Posts Tagged ‘ECB’

Will Greece Pay Its Debts Via The Agamemnon Option?

Wednesday, June 17th, 2015

Legend has it that, at the onset of the Trojan war, the Mycenaen king Agamemnon sacrificed his daughter Iphigenia to Artemis, the goddess of (amongst other things) wildness, in order to obtain favorable winds for the Hellenic fleet’s crossing of the Aegean.

Some three millennia after the events that inspired this story, the government in Athens finds itself again attempting to appease greater powers in the face of an increasingly wild regional conflict. And yet again, perhaps Greek leaders have already made a terrible sacrifice of youth which could go some distance to calming the seas their beleaguered nation must navigate, if those greater powers view the offering with favor.

Standing in for Artemis are the so-called “Troika” of Greece’s institutional creditors, the International Monetary Fund (IMF), the European Central Bank (ECB) and the eurozone countries. In the role of poor Iphigenia we have a generation of young, educated, professional and entrepreneurial Greeks. In these more civilized times, however, the sacrificial instruments are not altar and dagger but an airline ticket and an EU passport.

At least two hundred thousand Greeks have emigrated since the financial crisis began, the vast majority of whom are youthful, skilled and facing bleak prospects in their home country. They are the next generation of Greece’s experts in medicine, the sciences, engineering, finance and academia. Their primary destinations are other EU nations – for example, the UK’s Guardian reports Germany alone has received 35,000 Greek physicians.

While many of these émigrés might prefer to return to their native land someday, Greece’s stifling regime of regulation and taxation, its bloated welfare state and rampant corruption are likely to continue to render that nation far too uncompetitive to accommodate their ambitions. The 2014-15 World Economic Forum competitiveness ranking places Greece eight-first, just behind Uruguay (but, in fairness, one ahead of Moldova). By contrast, the U.S is third, while Germany ranks fifth. Rather than implement meaningful additional legal, pension and labor market reforms, Athens proposes to roll back many of those the Troika has already imposed, thus ensuring this unfortunate state of affairs is likely to continue for some time.

Yet there is a kind of tragic silver lining in all this, both for Greece’s creditors and its government’s apparent vision. Consider the value of Greece’s professional diaspora in Europe to its recipient nations. Let’s do an admittedly “back of the envelope” calculation. First, a few compensation figures. For German engineers the average is around $57,000, for bankers around $55,000. The average physician in Germany made $155,000 in 2010, in France a bit lower at $131,000. So for the sake of argument, let’s assume a $50,000 per capita income for two hundred thousand Greek professional émigrés (a number which could rise if Greece continues on its current trajectory) and an average working lifetime of thirty years. Discounting by the current German thirty year bund rate of 1.5% over that time frame (a not unreasonable proxy given integration into largely northern European economies) yields an expected present value of $240 billion. Assuming a 50% rate of total taxation (income,VAT, property etc.) yields $120 billion, or approximately 44% of the $273 billion Greece owes the Troika creditors and the central banks of the eurozone. In particular, this is $30 billion more than the $90 billion the ECB has extended to Greek banks under the former’s Emergency Liquidity Assistance (ELA) program*.

Thus, if the Troika and the eurozone’s central banks are to take a hit on Greece, the transfer of that country’s human capital to the rest of Europe and other IMF members should provide the creditors with some recompense (in an ideal world some inter-creditor transfer system would be implemented to make things fair, given that many Greek expats may head to the non-eurozone UK and the non-EU United States, and that poorer creditors like Portugal may not get a pari passu share of Greek emigration). A full realization of the value of this emigration might ameliorate the Troika’s reticence concerning whatever restructuring, discount, or other euphemism for a Greek default ensues, perhaps to the point of extending the ELA to prevent bank runs, with a bit left over for some form of humanitarian aid.

To be sure, some of the Troika’s actions and proposals have been neither helpful nor realistic, especially as regards overly aggressive near-term primary surplus targets (1% for the next couple of years would be in the outer realm of the possible). Yet the irony here is that, absent very necessary reforms to the welfare state that Athens is loath to agree to, the conditions in Greece are likely to persist, such that young, talented Greeks will remain in diaspora, lending their abilities and energy to the economies of Greece’s creditors. Effectively, Athens will have guaranteed at least a partial repayment of its debts, albeit at the cost of its nations’ youth.

Of course, the Greek polis may not be entirely pleased with its government’s sacrificial policy. After all, in Pindar’s poetic telling, certain members of Agamemnon’s constituency, notably Clytemnestra, mother of Iphigenia and his queen, registered displeasure with the monarch in the manner of a time before the invention of the parliamentary no-confidence vote, making for arguably the most notorious bathing scenes in literature. With polls consistently showing a majority of Greeks in favor of remaining in the eurozone even if that means agreeing to painful reform, Greece’s leadership may yet choose to compromise. Otherwise, they could find themselves grateful that the democratic process allows them to lose power without taking a bath considerably less pleasant than even the one they would impose on their creditors.

Then again, in some old versions of the tale, at the last moment Artemis rescues Iphigenia and replaces her with a stag, so hey, there’s always the chance of a deal, though bailing out Greece will take a lot more than a single buck.

*Of course this analysis neglects the social welfare cost of the émigrés to their adopted countries; this may be justified to the extent that these young people are already educated and that much of the other expenses will be incurred in old age and thus are to be heavily discounted in terms of present value. Such costs would also be partially offset by revenue from assets transferred out of Greece by the expats and other Greeks, and also by revenue from enterprises founded by disproportionately entrepreneurial immigrants, at least if one goes by the American experience.

Aware of Greeks Tearing Rifts, Germany May Have To Let The ECB Do More Than Twist

Thursday, June 28th, 2012

As the prospect of Brussels hosting yet another euro-summit showcase of intransigence and impotence looms before us, even the redoubtable Angela Merkel may be forced to contemplate allowing the European Central Bank to become quite a bit more like the US Federal Reserve. Otherwise, European divisions made obvious during the latest Greek elections may become irresistible tidal forces as the crisis reaches Spain and Italy, opening an economic chasm into which even Germany could fall.

In the wake of two rounds of “quantitative easing” that have left the Fed owning about 12% of US Treasury debt, the Fed has announced its intention to continue attempting to stimulate the economy by extending “Operation Twist,” selling shorter dated Treasuries and buying longer maturity T-bonds in order to bring down long-term borrowing costs (see “Uncle Ben’s Reverted Price”). But US long rates are already quite low, indicating that, at least for the moment and despite past and potentially future fiscal fireworks on Capitol Hill, the bond markets remain rather unconcerned about US credit quality. This may be in no small measure due to the Fed’s demonstrated willingness to purchase massive amounts of Treasuries.

By contrast, as euro-crisis contagion spread from Greece to the rest of the periphery, the sharp rise in the yields of Spanish, Italian and of course Greek debt speak to markets’ deteriorating faith in these credits. For a time these rate hikes were held in some check by ECB sovereign debt purchases; since 2010 the central bank has bought some 200 billion euros of Portuguese, Irish, Italian, Greek and Spanish (PIIGS) paper, creating a degree of precedent for this kind of strategy. However, unlike the Fed, the ECB’s constitution does not include a mandate to pursue full employment in addition to maintaining price stability, so the euro’s central bank was forced to act in the name of maintaining the integrity of the banking system, whose collapse could be deflationary. Two German ECB members took such exception to this rationale that they resigned in succession, reflecting Germany’s traditional post-war concern regarding inflation. For Mario Draghi, the ECB president who recently highlighted the limits to what the central bank can do absent fiscal and structural reform in Europe, much more substantial action would likely require German support, and the quid pro quo of at least a somewhat credible promise of that reform.

Like their American counterparts, the yields on German bunds are quite low. And for Germany as for the US, these low yields are not due to low debt to GDP ratios, as the German figure is now near 90% and likely to rise significantly higher with the announced issuance of Deutschland bonds through which the central government will back borrowing by German states. Rather, both the US and Germany are in some sense in command of the mechanism for creating the currency in which they borrow; for the US this power is unambiguously invested in the Fed, while Germany enjoys a kind of negative control of the ECB, since with the exception of Finland and the Netherlands, the rest of the eurozone seems to have little objection to money creation through policies such as sovereign debt purchases.

A crucial point here, and one readers of this blog will be familiar with, is the difference between real default on sovereign debt caused by inflation and nominal default, in which the bonds do not fully pay off, even in a depreciated and inflated currency (see “Europe Learns To Default The American Way, Restoring Transatlantic Balance Of Irresponsibility”). Because the latter does not result in an inability of banks and other holders of bonds to meet their obligations (like deposits) payable in the same currency as the bonds, the real default of inflation, though potentially quite pernicious, may not precipitate acute systemic financial crises, and thus institutions may be willing to hold debt at risk of inflation but not nominal default. So at least until the inflationary crows hatched by monetization come home to roost, a central bank’s buying of its currency’s sovereign debt may lower yields on that debt, as may even the possibility of such buying, based on the central banks’ ability to make such purchases.

Germany is understandably wary of letting profligate states borrow on its credit card. If it’s serious about not allowing eurozone-wide “Eurobonds” to refinance peripheral debt, and with the necessarily limited firepower of bailout funds like the European Financial Stability Facility (EFSF) and its successor, the European Stability Facility (ESM) limiting their credibility, an ECB with the theoretically unlimited power of the monetary printing press may have to be the buyer of last resort for the debt of the PIIGS, effectively creating euros to re-liquify the banking system, preventing runs and reflating the eurozone’s economy. For Germany, staying in the euro absent such an action could mean the loss of its periphery export markets while its own bank exposure to those countries drags the German economy down (see “It’s Hard To Make That German Export Wiener Without PIIGS – And That Goes For Chinese Dumplings, Too.”). Alternatively, a report from Merkel’s own government puts the cost of an exit from the common currency at 500 billion euros, with a 10% GDP drop and five million Germans unemployed.

Ah, but there’s the matter of those inflationary blackbirds I mentioned, and an old Spanish saying – if you raise crows they will peck out your eyes. With eurozone inflation running at 2.4% in May and the German rate even lower (1.7% in June), the ECB has some inflationary breathing room, ironically due to a global economy weakened by the euro crisis itself. Yet Germany’s concerns are well founded, and in exchange for a more Fed-like ECB it could and should insist on rapid reforms in Europe. These would have to go beyond austerity and the purely fiscal, embracing structural changes addressing woefully low competitiveness in much of the eurozone. Only then can there be confidence in a limit to monetization and any hope of peripheral countries paying debts current and future. Clear milestones and a commitment to a time scale much faster than the ten years contemplated in European Council President Van Rompuy’s plan would be essential. Unfortunately, the most serious opposition to such reform is likely to come from the new French government, which would have to reverse the newly elected François Hollande’s support of earlier retirement benefits and restrictions on layoffs even as French competitiveness dives.

But hey, what in the last two hundred years of Franco-German relations would cause one to doubt that France and Germany can’t work things out?

“Send Treasury Your Retired, Your Not-So-Poor, Your Befuddled Classes Yearning To Invest Risk-Free…”

Thursday, February 9th, 2012

If they continue on their current course, the architects of America’s fiscal and monetary policies might want to consider the above revision to Emma Lazarus’ great exhortation on the pedestal of the Statue of Liberty. For it is in no small measure the flight of capital from investment on other shores that’s has been driving down yields on United States Treasuries, allowing the US to borrow with remarkable abandon despite ratings downgrades and Washington’s ongoing budget follies. As forbidding as the US debt and deficit might be, last year investors continued to bid up America’s debt, lowering the interest cost to finance economic stimulus programs while keeping tax rates unchanged. This injection of capital has almost certainly helped to spur the nascent US recovery, just as some economists argue pre-war European flight capital helped lift America out of the Depression in the later 1930’s.

Washington has had various factors to thank for the easy credit terms the world continues to offer. From Iranian saber-rattling to Japanese earthquakes, many forces served to drive frightened capital into the arms of the US Treasury market. However, at the top of the list is surely the political leadership of the Eurozone. The Obama-Boehner show has nothing on the extravaganza headlined by Merkel and Sarkozy, with a supporting cast of various and changing guest stars governing the solvency-challenged PIIGS (Portugal, Ireland, Italy, Greece and Spain) and of course the folks at the IMF and ECB (every comedy needs a few straight men and women, after all). This noisome cavalcade had provided a continuous flow of confidence-shaking news, keeping sovereign default risk and systemic shock ever present in investors’ minds. Meanwhile, the US has muddled through a budget deal which, while insufficient in the long run, indicated some capacity for concord even in the current poisonous political atmosphere. Similarly, the Fed, aided by TARP financing, seemed to succeed in stabilizing the American financial system. Through late in 2011, the result was an increase in the cost of euro-denominated borrowing for key large Euro sovereigns with the exception of Germany, the yield on whose bunds declined almost in lockstep with a simultaneous drop in US Treasury bond yields.

At the time of this writing, with the “voluntary” Greek debt restructuring talks dragging on, observers may understandably have a difficult time conceiving of an end to “Euro-fear.” Nevertheless, it is precisely the possibility that, with or without Greece in it, the Eurozone will find a way to get its house in some kind of order that threatens America’s ultra-low borrowing costs. We are in fact seeing some tentative signs of, as Churchill put it, not the end or even the beginning of the end, but perhaps the end of the beginning.

New ECB president Mario Draghi’s Long Term Refinancing Operation ostensibly provides a three-year, multi-hundred-billion euro stabilization line of credit to European commercial banks, but as the ECB is “allowing” (read: encouraging) those banks to use this credit to buy better European sovereign bonds (and avoid having to dump weaker Euro nation credits in bulk) what we’re really seeing is a back-door program to lower European states’ borrowing costs. Because the ECB loans represent money created by the central bank, this is a form of bailout that does not require direct taxation of “core” European nations citizens (e.g. Germans), though to be sure, they may end up paying the price through inflation (see “Europe Learns To Default The American Way, Restoring Transatlantic Balance Of Irresponsibility”) and devaluation, though export-driven economies like Germany actually need a weaker currency more than they might like to admit (“It’s Hard To Make That German Export Wiener Without PIIGS – And That Goes For Chinese Dumplings, Too”).

Second, whether or not the Greek debt restructuring talks result in a formal default or an effective one (and the contemplated 70% write-down will surely be a default in fact if not in name) is not so important as whether the process is orderly. So long as any any write-offs and triggered credit default swaps are handled in a way that does not lead to bank runs and frozen markets, such an event could be kept contagion free. There is no guarantee such a systemically benign scenario will play out, but the aforementioned willingness of the ECB to inject liquidity on a massive scale does provide reason for optimism.

And therein lies the rub for US government borrowing costs: as the Eurozone crisis subsides, so may the safe haven “panic bid” on US Treasuries, causing the yields on those bond to rise and further increasing the burden on American taxpayers of financing the deficit. Indeed, the 10 year US Treasury yield has crept up from below 1.87% in late November of last year to over 2.02%, while conversely (and despite it’s own rating downgrade), France’s ten year debt yield declined to below 2.90% since spiking above 3.73% during the same period. Similarly, the Italian 10 year yield dropped from over 7.36% to less than 5.49%.

To be sure, there are significant benefits to the US economy in this “risk-on” shift; the reduction in Eurofear has bolstered equity markets with a knock-on wealth effect boosting consumption and, yes, tax-revenue even in the absence of a rate hike. Even so, higher T-bond rates translate into an increased cost of servicing America’s heavy debt, so even if the core Euro countries seem to be picking up the tab, their Greek holiday may not come without cost for Uncle Sam.

N.B.: One advantage of a weakened euro – cheaper French wines (in dollar terms), and in particularly that said-to-be-excellent 2009 Bordeaux vintage; for insight into this and all things vino, check wine expert (and Duke econ grad) Jessica Bell’s very excellent webcasts at

Test Stressed

Friday, July 23rd, 2010

By ignoring much of the potential impact of a sovereign debt crisis on the solvency of Europe’s banks, perhaps the regulators who ran the so-called stress tests released today were trying to send the world the message that they don’t take the possibility of a eurozone sovereign default seriously, and neither should the markets.

In conducting the tests, the Committee of European Banking Regulators and the European Central Bank assumed various haircuts on the values of Greek, Portuguese, Spanish and German debt, but applied these only to the trading books of the examined banks, not to their loan portfolios. In effect, this assumes that the impact of a contemplated crisis will be limited to a short-term liquidity discount on national obligations, but that any bonds held to maturity will in fact pay off in full. Indeed, Bloomberg quotes ECB vice president Vitor Constancio as saying a sovereign default scenario was not included because “we don’t believe there will be a default.”

As a result of this and other arguably dubious assumptions (apparently including parallel shifts in the yield curves of eurozone members – one would think such movements might be quite different for a defaulter as opposed to other euro nations) only seven of the ninety-one banks examined failed the tests and will be required to raise more capital.

Now the eurozone regulators’ gambit only works if the markets are convinced that member nations’ governments really have the will and means to prevent a true sovereign default. In fairness, recent EU and IMF lending initiatives combined with fiscal restructuring in nations including Ireland, Spain and to some extent Greece have lent support to the euro and European debt markets. However, by banishing true sovereign default from their realm of contemplated possibility, the CEBR and ECB have put far more of the responsibility for European (and global) banking stability back in the hands of Europe’s politicians. Banking on the vicissitudes of political capitals as opposed to increased bank capital might itself be a potentially risky move.

Europe Learns To Default The American Way, Restoring Transatlantic Balance Of Irresponsibility

Thursday, May 13th, 2010

The game-changing aspect of the eurozone member states’ plan to stabilize the euro is not the $139 billion Greek bailout or the trillion-dollar currency stabilization fund per se, but rather the about-face of the European Central Bank, which will now reverse a longstanding policy and purchase the debt of euro states. In doing so, the ECB and its president Jean-Claude Trichet, have opened the door the the monetization of euro sovereign debt, which is to say the effective real default implied by inflation and currency debasement.

In essence, the ECB can now create euros to buy Greek or other European debt, including cross-eurozone bonds issued to finance the euro stabilization war-chest. Since that fund could borrow to support the euro and the ECB can purchase that debt as well as the bonds of individual euro nations, the net effect is to allow the assumption of a distressed member state’s debt by the entire euro membership and the inflating away of that debt through euro creation on the part of the ECB.

If all this sounds familiar to American ears, it should, since the power to monetize dollar-denominated debt has long been possessed by the central bank of the “dollar zone,” that being of course the Federal Reserve. Indeed, most central banks around the world have the ability to inflate away debt denominated in the currencies they create. A crucial difference between the ECB and its brethren has been that sovereign borrowing in the currency over which it presides has been done by sixteen individual states, and that debt has until now been off limits for purchase and thus monetization. The analogous situation in the U.S. would be if all government borrowing were done by the individual states through municipal bonds.

Now, monetization with its attendant inflation and devaluation is indeed a form of default, since in real terms debt holders are paid back in money which will now buy less goods, services and foreign currency than it did when it was lent. Yet even if bondholders are burnt in terms of purchasing power , there are certain systemic advantages of real default over the nominal variety, in which lenders are paid only a fraction of the currency (euros, for example) which they are owed.

Consider banks borrowing from depositors in euros and lending to eurozone governments by buying their bonds. In a nominal sovereign default, the bank might not have enough euros to pay back its depositors, which is the kind of thing that tends to lead to bank runs. But in a monetization-driven real default, the bank gets paid in full and so do the depositors, albeit in a debased currency. Banks’ and depositors’ euros might not be worth much but they get each and every one they are owed. Financial institutions’ balance sheets may shrivel in real value but they continue to balance, avoiding runs and some types of systemic shocks.

Similarly, and rather paradoxically, the certainty of nominal payment under real default has at least one “operational” advantage in the creation of the reserve currency the eurozone members would like their currency to become: knowing the ECB can print euros to pay off euro debt, the world’s central banks can invest the currency in assets whose nominal return can be calculated with more certainty, as can future holdings of the currency itself. Again, the future value of that currency may be in question but not the amount of it to be received.

The balance sheet stabilizing aspects of real default can come at a high price, including the destruction of savings’ buying power, growth-killing price uncertainty and, as demonstrated in the Europe of the 1930’s, social unrest and war (this has something to do with the reticence of Germany in regard to the euro rescue, as evinced recently in the Westphalia vote). Inflating away debt is a treatment best administered sparingly, if at all. How much tolerance electorates of more solvent euro nations have for being taxed to pay the bills of their less productive, more profligate neighbors may well end up the determining factor for the euro’s survival, at least in its current form.

One silver lining for the Europeans (at current prices a golden one would be too much to ask for): with both the U.S. and Japan up to their eyeballs in government borrowing, the real default risks of dollar, euro and yen sovereign debt could at least partially negate each other in a rough balance of fiscal and monetary irresponsibility. And if these currencies’ mutual risk of debasement puts more pressure on China to revalue the yuan, I can almost hear a chorus of finance minsters singing hallelujah.

It’s worth mentioning that, in the wake of the Fed’s recent broad-spectrum asset purchase programs, we may yet see the day munis are added to that central bank’s balance sheet. After all, even a casual observer of the disconnect between California’s entitlement-driven spending and any realistic projection of its tax revenues could be forgiven for viewing Athens as simply Sacramento on the Aegean.

Addendum: Those of you who enjoyed my rather skeptical remarks on the role of swaps in the Greek crisis (“Greece And The Zen Of Credit Default Swaps”) may also enjoy a similarly-minded piece by Stefan Schultz in Der Spiegel, in which I’m quoted extensively. One caveat: it’s much more enjoyable if you happen to read German; if not, should you paste it into a translator program, note the amusing fact that Trester is the German word for wines otherwise known as marc or grappa, which is how my surname may be automatically translated.