Governments were forced to recapitalise banks, take over a large part of the debts of failing financial institutions, and introduce large stimulus programmes to revive demand. According to the OECD, total industrialised country public sector debt is now expected to exceed 100% of GDP in 2010 – something that has never happened before in peacetime. As bad as these fiscal problems may appear, relying solely on these official figures is almost certainly very misleading.” [emphasis added, M.L.]

You will note that the BIS economists do not focus on Greece in their paper – after all, that country’s share in Eurozone GDP is a mere 2.6% and its share in total OECD public debt microscopically small. The BIS economists don’t single out Greek “creativity” on statistics, but they say that official figures on public debt are in general “very misleading”. Nevertheless, even when sticking to official figures, we get a sense of proportion of the public debt problem:

Country Budget Deficit 2010* 2011 Public Debt 2010* 2011
Germany 5.3 4.6 82 85
Greece 9.8 10 123 130
France 8.6 8 92 99
Ireland 12.2 11.6 81 93
Italy 5.4 5.1 127 130
Japan 8.2 9.4 197 204
Portugal 7.6 7.8 91 97
Spain 8.5 7.7 68 74
Britain 13.3 12.5 83 94
USA 10.7 9.4 92 100
China 2 2.9 22 23
India 10 8.7 86 86
Latin America** 2.4 2.2 37 35
Other S.E. Asia 1.2 1 37 38
C. Europe*** 4.4 3.9 28 29

* Percentage/GDP ; ** Brazil, Argentina, Mexico, Chile; *** Czech Rep., Hungary, Poland

Looking at this BIS table, one wonders what the hype about Greece is based on?

Admittedly, Greece is in the front group of very indebted countries along with Japan, Italy and the USA – and France, Portugal, Ireland and Britain are not far behind. In world GDP ranking, the USA is No. 1, Japan 2, France 5, Britain 6, whereas Greece ranks 27, Ireland 35 and Portugal 37. Italy is No. 7 and Spain No. 9. After all, the 2010 Greek budget deficit is about 1.3% of the US deficit.

The ugly truth is that the whole “trilateral North” – USA, Japan and the EU – is stuck in public debt of unsustainable levels – in glaring contrast to the financial and fiscal condition of the rising powers in the “South”.

Double Standards

The Neue Zürcher Zeitung can certainly not be blamed for anti-American bias. After having spent the last five years in Washington and New York, Walter Meier, the NZZ’s economic affairs correspondent in the USA, has just returned to Zürich. His “farewell” article on Feb. 8 was titled: ”The USA Faces Economic Decline”.

Meier reports that profound pessimism has gripped the American population as Americans begin to realize that economic, financial and social crisis – 8.5 million jobs lost in two years – is “homemade.” The whole country is over-indebted – private households, enterprises and the state. 40% of federal budget expenditure is debt-financed. Projected budget deficits for the next couple of years are above $1.000 billion – $1.600 for 2011. By 2020, the deficit is to be “reduced” to $700 billion.

Meier than notes that America’s well-educated “baby boomer” generation is retiring, while the fresh supply of young people with high technical skills is insufficient while the inflow of foreign students and highly skilled immigrants is declining. At the same time there is an abundance of lawyers, accountants and financial jobs. Health costs are very high, absorbing an unsustainable 17% of GDP. Most Americans live in suburbia with almost no public transportation. Depending on their automobiles, they must pay for ever rising fuel prices. Infrastructure generally is in an abysmal condition.

When I compare the NZZ’s observations on the situation in the USA with the past weeks‘ plethora of articles in the mainstream media reporting about the “disastrous” situation in Greece, I wonder what the difference is? Why all the fuss about Greece, when a much bigger and much more important country like the USA is facing similar problems?

Well, I would make a qualification here. I do know how Greece looked like in 1970s: It was a backward and underdeveloped country, which had to send a significant portion of its young workforce to foreign countries as “guest workers.” When I last visited Greece in 2007, the country had radically changed for the better. The infrastructure development in Greece has been quite extraordinary – mostly due to EU funding. Of course, the Greek public sector is overblown and inefficient. There is political corruption, endemic tax evasion, and fiscal manipulations, including ceding state revenues to Goldman Sachs Citigroup, Barclays and Morgan Stanley for semi-secret credits. But, are these defects exclusive to Greece?

The Eurozone finance ministers will enforce tough budget cuts and tax increases in Greece. De facto, their main leverage is the interest spread for state bonds within the Eurozone: It was almost nonexistent in 2007 and has recently shot up to around 350 base points vis-a-vis German “bunds.” As usual, the austerity measures will primarily hit the lower and middle classes in Greece. During 2009, we have seen just that in Hungary, Ireland or the Baltic states.

I think that the probability of a Greek state bankruptcy is close to zero. The latest Greek state bond auction in January was oversubscribed. If Greece were to face a buyers “boycott” at the next state bond auctions in April and May, state-controlled banks in Germany, France and other Eurozone countries will buy the bonds – the EMU’s “no bailout” clause notwithstanding.

The “Southern Belt” and the EMU

“Greece’s fiscal tragedy,” proclaimed Bloomberg on Feb. 19th, “has exposed the flaws in Europe’s hybrid of monetary union and fiscal indiscipline. The crisis risks extending the euro’s 6 percent slide against the dollar this year, its expansion into eastern Europe and its prospects to challenge the dollar as an international reserve currency. “

Will the “Greek crisis” undermine the euro? I’m quite sure it won’t.

Since the early 1990s, Wilhelm Hankel and other economists have pointed to the core problem of the EMU: It’s is not a currency union among economic and financial equals. The EMU merges countries with a strong manufacturing base and export performance (Germany, Benelux, Austria, Finland, Slovakia, Slovenia) with countries with a weaker industrial base and traditionally high current account deficits (Spain, Portugal, Greece). France and Italy take a middle position.

During the first decade of the EMU, the current account surpluses of the “EMU North” have balanced the current account deficits of the “EMU South.” And the ECB’s “one size fits all” interest rate has de facto provided “subsidized” credit to Greece, Spain and Portugal. Prior to the EMU, the southern countries‘ access to credit was much more restricted and they had to pay higher interest for it. Hankel argued that the “invisible transfers” within the EMU would become unsustainable for the “North” and inevitably lead to the breakup of the EMU.

However, Hankel underestimated the increase in technology-driven competitiveness in the “North” due to the fact that the “South” lost the advantage of price-vectored competitiveness via currency devaluations. As demonstrated by Germany’s rising exports to Eurozone countries, the EMU became a net gain for the “North” – in spite of the “invisible transfers” within the EMU.

Some of the plentiful and cheap credit available to private and public actors in Greece, Spain, Portugal and Italy was used productively, notably for hard and soft infrastructure projects. But much of it was spent unproductively, notably for real estate speculation, and for consumptive purposes – some socially legitimate, some simply wasteful. Both the real estate bubbles, notably in Spain, and rising public debt level became unsustainable. A correction was inevitable: Unpleasant, painful for the majority of the population, but no catastrophe.

The renewal of the manufacturing base in Southern Europe, improvements in science and education, new economic cooperation efforts towards Latin America and the Arab countries, and the reduction of the economic weight of the construction sector and the tourism “industry” are simply inescapable economic necessities for the southern countries of the EU.

Currency and CDS Speculation

What has made the situation really messy in recent weeks, are not overdue adjustments in Southern Europe, but a rampant financial speculation drive by the “big players” of international finance – notably Anglo-American banks. The fiscal problems of Greece were exploited to launch a dual speculation wave: First, speculating against euro, secondly, speculating on credit default swaps (CDS).

Currency speculation is based on a relatively simple mechanism: First contract credit in the currency A, you want to see devalued, and then exchange it into cash in another currency B, you want to see appreciated. Then you create a hype by using real or perceived problems afflicting the targeted currency A. Once currency A has been devalued sufficiently, you exchange the cash (in currency B) back into the depreciated currency A – and you get more of it. Then, you pay back the credit (of constant nominal value) in currency A – the difference is your profit. With the use of derivatives, this core mechanism can be amplified by orders of magnitude. As the exchange rate between the dollar and the euro has risen by more than 5% in the last four weeks of the “Greek crisis,” currency speculation against the euro has been quite profitable for banks and hedge funds.

Financial gains drive currency speculation, but geo-economic factors are never far off. Bloomberg’s above mentioned reference to the latest depreciation of euro as weakening the challenge to “the dollar as an international reserve currency” tells us what to look for. In midst the hype over the “Greek crisis,” Bloomberg carried a news item on Feb. 16, titled “International Demand for U.S. Financial Assets Slowed.” The piece was not prominently featured, but its content was rather exiting: “China was a seller of U.S. Treasuries for a second straight month, with sales in December totaling net $34.2 billion… Japan replaced China as the top foreign holder of U.S. Government debt”. If we correlate China’s sell off of US government bonds to the Greek budget deficit, we get an intriguing result: China reduced its holdings of US government debt in one month by almost twice the amount of the Greek budget deficit for the whole year 2010.

The latest speculation against the euro has been combined with CDS speculation. CDS are an “insurance” against credit default. The likelier a default – or the perception thereof ! – , the higher the “insurance premium” and profit for the seller of CDS contracts. Hedging against credit default would even make sense, if the buyer of a CDS contract actually possesses the credits to be “insured”. But it is estimated that less than 5% of CDS contracts are plausible hedging.

The rest is speculation operating with “synthetic” derivatives – CDS contracts with no plausible connection to actual credits owned by any of the parties involved. The big players on the CDS market are J.P. Morgan, Goldman Sachs, Morgan Stanley, Deutsche Bank and Barclay’s Group – each with CDS portfolios ranging from $6 trillion to $7.5 trillion – and hedge funds.

The real perversion of CDS speculation is – as in all financial speculation – that it can only thrive on market volatility, political and social instability and insecurity in general – real or perceived. And here we see a peculiar symbiosis between the mainstream media and the global players of international finance.

There is one inescapable conclusion from the “Greek crisis”: Financial regulation. No CDS-style credit “insurance” without directly corresponding credit! And the latest round of currency speculation underlines once again that there is no alternative to the introduction of a financial transaction tax. The finance sector has driven states in the worst debt morass in peacetime. Because their very credibility is at stake, the states have simply no choice but to effectively regulate the finance sector. Call it an absurdity or a paradox: The banks will inevitably punish the states for not regulating them.

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