Monday, February 2, 2015

Dear Eurozone officials, Mr Putin is waiting

The FT has a remarkable story today about how Eurozone officials are worried about Greece. To quote:
" the fears of eurozone officials that the Greek government was unaware of the precariousness of its financial situation"

This is kind of amazing. There is an old adage - which is that if you owe someone $100 you have a problem. If you owe someone a $100,000,000,000 they have a problem.

Greece's debt (and hence the German/Eurozone problem) is somewhat larger than that.

Moreover Greece runs a primary budget surplus. The only reason the Greek government needs money (ever) is to roll existing debt.

If they default on existing debt that problem goes away.

Paul Krugman summarised the problem with devastating clarity.

Bluntly he points out the Troika (and the above worried Eurozone officials) can't hurt the Greek Government by denying incremental finance because the Greek Government does not need incremental finance.


Krugman does however point out that the Greek banks require finance. As Krugman puts it:

"the power of the creditors over Greece comes via the ability to crash the Greek banking system, which is heavily dependent on the ability to borrow at need from the ECB. Cut off that support, and Greece suffers banking collapse. So yes, the creditors have a large club they can use on a recalcitrant Greece."
But Krugman overstates that club. It is entirely within Alexis Tsipras's power to default to the ECB too. Indeed the pattern for government defaults is to simultaneously force a private sector default.

How about this for a negotiating position... we will pass a law to make it illegal for any Greek bank to repay the ECB. Period.

Then have a one week banking holiday, re-denominate all remaining Greek bank assets and liabilities in Drachma, and if a default event passes any court we will nationalise the Greek banks as-per-Washington Mutual - leaving the obligations in some stripped-down shell from which there is nothing to collect.

Finally, in this environment, depositors will receive shares in the new Greek banks in proportion to their deposits. Those shares will be worth a lot because an obscene amount of bank liabilities will be wiped out.


This will crash the Greek economy? You make me laugh. We are already at Great Depression levels and removing the burden of your silly debt schedules will be incredibly stimulative.

Sure we will lose access to clearing but Vladimir Putin is lending us a few billion dollars and we have a clearing arrangement in Singapore. [They will do this for anyone from Libyan dictators down...]

Moreover I was once told by Capital One - a respected US credit card company - that recently bankrupted people make the best credits.* After all their past debts have been cancelled and they are by definition solvent. It won't take two years and the financial markets will be happy to lend to us again.


Finally we are not a wildly interconnected economy. Its not like Finmeccanica - the Italian company which makes components for Boeing Dreamliners and thus needs the global financial and payments system to function. We do simple stuff, sell olive oil and feta cheese and lots of tourism services.

It won't take long but we expect our beaches to be overrun with fat often drunk German tourists. And we kind of like it that way. The fatter the better. At we will sell them Retsina. It will be cheap and they might learn to like it. You Germans like to drink, don't you.


So what do I want?

Enough money that I am allowed to run primary deficits. Fairly large ones. 1.5 percent of GDP would be nice but I will settle for 1 percent. And of course you know we are never going to repay it.

I don't care how you do this. You can do it as a direct subsidy, you can do it any way you like. But as we are not going to repay it so at some stage you are going to suck it up. For political purposes you probably want to dress it in some "equalisation scheme" so it is less obvious what you are doing. But that is your problem. You know what I want.

I am off to the hotel to read a little. Just kick back. Sunday night I have a flight booked to Moscow but I might go early. I hear the girls are hot there.

And besides Mr Putin is waiting.


*On a personal level I was truly told that by a Capital One senior staffer.


Alki G said...

Also Vlad will return one of my marbles which was wrongly purchased by a filthy Briton when I was feeling skint. Plus ca change.

Anonymous said...

Putin is waiting with what, rubles to lend?

This whole thing could have been avoided if both the public and private sectors had taken the haircut on the restructuring 3 years ago, but here we are. Double standard i guess though, karma at its finest.

That all said, it's hard not to sympathize with Greece in a veritable depression. A primary surplus has been achieved and if they have made concrete progress on structural reforms, then a restructuring is long overdue. But it's hard not to cede some points to the Troika since retirement ages have apparently not budged and many public sector workers can still retire at age 50.

How would the WaMu bankruptcy be applicable to a strategic default? Do you think it would be a clean financial catharsis without hundreds of lawsuits, years of bank examiners and lawyers combing the books, stakeholder acrimony, etc? I'm skeptical that an entire banking system will emerge clean and then people move on. Just look at Cyprus banking system nearly 2 years on for a guide. Oh, and Russian money there didn't exactly save the day.

John Hempton said...

Mr Putin still has plenty of cash to lend. At the rate it is bleeding out that may not last long. But that is all-the-more reason for Greece to go quick.

And besides - Greece could have a nice business in sanction busting.


Anonymous said...

They could, but does Greece want to incur the wrath of the foreign policy establishment in addition fo the finance establishment of the EU? Seems to me Greece needs more friends not fewer at this point. And I beg to differ about Putin having enough cash when you take into account USD liabilities by kremlin-backed companies, although none of us is in a position to confirm that.

China, on the other hand, could really get themselves a sweet deal with some cash to Greece. Loans backed by shipping lanes, bulk carriers, port facilities. And you don't incur the wrath of Brussels, NATO, and Washington.

Anonymous said...

Let's not forget that Greece is actually in NATO as well. And ironically is one of only 4 of its members to meet the minimum 2% of GDP expenditure on defense...

Anonymous said...

John - I really enjoy reading your posts but I think you're off the mark here.

1. Primary surplus: Greece perhaps was running a primary surplus in 2014. But tax receipts (apparently) fell in the run up to the election (as Syriza said they'd cut taxes..).

2. If there was a full blown banking crisis then the contraction in GDP would definitely wipe out whatever primary surplus there was. It's lazy to say "the Greek economy has contracted a lot - so therefore it won't contract further". One thing that the last few years should have convinced everyone is that banking crises are seriously (and persistently) growth negative.

3. Proposing or passing a law like you suggest would precipitate a bank run, unless a bank holiday was declared instantly. If this was leaked you'd also get a bank run.

4. A banking crisis, precipitated by the Greek insistence not to repay the ECB, would mean Grexit. But we know (thanks to the Wolfson prize) that it would take ~6months to print a new currency for Greece (we know e.g. from the amount of time it took to give South Sudan a new currency). Throughout this time, the Greek banking system would have to remain shut to stop the stampede of depositors. Imagine what six months with no banking system, outside the Euro, would do you your economy? I shudder to think..

obelix said...

Are you guys aware of the amount of other net subsidies that EU sends to Greece? From recollection (have to check the figures) the last time I checked it, the number was something like 3% of Greece's GDP. Logically, EU will start holding those back at the default. The primary surplus is accounting fiction.

It is also the case that EU needs to make an example of Greece if they choose not to pay. Once Greece is out of eurozone and EU, they have many trade policy methods of making it very difficult for Greece.

Sandymount said...

In a one move game, maybe. But if the Greeks get some kind of a deal, it wont be long before all the other nations who were 'bailed out', (i.e. taxpayer forced to make good 100% of creditors claims). Sinn Fein in Ireland must be praying for a Greek bailout, for example.

Frozen in the North said...

I heard that argument last week, again, that the Greeks have no choice but to bend to the will of the ECB. I don't think so. BTW truly enjoyed Spiegel's poll of German -- surprisingly 75% of Germans were against Greek debt forgiveness -- I was surprised it was not more.

There is a real problem with lenders who seem to take the attitude that default is entirely the borrower's fault. After all, no one forced Germany to lend to Greece... the hypocrisy has been "Full on" since 2008, when suddenly lenders bore no responsibility for lending 100% against assets.

Sure the greeks were morons, and from my past experience real A-holes to boot. Its usually the case that the more stupide the Finance minister the more he acts like a good -- let e tell you the Greeks were right up there, real GODs.

It remains that with a budget surplus, an economy that has shrunk by nearly 30% in five years, and a debt burden that has not shrunk by one Euro -- there's a massive problem.

The problem is not the Greeks, its Europe. The sooner they ECB makes-up its mind about how many country they are ready to let loose (Greece, Cyprus and Portugal would be my guess) the easier the whole process will be. In reality these country account for no more than 2% of Europe's GDP -- and it will provide a real measure of sobriety. Plus it will tell the market a lesson it has forgotten: You do something stupid, you bear the consequences!

CrocodileChuck said...

'..a respected credit card company' [COUGH]

"Irony stands mute", Jozef Stalin

mankul said...

Not only Eurozone. Even China has serious problems which appear to be beyond solution.
The Golden Rule- As you sow,so shall you reap is coming back to haunt all and sundry who put countless innocent folks to incredible hardship!

Did China’s President Xi blink first in his move against Alibaba and Jack Ma? — Medium

狂猪 said...

"strategic default" implies

- Alexis Tsipras and party will get fired shortly after because of the resulting calamity. Self-preservation implies this is the least likely option.

- Replace Euro with Drachma is replace austerity pain with inflation pain plus an immediate and massive system shock. Keep in mind that inflation and bank runs impact those with money (i.e. with influence) disproportionately.

My bet is the new Greece Government is bluffing. If Mr. Tsipras goes through with default, while I cannot predict Greece 5 years from now, 12 months from now Greece will be much worse off than today. Mr. Tsipras can hope that Greece will bounce back faster because of this choice. However, he and his party will get kick out of office long before that day arrives.

Gatehouse said...

Good post, just some points I would like to contest:

1. Greece does not have a primary budget surplus. It never really had one, the glorified and often recited surplus was only due to "creative accounting" by Eurostat (who are as reliable and useless as the old Greek statistics). In addition to that Greece also simply delayed paying suppliers, this arrears also helped with the "primary budget surplus".

I find it amazing, how well propaganda (and the "surplus" was propaganda) works. Politicians just have to repeat sth. often enough and it will be believed by most in the end.
Blog from the current Greek finance minister about the 2013 Greek "surplus", calling it a "statistical mirage"!! (He was right)

2. I think Putin has the will to help Greece, but I doubt he has the ability.
The spirit is willing but the flesh is weak
Putin not only has to finance projects in the Russian economy (and keep oligarchs happy) and Crimea, but also his "new friends in Ukraine" and has to also prop up his dictator friends in Belarus, Central Asia and Syria... So even though his reserves are still rather vast, I doubt they are large enough to lend to Greece. (Would Putin expect loan repayment from Greece? Serious question)
With regards to sanction busting ... Turkey/China/rest of Asia have that already covered

However, I agree with your main conclusion: Greece has to default and leave the Euro madness. A return to Drachmas will be painful but necessary and inevitable in the long run.

Anonymous said...

Greek banks defaulting on the ECB is not very interesting in so far as the ECB will then keep all the (non Greek) collateral they hold (as of end of December ECB funding was all repos it seems).

Perhaps it could be interesting after a mass bank run funded by ECB ELA, but then it would mean that most Greeks depositors end up with paper euros or non Greek euro (online) accounts, hence little reason to adopt a new currency.

Anonymous said...

This analysis is so far off! If Greece is out of the Euro the first thing to go is the trade deficit. Who cares about what the government says about the primary budget surplus. If the Greek public servants don't care for retiring a fewer years later in parity with the Germans, just how much will they like their pension in Drachma?

CrocodileChuck said...

John Leontop said...

The Europeans should read Varoufakis`background. He has published a number of pieces on game theory. This will keep him in good stead. I am afraid the pros (Greeks) will be playing the amateurs (the European politicians).

Dan Davies said...

The basic problems are (although John's plan is rather closer to reality than anyone at the Commission would like to admit).

1. The primary surplus is dependent on privatisation receipts (which Syriza want to cancel) and the spending cuts (which Syriza want to reverse). If you come in as the anti-austerity party and then deliver the same budgets as the last guys, you're got a problem.

2. The problem with drachma-isation is that Greece imports fuel and food. The oil price has fallen a lot, but it still needs to be paid for in dollars. Fuel rationing is no joke, particularly in a country like Greece where it will immediately become the subject of massive corruption.

3. Everyone wants a deal. The madman-Putin strategy is dominated by a simple phone call saying

"Come on guys, we all know that a 4.5% primary surplus is dreamland and that this sort of thing is going to keep Europe in recession forever. Programs are made to be renegotiated. Primary balance of zero (implying a total budget in deficit) is much more realistic. We can talk about the long term debt burden in the long term. I know our banks are completely dependent on official funding, but that's a problem to deal with much later too. In return, we promise to stop running round Europe suggesting clownish financial engineering schemes and we'll try to cut down on the cuddling up to dictators".

JP said...

It's amusing how many analysts out there are commenting on how Greece is digging its own grave with this or that tactic, when the way one wins a game of chicken is to dig your own grave, write your will, bid farewell to your family and friends, get in the car, rip out the steering wheel, and throw it at the other guy. (And hope the other guy isn't actually crazy, or doesn't do it first.)

狂猪 said...

According to Eurostat, Greece gdp went from -3.9 to 1 or a positive swing of +4.9! Imagine if this accelerating rate of change is allow to continue. This is looking like a strong sign that Greece is at the beginning of springing back.

However, if Greece leave the Euro now, much of the effort and pain up to now will be for nothing. The subsequent bank run and shock will surely crater 2015 and maybe beyond.

John, are you perhaps ignoring the fact that all the pain up to now are sunk cost for Greece? Do you really think Greece can go back to Drachma and still have a positive growth year for 2015? Also, going the Drachma route means retirees will bear the blunt of the pain. Is that OK?

Alexis Tsipras came to power opportunistically by appealing to the populists. It wouldn't be surprising if the last 2 months have already took significant gdp points off this year's growth. Alexis should be satisfy with harvesting what his predecessors have sow. Going beyond that he is acting extremely reckless and greedy.

Anonymous said...

there certainly are politicians who think this way (argentina comes to mind); other leaders - not necessarily this lot - may spare a thought for the destruction of net worth/impoverishment of their population as a result and the hell it will be for its citizens to live under bankrupt government; some may worry about the fact that few defaulting governments remain in power for long after they have defaulted.

Anonymous said...

Turns out John was 100% spot on... only question is: Why would you prolong the negotiations forever when that causes your beautiful 1% surplus and tax receipts to evaporate... Could have negotiated for 1 week, created a surprise default, set the referendum in motion, before the Greek investement and tax receipts would have tanked...

General disclaimer

The content contained in this blog represents the opinions of Mr. Hempton. Mr. Hempton may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Hempton's recommendations. The commentary in this blog in no way constitutes a solicitation of business or investment advice. In fact, it should not be relied upon in making investment decisions, ever. It is intended solely for the entertainment of the reader, and the author.  In particular this blog is not directed for investment purposes at US Persons.