YOU TRIPPIN? NOTES ON GREECE'S HOUSEHOLD CONSUMPTION DATA

Ever wondered what the fastest growing category of consumption is in post-crisis Greece?

Well it's the same one as in pre-crisis Greece. Drugs. Reports of 'sisa' scything through the streets of Athens, booming HIV infection rates among injecting users and the setting up of Greece's first supervised consumption room back in November may have given observers the impression that drugs are confined to the fringes of Greek society.

The fact, however, is that the formal household sector is chasing highs too, and has been for years. Only in three out of the last eleven years have Greek households failed to clock up a double-digit increase in the use of 'narcotics' as defined here, with the total amount spent in 2011 equal to roughly EUR1.2bn (or EUR110 per person) in 2010 prices.

What you can see from the graph to the right, however, is that consumption growth was in freefall pre-crisis, and the trend has reversed since, despite (or possibly because of) falling incomes.

The figures, however, are confusing in several ways. For one, Greece appears to be better at collecting data on narcotics-related spending than any other country in the EU. You can see for yourselves - most countries are unable to publish figures, and those that do, publish unrealistically low figures anyway. Going by Eurostat's figures, Greece alone accounts for half of the EU's drugs consumption. Frankly, that is impossible.

On the flip side, Greece's own figures may be inaccurate too. 100 Euros' worth of drugs for every man, woman and child sounds a bit high, particularly so when one realises that regular drug users are in fact quite rare. In Greece, for instance, only about 15% of high school age boys and 7% of girls had ever used any illicit drugs in 2011 (data here). The figures are quite similar for adults, with recent users making up nearly half of all lifetime users (data here). So if, say, about 5% of the population (allowing for under-reporting) are responsible for 90% of the total spend, that means they would each spend about EUR2,000 per year on their habits. It's possible, but it's a big stretch - and in 2011 no less. Remember, these are people upstanding enough to sit through a household consumption questionnaire. A real problem user wouldn't be able to sit through that without a fix of something, I doubt I would either.

The consumption data of course come from Household Budget Surveys (HBS) run by national statistics agencies such as Greece's ELSTAT. Harmonisation and comparability are, unlike with some other datasets, not a huge priority, so it pays to look at the original questionnaire and methodology. In the case of Greece, you can check out the full documentation of the latest survey round (2011) here or a more complete version (with questionnaires) in Greek here. What really stands out to me is that none of the questionnaires actually include any explicit questions on the use of narcotics - which makes sense. But in that case, ELSTAT must literally be relying on respondents to volunteer information about their drug habits, and they must be much more willing to do so than their fellow Europeans.

Time to snoop around a little.

TO BE CONTINUED

NAIVE EXTRAPOLATION REDUX

Some time ago I wrote a rather controversial post demonstrating how far divorced Greek output per capita was from from the country's competitiveness levels. I wanted to demonstrate, among other things, how far Greece had left to fall - the difference between the country we were and the country we'd been allowed to pretend we were.

My rationale was simple - an open economy cannot sustain its standard of living indefinitely if it cannot offer the same risk-adjusted returns to human, physical and financial capital as other similarly developed countries. Both money and people are mobile and eventually they will move to where they are best utilised.

So I devised a simple -too simple- test: let's take the ten economies closest to Greece in terms of competitiveness and check out their average per capita product - to smooth out the noise. It suggested some pretty catastrophic stuff.

In fairness, that was a little too alarmist; not that the controversy was about this. Rather, the controversy revolved around the economics of the post, which are admittedly less than rigorous - I've got nothing but intuition to go by and that's never a good guide.

In any case, I thought I'd run a version of the same exercise now, using data up to 2012 and leaving non-European countries out of the equation. I used per capita GDP figures and forecasts from here and WEF competitiveness scores from here. Because I've restricted this to European countries, instead of averaging out countries of 'similar' competitiveness, I can simply fit a curve to the observations - the result is what you can see below:

This rule-of-thumb calculation suggests that, by the end of 2012, Greece was about half-way to the bottom of the well, which is EUR11,550 - that's another 23% left to fall, bringing us to the same real GDP levels as the Czech Republic.  However, in purchasing power standard terms, the Czechs actually live better than we do. Do the math and you'll find that the 23% reduction should bring real standards of living in Greece right below those of Poland.

What this means, in a simple enough comparison, is this - though the 2012 figures will have been worse.

I call this the worst-case scenario, in the sense that it assumes competitiveness will remain at 2007 levels, reflecting zero reform. This is not entirely accurate - since the WEF's index of competitiveness (and real-world competitiveness too) depends heavily on macro stability, our competitiveness has fallen dramatically lower than 2007 levels.

My assumption here is that once the current crisis abates, the impact of macro instability on competitiveness will be reversed, but this is not necessarily true - we might never return to stability, or we may do so at such a profound cost to the country's human and social capital that the 'crisis effect' will become entrenched. I will try to test this in future posts.

In any case, my 'worst-case scenario' could be improved by reforms - Greece would need to return to the competitiveness levels of Italy or Poland (near the 40-41-mark on the graph) in order to regain the real incomes of 2007. It's not entirely impossible, is it?

THIS! IS! NOT! ARGENTINA! (UPDATE)

The other day, I got an email from Dan Beeton, the International Comms Co-ordinator at the CEPR. As veteran readers will recall, Dan and I have occasionally worked together on debunking the Weisbrot hoax. Dan is a colleague of Mark Weisbrot, so he has an interest in this.

Dan shared with me the latest CEPR paper which draws some compelling comparisons between Greece and Argentina and uses these to make the case against further austerity and in favour of Greece defaulting and leaving the Euro. I’ve promised to help disseminate this paper both on Twitter and on this blog. Not because I agree with it, but because I believe that since a Greek default is desired by a great deal of the population and ultimately inevitable, it is important for its advocates of default to become more rigorous in their argument.  

For the record, as you will know, I’m all for defaulting once we’re running a primary surplus, though I would caution that this will not in itself make Greece’s finances sustainable.

That said, as much as I respect Weisbrot and his colleagues at the CEPR, I’m sick to the back teeth of comparisons between Greece and Argentina. They are just too simple. Argentina was on a foreign currency peg; Greece is in a monetary union, which is like a foreign currency peg. Argentina had an IMF intervention, Greece had an IMF intervention. Argentina defaulted; Greece is expected to default. Hey presto, Greece is Argentina. What worked for one, must surely work for the other. It’s so easy to predict the future when you already know what you want it to look like. So I thought I’d talk you through some of the main ways in which Argentina in 2002 was not like Greece in 2011. I know it won’t convince the defaultniks but at least I’ll get this stuff off my chest. 

First, it’s important to appreciate how big the Argentine budget deficit was when that country defaulted. As I’ve said on this blog ad nauseam, a country with a primary surplus can default anytime – it can still pay its way regardless of what creditors do. A country with a primary deficit has a problem. Argentina’s budget deficit in 2001 was a paltry 3%. At the time, Argentina was paying 3.58% of GDP in interest (same source), so in fact they were running a primary surplus of 0.8%, courtesy of the IMF’s bitter medicine, compared to our projected 2011 primary deficit of 2.3%, which may yet turn out to be much higher, but is only at this non-eye-watering level courtesy of the IMF too. Search the latest CEPR paper for references to Argentina’s primary surplus. Not one. Yeah, I thought so. Even rigorous-minded Keynesians don’t believe deficits matter. You know why? Because cool guys don’t look at explosions.

Similarly, the CEPR paper makes the point that Greece’s exports are much higher as a share of GDP than Argentina’s back when it defaulted, and therefore better placed to drive growth. First, I would point out that Greek exports have grown, by nearly 10% in 2011. Second I need to explain that the share of exports on GDP is not the only thing that determines the sustainability of falling off a currency peg.

In early 2002, Argentina’s current account was nearly balanced, with a deficit of 1.4% of GDP in January. Nearly all gains in competitiveness went into growth. Greece is a different story: we’ve got a current account deficit of over 10% of GDP. Hence, while Argentina was able to grow at the very substantial rate it did using a devaluation of about 65% between 2001 and 2005, it would take a much greater devaluation to replicate this effect in Greece. Remember, even with massive inflation, you can’t devalue by more than 100%, although Keynesians will no doubt find a way (perhaps a tax on holding the national currency?). But even with their ‘modest adjustment’, the Argentines paid dearly for this strategy. You can check here what happened to inflation in the aftermath. It topped 25% in the first year, and was almost 15% the year after that, and has since never recovered to pre-default levels. In fact, Argentina is still blatantly manipulating inflation figures to keep up appearances – so much so that they have to threaten and fine anyone who dares publish more accurate figures (unless they are a union, and then only if they keep their estimates of real inflation for the negotiating table only).

If you are advocating foreign-currency default but don’t know why inflation is bad for a country, I’m tempted to suggest that you deserve to have its massive double-digit slapped across your face. But let me explain nonetheless: inflation means your money is worth less in relative terms and is harder to store, i.e. convert into wealth such as savings or a house. Inflation is a tax on everyone who earns a wage or benefits but has little negotiating power with the government, as well as everyone who saves money in a bank or owns a cash-poor business. It is, on the other hand, a subsidy to anyone whose income comes from investment, anyone who owns gold, anyone who owes money in the national currency, anyone who has the political connections to negotiate higher salaries, and any business able to borrow cheaply.

Think really hard of which of the two sides you’re on and you’ll know whether it’s good for you. Rich people and banks are typically winners from massive inflation. The working poor are typically losers. That’s partly the reason why, despite Argentina’s success in battling income inequality, wealth inequality (as measured by the wealth Gini coefficient) has not only failed to come down, but actually increased since the default, from 74% in 2000 to about 75% in 2010, and is in fact way higher than Greece’s.

That’s one point. On to the second. Whatever the fiscal and current account deficit figures, we need to get one thing clear: the Greek state is much, much bigger than Argentina’s was when it defaulted. More than double in size in fact. Even without paying any interest, the Greek state would still be leeching much more money out of its economy than Argentina’s ever did, either pre- or post- default. Hence the potential for growth post-default would be much smaller without, you guessed it, more austerity! Don’t forget, unlike government investment, government consumption does slow down growth.

I can sense your disbelief at this point. The assumption among most commentators is that anyone who flicks the finger at the IMF must be a socialist who believes in an all-encompassing state. But in fact, by 2001, the last full year before it defaulted, Argentina was spending just 18% of GDP in primary government expenditures. Contrast this to Greece’s projected primary spending of 42.7% of GDP in 2011 (which, again, could turn out to be higher). Remember, I’m using the primary spending figure because clearly in a default(nik) scenario we wouldn’t be paying interest at all.

This comparison, incidentally, tells you a little bit about why Argentina grew so fast post-default.

If Greece were to default and revert to spending, minus interest, what Argentina did as a share of GDP in 2001, just before it defaulted, we’d save 24.7% of GDP and, in my preferred scenario, return it to the taxpayer through tax cuts. And according to the IMF’s calculations, a tax cut of that monumental size would boost the Greek economy’s output by 1.3x24.7%=31.1% within 2 years (or anyway that’s how much an equivalent increase in taxes would shave off our output). Libertarians would of course love this, and provided we could find that extra 2.3% of GDP through some other revenue (such as privatisations) it would actually be possible, but defaultniks would typically hate both small states and privatisations, so I don’t expect them to come out in support of us becoming like Argentina in this regard.

Not that we could do that, either. Too much of our primary spending is locked in. The second major difference, you see, between Greece and Argentina is demographics. Greece has for many years been a much older society than Argentina. In 2002, Argentina’s old-age dependency ratio was a mere 16%, while Greece’s ratio for 2011 is just over 28%. You can check this for yourselves here (select ‘detailed indicators’ on the right).

Now by looking at the correlation of health, survivor, sickness and disability spending with old age spending, it is possible to approximate the total impact of ageing: it adds up to about 17% of GDP per annum (if you don’t like my estimate, try your own using the COFOG government spending data provided by Eurostat). Remember I’m only adding to age-related spending the additional spending on other things attributable to ageing.

Now, if our old-age dependency ratio were the same today as Argentina’s back in 2000, it’s only a matter of simple math (and an assumption of linearity which I admit may be wrong) to deduce that we would be spending 7.1% of GDP less on our aged and see a primary spending figure of 38.1%. Still more than twice what Argentina was spending when it defaulted.  Although that would, in theory, put paid to Greece’s primary deficit, cutting that much off pension and health spending would have disastrous effects on Greek society.  In fact, let’s go balls-deep in the defaultnik scenario and assume that Greece cut all of its toxic public procurement budget as well – no new roads, no new arms spending, no nothing – that would save us 13% of GDP at most. We’d still only get down to 25% of GDP, which is still way higher than what Argentina used to spend when it defaulted.  

Note by the way that Argentina didn’t have to worry about destroying its pension system when it defaulted, because by the time it defaulted it had privatised its pensions system, courtesy of the same hideous reforms that defaultniks hate so much. In an earlier paper, the CEPR credits this with losing Argentina about 1% of GDP in government income annually (presumably, of course that was meant to be the people’s money, not the Government’s, but hey let’s humour them), but they forget to mention that it is precisely this that made it possible for Argentina to default without destroying or confiscating the pensions income of its own citizens.

But in any case, this little exercise suggests that, even if our population was currently as young as Argentina’s when it defaulted, we’d still be in a far worse position to default than they were. But at least we would be able to default.

Remember, ageing is not reversible. Pre-austerity, it used to add a significant 0.46% of GDP to our primary spending per year. At this rate, if we were to balance the 2011 books in one fell swoop, by 2020 we would be running a 4.6% primary deficit once again. Unless we cut pensions and benefits savagely, of course. Which we have, to the towering rage of defaultniks everywhere.

Why is pensions income so important? Well because they are a huge part of the Greek household income. Now there’s no actual calculation available of this, so I’ve had to come up with my own. I can only offer a mix of 2011 and 2010 figures, but that’s a start. Greece’s pensions funds paid out EUR25.6bn on pensions in 2011 (pg. 95 here), against total household consumption of EUR165.8bn in 2010. Household consumption has probably fallen since, so that resulting ratio of 15.4% is definitely an underestimate. So basically, destroying pension funds via default would eat into private consumption in a massive way (it already has). Another big handbrake on growth, I think.


Defaultniks often point out how investment would supposedly soar in a country freed from the burden of debt. but age once again reaches for the handbrake. Without the ability to tap global capital markets, only domestic savings will be left to finance investment and that will not be nearly enough in countries like Greece (discussion here). Savings rates don't typically go up as a country ages; past a certain point they go down: people reach their maximum savings rate at a certain age and then start eating into their savings to pay for the kids' school fees, for healthcare, for whatever have you. Pensioners are, in fact, de facto negative savers. Have a look at the graph below if you don't believe me (source):

If you're feeling really gloomy right now, you've got my gist. The last decade was actually Greece's golden age of age-related saving propensity, if there is such a term. It was the time in our near history when we were most disposed towards saving, and our governments made sure we didn't. Game over.

The difference in household savings rates between 2011 Greece and 2002 Argentina implied by the above graph is about 8% of GDP. That's 8% of GDP less that we Greeks will be able to put into investment, post-default, than Argentina was able to. That's twice our 2010 gross national savings, bottled up for the foreseeable future by the irresistible force of human destiny. It's also more, by the way, than what we're currently paying in interest.

Here’s one final comparator that people often forget, and it’s related to all of the above. 2002 Argentina was way more entrepreneurial than 2010 Greece:  the average Argentine adult is almost three times as likely as the average Greek to be in the process of starting a business as the average Greek adult, even though entrepreneurial activity fell by half post-default: as growth returned, the appetite for enterprise fell quickly. Entrepreneurs are important to growth because they help convert all of that free post-default cash into sustainable wealth. One reason why we’ve got so many fewer of them is, once again, age: it’s easier to take a huge gamble with bankruptcy when you’re 28 (the median age in 2002 Argentina) than when you’re 41 going on 42 (the median age in 2011 Greece), and who would blame you?

The result is that even if Greece could somehow pump all of that money we spend on interest into the economy, it’s doubtful whether it would ever turn into growth of the sort the CEPR and our local defaultniks are hoping for without an exogenous boost to entrepreneurship. Don’t be quick to blame the Euro; Argentina had a currency peg too pre-2002, remember? That’s the whole point. In fact, I think the difference here is largely down to demographics and the size of the state, but it’s harder to prove this, so let’s park it for now.

This is not the end of the long list of differences between 2002 Argentina and 2011 Greece. It’s just all the stuff I could come up with at relatively short notice. But I hope it helps clarify how tenuous and wishful the Greece-Argentina analogies are.


UPDATE: 


Demetri Kofinas, aka @CoveringDelta, has paid me a tremendous compliment by inserting a reference to this analysis on the very successful show he produces on Russia Today - check it out here. Thank you Demetri!

FEAR NOM NOM MORE TEH HEAT OF TEH SUN (UPDATE)

Dear readers, I know I am beyond apologies for the latest radio silence. I can only explain myself by saying that it has, for the last two months, felt pointless to discuss the realities at home. I have little to add to my main narrative and the fog of war lies thick over the day-to-day developments. I’m not convinced there’s any shortage of economists talking crap in the world, so why add to their number.

There are some core themes that cannot be denied. As I’ve been saying for over a year and a half now, Greece will default. I have hoped against hope that we would do so in an orderly fashion, in whatever little time the bailout money could buy us, and emerge a reformed country with an outside chance of growth in the future. It is clear now that this is not going to happen.

Why now? Because we have proof now that the bailout can never meet its three original objectives. Bear with me while I add updates; this is going to be a long post.

===============================

TEH FAIL NO.1: PRIMARY SURPLUS

Whether one wants Greece to default or to start paying down its debt, maintaining a primary surplus is a necessary condition. As I have documented, for the first year under austerity the primary deficit did in fact fall. Then its trajectory reversed sharply. There are several reasons for this.

Topmost is the fact that the Government and the IMF ignored the latter’s own research which points out that the various means of reducing the deficit can be ranked as follows in terms of outcomes for employment and GDP:

cutting benefits > cutting public spending >  increasing direct tax > cutting public investment > increasing indirect taxes.

Ours was a slightly more novel approach. Compare the original plan (Box 3, pg. 11 here) with the plan as of the fourth review (Table 5, pg. 53 here and budget execution bulletins here). If you can’t be bothered, check out my brief summary below. The figures are contributions to the fiscal adjustment in % of GDP, and the 2011 figures are the IMF’s estimates.

Simply put, in the cause of political expediency, our Government delayed cuts to benefits and instead front-loaded the contribution of indirect taxes (remember, the best and worst way to cut the deficit respectively). It then proceeded to more than double the originally intended contribution of the public investment budget, effectively killing whatever recovery might have been possible in the womb. The result was, predictably, a deeper recession than expected, missing the original forecast by 0.6 percentage points in 2010 and by a lot more, possibly 2.5 percentage points, in 2011. Not that anyone can trust the actual figures. And as a result of that the Government missed its target for direct tax revenue by a whopping 2.5% of GDP and its target for indirect tax revenue by 0.9% of GDP, with 2011 accounting for nearly all of the shortfall.

But more than this, it’s important to realize just how ingrained the Greek primary deficit is. In the past decade, it took about 4.8% real growth per annum for Greece to return a balanced primary budget. You heard right. Successive governments built a state that could only. ever. work. in the best case scenario. And they almost got away with it because the combination of EU money, credit expansion and a benign global economy meant that, for a short while, that was the kind of growth we could look forward to. In fact, the real damage seems to have been done from 2003 onwards – when the level of real GDP growth required to balance the primary budget rose to an impossible 7%.

It is, after all, as they say. Once you give up on black, you can’t go back. In case people haven't noticed, the Government's job is to shift the trendline in the graph above upwards so that it crosses the origin - i.e. so that the trend primary balance without growth is zero. 

Realising this at last, the Greek government has given up on taxing income, which has the annoying feature of being dependent on growth. Instead it is now signaling that it going to directly tax wealth. By this I do not mean taxing the wealthy, just taxing people for the privilege of having property.

There is a depraved social aspect to this: as I explain here, the median Greek is relatively income-poor but relatively wealth-rich, and while the income distribution in Greece is very unequal by international standards, the distribution of wealth is not. Our government hopes that with the current set of incentives in place the people will start liquidating wealth in order to pay tax. It’s a very dangerous game to play.

The first instalment of this master plan was the now-notorious property tax, to be collected via one’s electricity bill. It has the advantage of not only taxing wealth but also delegating tax collection to the massively unionised  Public Electricity Company, whose union has predictably announced its intention to sabotage the new tax. Cue overture to the national anthem of WTFistan.

In the same vein, the Government unveiled its now postponed and possibly aborted plan (more emotional coverage here and here) to penalise any declared income that cannot be matched to consumption on the basis of receipts, to what looks like a ratio of at least 50%. The Greek state’s willingness to outsource tax administration to Joe Bloggs is of course not surprising considering how badly they themselves do it. 

===============================

TEH FAIL NO.2: COMPETITIVENESS

The second reason for the bailout was presumably that Greece could, given time, return to a position of international competitiveness which was lost over many years, and increasingly so since the adoption of the Euro.

I cannot stress enough how important this is. The chasm between Greek per capita income (even post-austerity) and the per capita income that can be justified by our competitiveness rankings is massive. According to my much-maligned naive mean reversion model for Greece, Greek per capita income would fall back to developing-country levels if internal devaluation were to be pursued without any further gains in competitiveness.

Benchmarking against 2007 competitiveness rankings, the most likely compromise would be for Greece to target Czech levels of competitiveness and fall to their level of per capita GDP. This would have meant a 13.1% drop in PPP-adjusted per capita GDP (from 2007 levels) against 5.2% experienced so far. In a worse (but not worst) case scenario we would instead converge to Latvia’s per capita GDP, accepting a fall of 39%.

Incidentally, I feel vindicated in promoting this way of thinking about Greece’s internal devaluation: using the quick test I outlined above and data from the latest Global Competitiveness Report by the WEF, the level of per capita income that can be justified by our competitiveness ranking fell by 5.5% in 2010. Very very close to reality.

So if competitiveness is so important, how well are we doing? In summary we’ve fallen another 7 places in the past year, to 90^th out of 142. Check pg 188 here for details, or quickly scan the tables below:

First, the professions have yet to be liberalized. In fact, the government has buckled completely before the might of the legal and engineering professions and is still fighting pathetic skirmishes with taxi drivers.

Second, despite a chorus of increasingly demented voices lamenting the selling-off of ‘the entire country’, privatisation and asset sales are proceeding at a snail’s pace because a) demand is abysmally low and b) the Government is committed to raising an amount of money that is simply impossible in a fire sale.

Third, while the Government made some headway on labour market reform, the IMF was forced to note in its fourth review:

…firm-level collective agreements, introduced in late 2010, would allow for wage reductions below sectoral minima (to the nationally-agreed floor) within the formal bargaining framework, thus overcoming this rigidity, but had been used little to date. (pg. 23)

Finally, public sector reform is becoming an irredeemable mess. Already, as discussed above, the balance of public consumption to public investment has been allowed to slip further towards the former. Never a good idea, as the eggheads have proven time and time and time and time again. Public investment builds capital which drives growth, while public consumption inevitably turns to shit. Literally.

To date, not a single civil servant has actually been laid off, although, in fairness, many on contracts have not had these renewed and many retirees have not been replaced. I still think our public sector is overweight to the tune of about 300,000 people, but this is not to say that laying off 300,000 people will solve the problem. We may well need to hire more of some kinds of civil servant and fire even more of some others; there’s simply no way of knowing because the actual skills needs of the civil service and the broad public sector are unknown. Because no one knows or cares what services the public sector is meant to deliver, the question of how many and what staff it needs sounds too much like advanced management speak.

To give you an example, here is a recent announcement of 65 Scientific Specialist vacancies with the Bank of Greece processed centrally by the Greek Supreme Council for Personnel Selection (more on this here). This is not a technical background note to a more user-friendly vacancy ad, by the way. This is the ad. Note how it never once quotes what the actual staff are meant to be doing. This is what we’re up against.

Hence the problem when the Government recently called on its agencies to provide a list of ‘surplus’ staff to be put on its controversial labour reserve scheme (essentially phasing them out of the public payroll gradually). Everyone responded that they were up to their gills with work and needed to hold on to every mammal with at least one working orifice.

Then there are those who have little time for competitiveness through reform anyway, and who are of course calling for a return to the Drachma, or a currency union with other Euro rejects. I realize many Greeks and indeed many of my readers are sympathetic. I can only point out two things: the following two questions are not equivalent, even though people treat them as such.

Would Greece be better off now had we not joined the Eurozone in 2001?

Would Greece be better off leaving the Eurozone now?

And here’s an even scarier thought.

Devaluation is actually possible even within the Euro and I suspect that future Greek governments (which, post-default, will still be lumbered with the euralbatross) will pursue this. The most likely alternative to having our own currency is what is called ‘social VAT’ – basically reducing employee and employer pension contributions and making up the difference to pension fund receipts with VAT. I don’t like this option, not least because it obliterates any hope of a pensions system that isn’t a Ponzi, but I’ve rarely got what I liked from governments in the past either. In fact it’s actually a pretty mild suggestion compared to this one, which would eliminate employers’ contribution altogether.

This will be the final roll of the dice – and if we do default, obliterating the capital of Greek pension funds, it may well be, along with a swap of bad bonds for slightly less bad bonds, the only option we have for recapitalising them in the short term.

MORE MUSINGS ON THE BAILOUT TO END ALL BAILOUTS

I've promised before to write more about the Grand Bargain for Greece agreed in late July - the latest bailout to end all bailouts. I'm still working on material for a new post but for now, here's one I prepared earlier.

What follows is an article I prepared for ACCA's Financial Services e-newsletter. It is written from a UK perspective but readers may still find it of interest.

Greece – can we look now?

Part I: The Exposure

On 21 July 2011, the leaders of the Eurozone nations announced to what must have felt like the entire world that they had reached a deal on a new rescue package for Greece, one that would reduce the country’s borrowing costs and outstanding debt, ensure its continued liquidity and hopefully set Greece back on the path of fiscal sustainability. They stressed that this is a one-off package, and that other embattled countries could not take it as granted that they would be offered the same.

What does this deal mean for the UK? The place to start answering this question is the exposure of UK banks to Greece. Now people tend to play with words when this question comes up, including in Parliament itself. For a start, it’s important to distinguish between exposure to Greek banks, exposure to Greek sovereign debt and claims on the Greek private sector, and then exposure to the much broader risk of contagion in the case of a Greek default. The good news is that there are definitive figures out there. The bad news is that they are dated and problematic in multiple ways.

Stashed away in the detailed tables of the latest Quarterly Review from the Bank of International Settlements is a detailed, if dated, answer to the question of direct exposure. As of December 2010, the UK banks’ total exposure to Greek public and private debt was $14bn. But less than half of this, around $6bn, was exposure to Greek government debt or Greek banks, where the risk of losses is greatest. Overall, UK banks appear to only carry about 2% of the total Greek exposure of European banks.

  

In fact, UK banks are nowhere to be seen on the list of top financial institutions by exposure to Greece, and what little they hold in terms of Greek bonds tends to be in shorter maturities. This is important because most bonds maturing after 2020 don’t seem to fall under the financing offer for Greece that was agreed by the banks through the Institute of International Finance (IIF) back in July. For what it’s worth, it appears that RBS is the most exposed UK bank, although it’s officially written down half of its £1.4bn worth of Greek bonds already.

This brings me to an important point. For the purposes of accounting profits and losses, the allocation of Greek bonds between the banks’ banking books and their trading books (which alone must be marked to market, leading to recognised losses when bonds lose their value) is crucial. Non-Greek banks typically hold about 31% of their Greek bonds by value to maturity, so most of their exposure is already marked to market – the banks will have recognised significant losses on them already. This is important because bonds bought at a deep discount may appear to be taking a haircut under a buyback scheme (the much-celebrated 21%) while in fact turning a profit for the banks participating in the swap. Coming back to RBS, for instance, the bank would recognise a profit of ca. £275m on this transaction. As a Greek, I feel a little cheated, but as a UK taxpayer... ka-ching!

By the way, if you’re thinking this impairments business might present a headache for auditors, you’re right. Especially given the wide variety of conflicting practices banks are likely to adopt. Further reading for the intrepid auditor here.

Now for the wider question of contagion and what it might mean for UK banks. To be fair, the contagion is already happening, so this is pretty much a moot point. But it’s easy to dismiss this as mere panic, an irrational response. That’s until one realises just how interconnected the European banking system is, and how exposed the UK is, through various different routes, to the contagion seeping out of Greece.

According to the BIS data I cited above, UK banks have a $22.8bn exposure to Irish banks and the Irish sovereign; another $20bn to banks and sovereign debt in Italy; another $6.8bn in Portugal; and a whopping $30.7bn in Spain. And the $80bn this adds up to are just the obvious risks, the black sheep of the European financial family. Given that the European stress tests earlier this year estimated the Core Tier 1 capital of the major UK banks for 2011 at about $300bn even in an adverse scenario, a substantial impairment of assets in the most troubled Eurozone countries would cause significant problems for them although it wouldn’t wipe out their capital. Still, there is no telling where the contagion would stop and indeed which other sovereigns and banks might follow should the PIIGS go.

This is why we must turn to the bigger picture.

Part II: Is the Eurozone insolvent?

Throughout the various stages of the European debt crisis, the argument has been made that, if only the Eurozone could co-ordinate fiscal policy and issue debt collectively, for instance via Eurobonds, it would put an end to all this drama of speculation and contagion – Europe would become a borrowing superpower and no one would ever dream of doubting its creditworthiness.

The idea that a fiscally unified Europe would be undeniably creditworthy is wrong on many levels. Superpower status, fiscal union, and indeed fully-fledged federalism, didn’t stop S&P from downgrading the US to AA+ earlier this summer. Perhaps more importantly, given who buys US debt nowadays, it didn’t stop the Chinese rating agency, Dagong, from downgrading the US to A with a negative outlook. Some might say that these downgrades reflect the mechanics, not the fundamentals, of US debt, and that’s fair enough. But even if Eurozone members can somehow be coerced into fiscal union (and they may well be in the following months) the delays and horse-trading involved in drawing up a collective Budget for the Eurozone will make the debt ceiling negotiations in the US seem like an elegant costume drama ball.

But it is the fundamentals, not the mechanics, of debt that truly worry the markets. In the Eurozone as in the States, policymakers may not want to countenance the thought that the entire bloc might be collectively insolvent. Yet for over a year this question has been preying on commentators’ minds. The IMF even did the math on this in a fascinating report last year that went largely unnoticed. They found that the Eurozone, mighty Germany included, is not, in fact, solvent in the long term. According to the IMF calculations, the only long-term solvent countries in Europe were Hungary and Denmark. Bulgaria and Estonia were also strong candidates, but that was about it. The news for the UK were particularly grim.

Markets also find it hard to think of sovereign nations as being insolvent; much of the world’s financial architecture rests on the assumption that there is a magic circle of ‘decent’ sovereigns that can never default, and this belief has persisted after the 2008-9 crisis despite ample historical evidence to the contrary. The only difference is the ever-retreating boundary of the magic circle, as each embattled sovereign puts pressure not only on those countries that are financially exposed to it, but also any country seen as equally or less ‘decent’. Right now, the magic circle includes very few countries beyond the small group of AAA-rated sovereigns, and the result is a AAA asset bubble that could pop with disastrous consequences.

European policymakers are increasingly testing the surface tension of this bubble. Consider the European Financial Stability Facility (EFSF). Caught up in their own rhetoric of being under attack by evil speculators, Europe’s politicians hailed it as a shield for the Eurozone. But market participants, still smarting from the experiences of 2007 and 2008, quickly identified it as no more than a massive Collateralised Debt Obligation (CDO) and treated it accordingly. The market tested first the junior, then the mezzanine, and finally the senior tranches (see also here and here) of this construct – the guarantees by France and Germany. The very existence of the EFSF prompts the market to do this, much like the very mention of fiscal integration prompts the question of the Eurozone’s collective solvency. This in turn explains the ever-diminishing half-lives of Eurozone initiatives to calm the markets.

Until the markets are convinced that Europe’s finances are sustainable, this drama will continue to play itself out regardless of what schemes are concocted by its leaders, and will claim ever more, ever more conspicuous victims. Long-term sustainability trends can be reversed more quickly than one would think – relatively small changes can add up to a lot over a 50-year horizon. But they do not reverse themselves.

ALL UR BAILOUTZ ARE BELONG TO GREECE!

*** IMPORTANT UPDATES COMING UP. PLEASE CHECK BACK FOR MORE LULZ***

Readers will have noted that I have refused to write anything on Thursday's Summit outcomes and the new Greek bailout. The fact of the matter is that the amount of information in the public domain is pitifully inadequate - and that's not just me saying this. I will try to update this post as new information comes out.

Greek readers can, for now, consider the very competent if politically charged discussion by Techie Chan on this matter. The gist of it, with which I completely agree, is that private creditors have taken far smaller losses than the 21% trumpeted by European leaders, and in fact will in some cases make a reasonable profit from this deal, that Greek debt is still unsustainably high, and that a large transfer of risk has taken place from Europe's banks to the European taxpayer. Stay tuned for my own discussion of this.

I am particularly disturbed by the triumphalism with which some news outlets aligned to the Greek government were reporting on the deal late last week, essentially calling doubters and naysayers out on their sour-faced skeptical remarks. They'd be shouting 'IN YOUR FAAAACE! IIIIN YOUR FACE!' if they could get away with it. Cue of course, a chorus of world-weary defaultniks lamenting the continued loss of sovereignty, decrying Shock Doctrine tactics (Naomi Klein's tedious political version of the Philosopher's Stone, which explains everything under the sun), denouncing the new interest rate as usurious and the like. Let them all talk.

I'd rather focus for now on a topic that fewer commentators are talking about back in Greece and for which the facts are actually out. This is the CDS market - remember the evil specuLOLtors that were supposedly betting on Greece going bust (some of whom were in fact Greek banks themselves)? Well they're pretty fxed now.

You see, the most important implication of Thursday's grand bargain was no outcome of the Summit talks themselves, but the earlier announcement by ISDA that such a deal would not constitute a credit event triggering CDS payouts. By confirming that politicians will use this loophole to its fullest extent, Thursday's announcements mean that CDS are now virtually a non-asset-class: they only ever pay out if Greece sticks two fingers up to our creditors a la #Debtocracy, or if some suit at the IMF forgets to put our welfare check in the mail. Neither of which will ever happen. Some back home may be cheering that CDS spreads are down but that's because the actual value of the CDS as a hedge is down, not because Greek debt is any safer. It's like police procurement chiefs cheering the savings created by the falling price of bulletproof vests, following test results that prove they can't stop bullets.

You may think this is something for teh EVIL specuLOLtors to sort out among themselves, but what it actually means is that Greek bonds are now going to become much more illiquid (and that's saying something considering how illiquid they are now), because investors can't hedge against losses. The same goes for Greek bank stocks: in the past, people might use a Greek bank + CDS combo to replicate a European bank portfolio and skim some of the arbitrage out of the market or use Greek CDS to hedge exposures in the Balkans and Eastern Europe. But worse, far worse, the same goes for other PIIG and European bonds, and their banks. The entire Eurozone's financial system has become less liquid overnight. Surely that can't be a good thing?

UPDATE: only a few hours after I wrote the few lines above, this happened. QED.

*** IMPORTANT UPDATES COMING UP. PLEASE CHECK BACK FOR MORE LULZ***

KILL MEEE... KILL MEEEEE... PART 4

BACKGROUND:

Kill me no. 4 is the sequel to the original 'Kill Me' post available here, which in turn is the sequel the Dog Ate my homework v. 2 post and of course the original 'Dog Ate my Homework' post. All of these posts are reactions to the IMF staff reviews of Greece's standby arrangement and the subsequent letters of intent from the Greek Government. 

Together the two sets of documents could explain how the Greek Government is from Venus and the IMF is from Mars, except of course everyone knows where the Greeks are originally from. 

Anyway dear readers, I know you've been waiting for this so here goes. 


Here are the quickest possible highlights of the Fourth Review by the IMF with only a little play by play from me.

Open discussions of Greece’s financing challenge and euro-zone countries’ insistence on private sector involvement to resolve this have convinced markets that Greece will restructure its debt (pg. 4)

[Translation: The market expects a default.]

The fiscal position has stalled (pg. 6)

[Translation: Current austerity measures aren’t working]

Wholesale funding markets remain closed, and exceptional ECB liquidity support has grown (pg. 5)

Banks’ combined market value of €13 billion falls well-short of their reported Tier I capital of €30 billion (pg. 6).

[Translation: The market says that the stuff regulators say your banks are OK to hold as capital is actually crap. Nice job everyone.]

First quarter 2011 targets were met, with the help of temporary factors (pg. 7)

[Translation: Q1 2011 targets were ONLY met with the help of temporary factors. Your coach is about to turn into a pumpkin]

GDP is now projected to contract by 3¾ instead of 3 percent in 2011 (an outlook broadly in line with that of other forecasters). (pg. 9)

[Translation: Everyone else’s forecasts haven’t changed; we should have listened to them]

Risks remain skewed to the downside in the near term (p.g. 9)

[Translation: You are more likely to miss your targets than meet them for the next few quarters]

The scope for shortfalls in policy implementation or in macroeconomic outcomes is limited […] stress testing shows that full and timely program implementation is absolutely critical: incomplete fiscal adjustment, privatization shortfalls, or delays in structural reform implementation (producing a considerably slower economic recovery and fiscal adjustment) would see debt remain at very high and likely unsustainable levels through 2020 (p.g. 10)

[This point is repeated in various different ways throughout the report. Translation: You mess this up one more time and it’s Good Morning Harare!]

The discussions focused on Greece’s deeper medium-term policy needs and identifying ways to replace the expected market financing that is now likely no longer available (pg. 10)

[Translation: you can’t borrow from the markets anytime soon.]

At the end point, Greece would be targeting a primary surplus in the range of 6½ percent of GDP (pg. 11)

[Translation: The adjustment programme only works if you achieve an impossible primary deficit target]

there is a good motivation to switch the headline program targets to focus on primary balances, namely to insulate the fiscal assessment from the potential variability in interest payments (pg. 11)

[Translation: In addition to the markets we also expect a default, which is why we’re not counting interest payments anymore]

The government has prepared a medium-term fiscal strategy (MTFS), which would […] reduce the size of the Greek state: overall spending would decline from 49.5 in 2010 to 43.1 percent of GDP by 2015 (pg. 12)

[Translation: The nightmarish small state we have in mind for you is the same size as Canada’s.]

All administratively complex programmes are massively back-loaded (this is not verbatim, but see Pg. 13)

[Translation: We’ve given up on administrative reform]

[T]o begin implementing the strategic plan for medium-term reforms, the authorities will begin […] a number of major institutional changes (creating a central directorate for debt collection, a large taxpayers unit, as well closing and merging several uneconomic and inefficient local tax offices). (pg. 14)

[Translation: You don’t have a large taxpayers’ unit or a debt recovery unit? WTF?!]

[T]he system will remain heavily reliant on ECB support […] peak support could top €130 billion. Greek banks cannot by themselves rapidly reduce their existing level of ECB exposure (pg. 16)

The authorities also committed to encourage banks to seek foreign merger partners (pg. 17)

[Translation: Someone has to bail out your banks. We’d rather it was other banks from abroad.]

The BoG […] may appoint a commissioner with managerial powers to run a troubled bank; it may withdraw a bank license and then put the bank into liquidation; and it can impose a moratorium on a bank's claims. However, the Greek legal framework lacks specific bank resolution tools towards lowering the cost of resolving banks. [T]here are no techniques to allow the continuity of banking operations, including sustained depositor access (pg. 18)

Reforms are also needed to ensure that the deposit insurance fund can be used to fund such techniques, and to establish depositor preference over unsecured creditors. (pg. 18)

[Translation: If you default before you fix this shit, your citizens will not be able to get their deposits back.]

[UPDATE: Since people are asking, this doesn't mean people will lose the deposits necessarily, and it could just be a scare tactic. But what it does mean is that in the event of a default, restoring people's access to their deposits will take time and the Greek government will have to negotiate the status of depositors' claims. Unless of course we sort out the legal framework first.]

The supervisor has thus requested that undercapitalized banks meet regulatory requirements or find appropriate merger partners by end-September. (pg. 18)

[Translation: Your banks need to put a fire sale together pronto.]

Still, for the timetable to hold, market demand must exist. This is a significant risk which the authorities can manage by ensuring that foreign investors can participate, and by establishing a track record of even-handed and timely execution of transactions (to demonstrate to bidders they have a real chance to acquire the assets). (pg. 20)

[Translation: Even if you hold a fire sale, who is going to buy this crap? They don’t even trust you to honour your end of the bargain]

firm-level collective agreements, introduced in late 2010, would allow for wage reductions below sectoral minima (to the nationally-agreed floor) within the formal bargaining framework, thus overcoming this rigidity, but had been used little to date. (pg. 23)

[Translation: Businesses aren’t using the one good labour market reform you managed to push through. Someone isn’t playing ball.]

the end-March indicative target on the accumulation of new domestic arrears by the general government was again missed in March. A waiver of applicability is being requested for end-June performance criteria (except concerning external arrears). (pg. 27)

[Translation: you’ve missed your targets but we’ll look the other way.]

A tailored downside scenario exposes additional vulnerabilities. Debt would peak at 186

percent of GDP in 2015 and remain above 178 percent of GDP in 2020, a situation highly unlikely to allow continued market access. (pg. 70)

[Translation: You know how you keep missing targets? Well if you stay on that path you’re on track to owe fuckloads forever.]