Wednesday, 28 January 2015

Greece is not the problem. The whole system is!

I am angry that Malta has built credit exposure versus Greece both bilaterally as well as through the EFSF and ESM not because I do not feel that somehow over-indebted Greece has to be bailed out in order to save the Euro, but because this burden should have been carried by the 11 original Euro area members that allowed Greece to join without having the proper credentials to do so.

I am angry because Malta's exposure did not go to save Greece, so much so that Greece is still in the soup with 175% debt to GDP which by all measures is unsustainable.  It went to save Greece's creditors  mostly banks from countries that were the beneficiaries of Greece's largess when its corrupt politicians went on unsustainable spending spree to line up the pockets of the oligarchs that sustained their political careers.

Malta joined the Euro in 2008 when Greece had been a member for 7 years.   We benefited absolutely nothing from Greece's largess.   The original Euro area members had 7 years selling the Mercedes, BMW's, Champagne, Chocolate and military equipment funded by Greece's growing debt which we were forced to co-finance.  Slovakia opted out of the bilateral financing to Greece and should have we.   Ireland, Portugal and the Baltic states, who joined after the EFSF was set up, have been given exemption from guaranteeing Greece's debt commitments through the EFSF.

What has been done cannot be undone and now we have to look forward.

Nobody should be surprised by the Syriza electoral victory with a mandate to renegotiate Greece's debt.   With unemployment at 26%, youth unemployment at 50%, GDP down 26% from the pre-crisis level and overall consumer spending down some 40% ( given that Greece was running a Balance of Payments deficit of 15% before the crisis but their Balance of Payments is now in surplus) Syriza had the only credible redemption plan i.e. that Greece cannot redeem its economy by further debt but by negotiating a substantial debt write-off with their creditors,   The false assumption that the Greeks will agree to run a large fiscal surplus for a generation to back pay money that creditor governments used to rescue their private lenders from their folly is a big delusion.

Yet Europe cannot afford to give Greece what it needs.   If such bilateral EU/Greece agreement were to be reached that would give a big boost to Eurosceptics in Spain France and Italy so that rather than solving a problem they would be creating bigger ones.

So Greece is not the problem.  It would be wrong for Europe to consider this problem strictly in terms of the blue and white horizontal striped flag.   The problem is the whole system and only a total holistic approach can deliver a sustainable long term solution.

Europe has two choices.     The easiest and the most politically convenient would be to call Syriza's bluff, refuse to negotiate anything substantial and use the debtors' prison approach to defy the democratic will of the Greek electorate and possible force Greece out the Eurozone where it will unavoidably default on its debt.   This will be very expensive to the creditor nations as they would in any case have to write off their debt or accept repayment in worthless Drachmas.  It would however send a strong signal to voters in France, Spain and Italy to be careful whom to vote for lest they finish in Greece's company out of the Euro.

This choice is also risky as it would defy the concept that the Euro is forever and will of itself create instability which could make the Euro dissolution a self-fulfilling prophecy.

The other choice is politically very difficult for the creditor nations but unavoidable if they mean to continue to enjoy the great benefits they are earnings from the Euro through the external competitiveness compared to what this what have been if they still had their Marks, Florins, Schillings or Francs.

Here the solution cannot be Greek focused.  It has to encompass all debtor nations whose debt to GDP exceeds 110%  ( as agreed by the eurozone ministers in 2012).    All this debt needs to be transferred to the EMS who will refund cost to the holders and the EMS will convert this debt into  notes bearing no interest but participating on a contingent basis on the GDP performance of debtor nation beyond the Euro average and with capital repayment spread over 50 years with a large front loaded moratorium.

How will the EMS finance this?    In part at least by including the principle that Euroarea countries who run a Balance of Payments surplus, so benefiting from the competitiveness generated by the Euro system, have to make defined contributions into the ESM fund for potential losses on their contingent exposure.

Obviously the debtor nations have to do their part too.  Any suggestion by Syriza that they go back to their old ways of hiring unnecessary employees into government service is a non-starter.   Debtor nations have to commit to run a moderate primary surplus by delivering their economy efficient by taking internal measures i.e. fight corruption, collect taxes as due, create the right environment for private investment and remove bureaucratic waste.

Greece and debtor nations need to do this for their own sake and not for the sake of their creditors.

Sunday, 25 January 2015

The seeds of austerity reap a democratic whirlwind

A panel displaying exit poll results in Athens on 25 January, 2015.

Preliminary results from the elections in Greece indicate an landslide victory for Syriza who will be able to form a majority government without need to form any coalitions.

I had given persistent warnings that extreme austerity imposed on an economy in deep recession will eventually give demagogues who promise easy solutions to complex problems an unquestionable democratic mandate.

Tsipras is as yet an unknown Prime Ministerial quantity and it is bad to pre-judge him.   But Tsipras can only deliver what he promised if he forces onto Europe a programme of debt forgiveness or a rescheduling of Europe's credits to Greece which leads to the same effect of halving the  175% debt to  GDP load.

This will put creditor countries like Malta between a rock and a hard place.  If Tsipras fails to honour commitments already undertaken in the bailout programmes and Greece will be forced to exit the Euro, Greece will inevitably default on its debts.   If Tsipras succeeds to renegotiate better terms for Greece on its debt,  the creditors including Malta will incur a financial loss on their loan exposure to Greece.

Which brings me to the question I had asked in an article on this blog in November 2011.   Why has Malta agreed to participate in the Greece loan bailout when this load should have been carried by the members that had let Greece into the Euro in the first place?

2011/11/28 maltas-cross-efsf

Slovakia managed to stay out of it.   The Baltic countries that joined the Euro recently have not been obliged to carry their share of Greek credit.   So why had Malta agreed to take the risk of carrying Greece credit?.

I wish Syriza well.  Greece needs new leadership and I pray that Tsipras plays his cards well to stay in the Euro on terms which will truly permit the Greek economy to grow and shed off its unsustainable debt burden.    But the solidarity which Greece needs and deserves should be footed by those who were beneficiaries of Greece's misdemeanour's in the first place.

Time lags and hedges

Unable to find anything to criticise about Malta's economic performance the PN has launched its flavour of the month criticism based on fuel pump prices which have not yet reflected the sharp drop in the price of crude oil that has been registered internationally over the last 6 months.

This criticism is unfair and unprofessional, for these reasons:

  1. Fuel prices at the pump only follow the crude oil price movements with a time lag even in the absence of any hedging.  Crude oil needs refining and the cost of refining does not go down simply because the price of crude oil has gone down.  On the contrary the cost of refining oil could well go up if the price drop of crude leads to higher consumption and refining bottlenecks. 
  2. The cost of crude oil and the cost of refining are two important but not exclusive ingredients regarding the prices of fuel at the pump.   Energy and energy services are priced in USD and the rate of exchange between the EUR and the USD has dropped 16.5% from the 1.34 as at 1st August 2014 and last Friday's 1.12
  3. Hedging is generally undertaken in order to give stability to prices at the pump.   Stability permits better planning and is more conducive to consumption and investment.    Government has committed since last budget to keep fuel prices stable until March 2015.  Obviously to give such a commitment government has hedged the price at which it procures its supplies. Hedging is not meant to speculate for making a profit/loss but is meant to provide stability.  This stability comes at a cost that when prices fall hedged prices would be higher than spot prices.
Should we stop hedging because for once price movements worked against us?   No absolutely not.   Hedging is important for stability.   And we should be happy that energy prices have dropped as this price drop will be reflected in the prices we hedge for the future.

So criticism that government is cheating anybody by keeping fuel prices steady is unfair and unprofessional.   Nobody has 20/20 advance vision and being wise after the event is a sport any donkey can practice.

Government is not in the business of speculating price movements in energy or foreign exchange.  It is in the business of getting the best deals in the context of stability.  And for this hedging remains an important tool even if for some short period of time it may prove uneconomic.

Crude oil price and EUR USD rate of Exchange since Aug 2014

Look at the price chart of crude oil and USD/EUR exchange rate since 1st August 2014 to date by clicking the above link..

Anybody who can prove that they anticipated that crude oil will drop 53% in 6 months and that the EUR will fall 16% against the dollar has a right to criticise the government hedging policy.  All the rest would be making donkey's wisdom of being wise after the event.

Wednesday, 21 January 2015

Quotable quotes

There are some quotable quotes in the today's Financial Times .

Alexis Tsipras, who will probably be the next Greece Prime Minister after next weekend's election says (in an Opinion piece titled 'Greece can balance its books without killing democracy'):

"Balancing the government's budget does not automatically require austerity.  A Syriza government will respect Greece's obligation, as a eurozone member, to maintain a balanced budget and will commit to quantitative targets.   However it is a fundamental matter of democracy that a newly elected government decides on its own how to achieve those goals."
"Austerity is not part of the European treaties; democracy and the principle of popular sovereignty are" 
"Our manifesto contains a set of fiscally balanced short term measures to mitigate the humanitarian crisis, restart the economy and get people back to work.  Unlike previous governments we will address factors within Greece........we will stand up to the tax-evading economic oligarchy" 

Martin Wolf in an opinion titled 'Bolder steps from Europe's central bankers' 
  "It seems that QE will be implemented (by the ECB) in the teeth of opposition.......from the German political establishment.   This raises questions about the sincerity of the latter's commitment to ECB independence"
"QE is going to horrify the burghers of Germany, but it must now happen..... everything is fine in Germany, but Germany is not the eurozone" 

And on the front page report there is is :

"To appease QE's German opponents, which includes the chancellor Angela Merkel herself,  Mr Draghi is expected to say that bonds bought will remain with the national central banks, so losses will not be spread among eurozone members. 
In Italy the finance ministry and the central bank have warned against watering down QE. " it's good the ECB is buying government debt but it would be a defeat for Draghi and a win for Merkel if the purchases were delegated to the central banks of each state" 
This potentially breaks the EU rules. It is as if it's accepted that the euro area's modus operandi is to clear things with Germany, and for the ECB to constrain its actions to what is best for Germany"

Monday, 19 January 2015

Germany accepts QE but takes away its bite

Rumours have it that whilst the two German members on the ECB governing council will be voting against QE at next Thursday ECB Council meeting, the rest will vote for it provided the bite of proper QE is removed by insisting that the national central banks will remain responsible for buying their sovereign government debt.  There will be no risk sharing whatsoever.

It would also appear that Chancellor Merkel has given her nod to such QE without bite as it addresses her concern that German taxpayers would become responsible through risk sharing for defaults on sovereign debt by other Euro countries.

In the circumstances a defective QE may be better than no QE but it is a pity that national interest is over-riding the risk of collective deflation.

The moral of the story is that surplus countries are quite willing to share the benefits of the Euro but not the risks.    There is complete asymmetry which is unsustainable.

If benefits and risks are not
symmetrically shared
the roof can fall on
everybody's head
The benefits that surplus countries are getting from their Euro membership were brought to the fore last week when the Swiss National Bank had to abandon their peg to the Euro and had to let their currency float upwards by some 20%.

This implies  that Germany and other surplus countries are enjoying a 20% boost to their competitiveness through the Euro.

There can be no benefits without costs.  If surplus countries keep insisting on enjoying the benefits without sharing the risks, they can bring the roof down on everybody's head.

Thursday, 15 January 2015

The true meaning of the revaluation of the Swiss Franc

This morning the Swiss Central Bank threw in the towel.  
It said it could no longer maintain and defend the floor of CHF1.20 for 1 EUR.  In spite of charging negative interest rates, capital continued to flow into the Swiss Franc forcing the Central Bank to accumulate an undesirable level of foreign currency reserves as it sold the Swiss Franc to defend the floor.  This would set up the Bank for huge losses on exchange when eventually market forces had to be respected and the Swiss Franc allowed to revalue.

So this morning we have seen the Swiss franc swing from 1.20 to the Euro down to 0.74 to the Euro and then finding some stability at just above par around 1.03 at the time of writing.

Even at this level it means a revaluation of 15% overnight.    What does this mean?

Switzerland, Germany, Austria and the Netherlands are economies that are deeply integrated.   Suddenly Switzerland, which is out of the Euro, had to revalue their currency and lose 15% instantly in their export competitiveness.   Why the same does not apply to Germany, Austria and Netherlands?   Simply because these are in the Euro and investors do not want to buy the Euro as it is weakened by the state of play in other Euro countries in the periphery like Greece, Italy, Spain and Portugal.

Which means the Germany Austria and Netherlands are making a feast out of the misery of Italy Spain and Portugal.  They are avoiding the pain, that Switzerland has been forced to face, through a free ride on the back of Euro countries in distress.

The Swiss lesson today is that reality can be delayed but cannot be avoided.   Similarly the Euro will at some stage have to face reality i.e. that convergence of competitiveness among the various member countries cannot be achieved through austerity on the deficit countries and feasting of the surplus countries.   Ultimately the Euro area will have to break into two distinct  Hard Euro and Soft Euro areas and then gradually arrange a re-docking into one Euro Version 2 under new terms and conditions which will include substantial integration at fiscal and debt levels.

When?   When the alternative would be seeing the whole Euro structure blow up either through market forces ( like the Swiss experience) or through political turmoil following election of poltical demagogues who promise easy solutions that do not exist.

How can one justify that a two super-competitive economies like Switzerland and Germany share so different fortunes with their rate of exchange? The Swiss Franc hardening and the Euro falling!!!   This is artificial to the point of being laughable; and artificial things do not last.

Monday, 12 January 2015

To QE or not to QE

That is the question the ECB will have to address during its forthcoming policy meeting on the 22nd January 2015.

The arguments for QE ( Quantitative  Easing  - a pseudo technical term for creating fiat money out of thin air to compensate for the fall in the velocity of circulation of money) are:

  1. Everybody is using QE and it has given good results in USA and UK and it also seems to be working in Japan.
  2. The Euro area is too close a zero inflation and very far from the ECB target of close but below 2%.
  3. ECB has exhausted its conventional monetary tools especially with interest rates at near zero and negative interest rate on liquidity parked by banks with the Central Bank.
The arguments against QE:

  1. In the context of Euro area where there are 19 national governments and 19 Treasuries QE is difficult to implement effectively as there is no single Euro area bonds to represent all Euro area governments.
  2. In the absence of such Euro bonds, about which there is no political agreement, the ECB would have to buy sovereign bonds to implement QE in ratios which reflect the shareholding spread of member countries meaning that QE for the ECB would not be the clinical tool it needs to be.
  3. As a result of 2. the ECB would have to buy bonds of core Euro countries where there is no need for QE and will not be buying enough sovereign bonds of periphery countries where there is huge need for QE intervention.
My opinion is that QE will prove largely ineffective in a Euro area context.   The ECB rather than QE should be looking to purchase on a large scale basis of bonds issued at very preferential rates and terms by pan-European financial institutions like the European Investment Bank ( EIB) and the European Stability Mechanism (ESM).    These are pan-European institutions which would not involve the ECB in forced buying of German sovereign bonds when this is totally unnecessary.

Furthermore the bonds issued by the EIB and ESM could be applied to effective uses to revamp the European economy.   EIB would invest these funds into the newly (yet to be) set-up under the Juncker Plan European Fund for Strategic Investment (EFSI).   The ESM would invest these funds to recapitalise through low coupon preference shares European Banks that need additional capital in order to honour the more rigorous CRD IV capital requirements regime but at the same can still provide an effective mechanism for channelling credit to where it is mostly needed ( European SME's who depend on a regular flow of bank credit) in accordance with monetary policy decisions taken by the ECB.   This will remove the blockage in the transmission mechanism of monetary policy which is denying SME's the opportunity to benefit from low interest rate credit as intended under the ECB's monetary stance.

So the question should not be whether or not to QE but whether or not to do something bigger and more effective.

Friday, 2 January 2015

Preparing for the Greemany high stakes game of chicken

Before the answers the questions:

  1. Why did the Greek PM Samaras bring forward to December 2014 the parliamentary vote for the appointment of the President, when it was pretty obvious that the chosen candidate will not get the minimum 60% approval required to avoid the calling of instant elections?
  2. Why did the Troika (EU/ECB/IMF) postpone to end February 2015 the payment of the last instalment of the bailout package which was due for payment by end 2014?
  3. Why are the Germans, if not the German Bundesbank, finally relenting on Quantitative Easing (QE) by the ECB, basically agreeing to the ECB buying sovereign bonds of Euro Area countries, which they formerly were strongly opposing?
  4. Why are yields on 10 year government bonds going up for Greece but coming down for Spain Italy and Portugal clearly showing that market panic is very much a Greece issue?
Sell the priceless Pantheon to save Greece?
The answer to these questions suggest that a high stakes game of chicken will soon be played between Greece and Germany and that Greece have a very weak hand to play.

Syriza has been leading the polls in Greece.   Syriza has pledged that if elected it will demand and obtain a renegotiation of the bailout terms agreed with the Troika.  Whilst Syriza leader has abandoned his pledge to “tear up” the bailout agreement with international creditors and is instead emphasising more moderate steps to address the debt load as well as his deep commitment to the Euro, it is very unlikely that a new government led by Syriza after the election of January 25th, 2015 will find much sympathy from the EU.   His demands for reversing several austerity measures involving fresh fiscal deficits at the same time as demanding substantial debt write-offs which this time will have to be carried by other Governments ( including Malta) and European Institutions like the ECB, are unlikely to be taken seriously.

It is for this reason that the last payment of the bailout package has been postponed till after the elections.   It is for this reason that the Greek President vote was brought forward.   The message to the Greek electorate is clear.  If you elect a government with a mandate to renegotiate the bailout terms and to veer off the austerity road to regaining competitiveness, than you would be voting for Grexit ( Greece exit from the Euro) and all its economic and social consequences.

It is for this reason that Germany is now warming up to QE by the ECB. QE would be a firewall against the risk of contagion onto Italy, Spain and Portugal if Greece overplays its hand and is forced to exit the Euro after defaulting on its bail out obligations and commitments.   It is for this reason that the market is already treating Greece as a story on its own without risks for other countries in bailout programmes or in excessive deficit control procedures.

The EU (basically read Germany) now feels confident enough to take the Grexit challenge of Syriza.  In so doing it would be sending a signal to electorates in other countries like Spain Italy and France where EU sceptic parties are gaining popularity and are promoting populist cessation dreams that there exist easy solutions if they leave the Euro.

I think in so far as Greece goes this is quite fair.   They elected leaders that bankrupted the country and they already benefited from  big sovereign debt write-off in 2012.   They cannot expect an eternal bailout without bringing their fiscal house in order, especially if they decide to abort the austerity restructuring just when it is starting to show some tentative green shoots.

But Germany should understand that Italy Spain and Portugal are not Greece and they deserve all the help they can get to invest in economic growth not just austerity.   QE will help but it is not enough.   What is needed is for Germany to use their fiscal space to stimulate domestic consumption and for the ECB to be allowed to monetise substantial infrastructural investment needed in Europe to stop this never ending recession.

In Malta we have been insulated from the harsh restructuring pain that Italy, Spain and Portugal had to go through to make up for their past excesses.   We may not be sensitive enough to the risks of any of these economies being hit by the Greemany game of chicken that will soon be played out.