Two Pounds of Flesh: Another Possible World-view Concerning the Impending Greek Default

Clearly, there has been no shortage of the usual pundits who are all-too-ready to point out how a possible Greek default would necessarily lead to a cascading global crisis of confidence and a possible domino effect, in terms of subsequent defaults by other at-risk European nations.  These predictions may all very well be true in varying degrees of severity, but even with this reality notwithstanding, there has been little dialog on the provenance of several past critical events that have brought Greece into this protracted mess in the first place.

The events of the preceding week, leading to the present memorandum agreement, have surfaced a particularly reptilian approach on the part of the “troika” (the collective term referencing the Commission of the EU, the European Bank, and the IMF) for Greece’s possibly receiving its next much-needed loan.  If one accepts the central thesis statement that the lion’s share of Greece’s contemporary economic difficulties can be traced back to the original nefarious circumstances by which Greece was initially inducted into the Euro-zone, it is perhaps instructive to review the economic reality that was Greece circa 1999-2002, when it was implementing its monetary conversion from the Drachma to the Euro.

To frame the discussion, in George Tsebelis’ recent and most insightful blog entry, he correctly points out that there have been recent failings on both sides (the Greeks’ failure to realize the prior budgetary restructuring goals set with the prior plan and the troika’s failure to incorporate any meaningful strategy for Greece’s economic recovery), with rather, the totality of the immediate discussion centering on bondholders simply being able to extract their maximum pound of flesh, with the revised qualifying conditions.  Tsebelis also correctly points out the issue of “the impossible request” contained in this set of revised assurances;  namely that Greece must “certify” its compliance with the plan in categorical fashion, independent of any possible revised governing will, derived from anticipated national elections.  As this is a terrible mandate that runs counter to the very underpinnings of democratic principles, there yet remains a sizable chance that the tentatively approved bailout package will prove to be a “bridge too far” in terms of its incursion into Greek sovereignty for the Greek populous to accept, with a default still occurring in the not-too-distant future.

So, from the above context of remaining uncertainty, it is germane to bring up an inconvenient truth from the past.  This truth is, specifically, that this latest melee is not the first, but rather, the second pass for the troika (whether it be intentionally or unintentionally) in mortally wounding Greece’s economy.

Turn the clock back to 1999 and we find a Greek economy that was generally consistent in running with a modest annual budgetary deficit, resulting in predicable inflationary dynamics.  However, with Greece being able to control the minting of its own currency at this time, it was able to essentially “self-medicate” in compensation for its recurrent trade deficit.  Moreover, contrary to what was largely extolled by German economists at that time, Greece’s internal economy of both durable goods and consumables was largely met by a diverse internal production capacity for at least 65% of its economy, and it was thus largely able to buffer its domestic goods pricing from external factors.

However, the intrinsic fundamentals of Greece’s economy were quite brittle at this time. Foremost was the reality that an excessive number in the workforce were federal employees, with this reality negatively impacting on the size and exuberance of any possible growth in the private sector.  Additionally, the expected revenue stream from both income and property taxes was far less than it should have been for an economy of Greece’s size, owing to chronic and widespread tax evasion. Together, these factors predisposed Greece to being highly susceptible to any changes in its macroeconomic climate.  Although Greece failed to meet the convergence criteria for entry into the Euro-zone in 1998, the then-recently reelected Pasok party Prime Minister, Costas Simitis, who narrowly won in April 2000, was ultimately successful in re-bidding for Greece’s entry to the Euro-zone in a staged transition between 2001 and January 1, 2002.  It can be seen that with Greece’s initial entry, the “perfect storm” of economic contraction was triggered, although few initially recognized it as such.

The first pound of flesh…

There is no playbook or single text that describes the optimal pathway to valuate and dynamically readjust one nation’s currency during the interesting transition period of adopting an external common currency, such as was the case with the transition from the Drachma to the Euro.  However, the process does have elements that call out to game theory and in this light, both Germany and France clearly had home court advantage.  The initially negotiated exchange rate of 340.75 to 1 was tied to an historically inaccurate conversion rate, with the European Bank being subsequently unmoved by supplemental Pasok party evidence of economic indicators forwarded as evidence of an improper valuation.  Additionally, Germany and France made a number of arguments late in the equitization process that further diminished Greece’s ability to correct the final locked-in conversion rate, with no amount of legerdemain on Simitis’ part in the 11th hour being able to rectify the imbalance.  Within several days (not even weeks) of the currency cross-over, Greeks were quick to point out that the cost of most domestic goods “jumped” inexplicably by 65-80%.   In petitioning the European Central Bank for a review of this anomaly, the Pasok cabinet was met with merely platitudes and obfuscation that this apparent temporal discontinuity in the average Greek’s earning power would soon be rectified by “market forces.”  It is an historic fact that such a rectification never took place.

In the aftermath of Greece’s cross-over to the Euro, the average Greek found their salary significantly diminished in purchasing strength, with this contributing to two run-away processes:  1) increased borrowing and 2) increased involution of the domestic economy, owing to a new reality of cash-starved government and banking sectors.  And of course, with a constricting economy came the usual vicious circle of reduced personal and business income leading to reduced tax revenue, ultimately leading to the government’s reduced capability to pay its disproportionally vast workforce.

Unable to print its own (even inflated) currency, Greece became further strapped in debt, leading to the contemporary reality that it is now unable to meet its dept obligations. This finally brings us to the immediate present.  Now after the troika’s having inflicted a mortal wound to Greece a first time, the blood-letting continues…

The Second Pound…

Now, in making its associated set of revised qualifying conditions for the latest loan, the troika has lost (or chosen to ignore) all institutional memory of the initial conditions that brought Greece to is current unsustainable dept burden in the first place.  Moreover, it’s conditions make no attempt to concurrently provide relief for the exponentially constricting Greek economy, which threatens to further compound the Greek national deficit.  The so-called proposed “haircut” on the balance owed to French and German financial institutional holders, as well as private holders of Greek debt will do precious little to decelerate the involution of what little Greek economy currently remains.

Notwithstanding the above legacy of poor choices on Greece’s part (initially entering the Euro zone, not correcting its flawed tax base and not exiting the Euro zone soon enough), there is still a very glaring provenance of bad-faith actions, on the part of the European Central Bank.  Hence, it is not hard to see a certain elegance in Greece now simply choosing to divorce itself completely from the Euro as quickly as it can and rather, return to a difficult but time-proven strategy of rebuilding its economy from the inside.  Yes, other economies may falter as a result of such a decision on Greece’s part.  But to be very clear, Greece doesn’t own this nearly as much as does the Central European Bank, that was perfectly willing to see Greece suffer in the aftermath of its falling to usurious practices.  Greece is unambiguously the victim here;  perhaps a most financially-unsophisticated victim of sorts, but a victim nonetheless.  Given that the default is essentially now a fait accompli,  the real economic discussion should center on cogent strategies that Greece can adopt to re-start its economy, from the inside out, in the most expeditious fashion possible.

Greece: Playing against the clock. Authored by George Tsebelis.

This is a critical time for Greek debt negotiations, and, regrettably, communication between the Greek government and the “troika” (the combination of the Commission of the EU, the European Bank, and the IMF) is out-of-sync. There are obvious reasons. The track record is negative (the first bailout failed, thereby necessitating a second one), and each side has many things to blame the other for, with neutral observers seeing both sides. It is true that the memorandum was focused mainly on financial issues of debt repayment and not on economic recovery of Greece to enable it to service the debt in the long run. It is also true that the Greek side fails to meet the goals set by the plans.

At this juncture, distributing blame is neither useful nor will it generate any consensus. Rather, we must focus on the future, in order to avoid a collapse of the negotiations, a disorderly default, and the world wide consequences (which despite claims that they will be less significant than two years ago) will be felt throughout the EU as well as in the US, China, and obviously the rest of the world.

The two negotiating parties have reached the following stage: On February 12 the Greek Parliament by a 2/3 vote accepted the new memorandum agreement. The meeting of the Financial ministers of European countries was planned for February 14, and it was replaced by a video call and postponed until February 20. In the conference call, issues regarding the lack of confidence in the Greek commitment were raised, and assurances about post-election Greek compliance to the agreement were sought.

The requirement of “post-election compliance assurance” is a terrible idea that by itself has the potential to derail immediately the entire package and send Greece into disorderly bankruptcy, and the EU and the world into a financial tailspin. Here is why: First, the request is impossible to satisfy in ANY democracy. Second, Greece is now in a much better state politically to fulfill its obligations than it was a week ago, or for that matter, since 2009.

1. The impossible request. The reason that we have elections in democracies is so that the people will decide the composition of their ruling bodies (Parliaments, or Congresses and Presidents). All parties accept the fundamental uncertainty of the electoral process, and all incumbents promise that they will accept their replacement if the people chose to decide this way. One can ask people to postpone an election, but not to cancel it. And one can certainly not ask people to guarantee what will happen after the election.

Let me use an example from recent EU history to make this point clearer to the people who request assurances. When the Greek Prime Minister George Papandreou unilaterally announced a referendum for the approval of the agreement between Greece and the Troika, the leaders of EU countries (particularly Merkel and Sarkozy) were outraged: One day they thought that they had a firm agreement while the next they discovered they had only a chance of an agreement. (Actually, the probabilities in their eyes were very low, because they knew from the French and Dutch referendums on EU institutions (which derailed for years the process of EU integration) that referendums do not get answered on the basis of the question asked but on the basis of the identity of the questioner.) All observers sided with their analysis, the referendum was aborted and Mr. Papandreou had to resign.

Now the roles have been reversed. The same people who objected to the Greek referendum want to proceed to make outcomes conditional on electoral results. The most likely outcome of such a process would be the polar opposite of what they actually want: the elections would give a majority to anti-EU parties; the bailout will not be signed, and Greece will go into disorderly bankruptcy.

2. The current political landscape. The Parliamentary meeting of February 12 produced a monumental change in the Greek political landscape. The main political axis of division is no longer Left-Right ; rather, it is the long-time latent euro-drachma divide (or what we can alternatively call the modern vs. old Greece divide or the pro-anti memorandum divide. Right now, three quarters of Greeks say they want to remain in the Euro despite the very onerous implications of this choice on their welfare.

The re-alignement of the political system to shift from traditional left-right divisions to the central question of the Greek alignement with the EU (which is in agreement with the will of the people) had not happened during the PASOK government. The party of New Democracy had a significant component (including its own leader) with the populist right and was opposed to the memorandum. This is what the EU has wanted for years during the previous phase of the crisis. Even PASOK had a strong component of “deep PASOK” which was supporting Mr Papanderou but was against reform.

The vote of February 12 transformed the situation, and forced the leaders of the two parties to dismiss those members who voted “no” not only from the parliament but from the parties themselves. Some of these members say that they had not realized that they would be dismissed for voting “no”, others that they will participate in the forthcoming election with new anti-memorandum parties. Be that as it may, the Greek electoral law gives a significant bonus to the first party (of the order of 50 out of 300 seats). This bonus was sufficient in the past to create single party governments, but right now, it is unlikely. New Democracy will be the first party (according to all polls) but its own percentage will be so low that a second party will be required for a government coalition. With the anti-memorandum elements (or most of them) gone, the only viable government coalition is New Democracy and PASOK. Indeed, if the first receives 25% of the vote and the second some 15%, they can then form a government with around 155 (out of 300) seats. Significantly, the political game and the pressure from the EU has produced impressive political results. But untimely continuing pressure from the EU side may well reverse them!

Time is of essence. The Greeks understand this. Indeed, they forced a Parliamentary vote on a Sunday before the Euro group Finance ministers meeting. All of us have seen videos of Athens burning on Sunday night during the voting procedure. These acts were committed by a very small group of people, with hoods who systematically went from one salient place to the next. Yet, immense forces of police were surrounding the Parliament and did not move. Why? Because they were afraid that the real goal was to attack the Parliament and postpone the vote, which under the circumstances would have led Greece to miss the EU deadline.

The window of opportunity for Greece, for the EU, and for their partners (US) and creditors (China) will close if, on Monday, Eurogroup meeting decisions are made conditional on the outcome of Greek elections. Athens burned but the vote was salvaged. The major parties split and a new party system is emerging with a coalition between them in support of the memorandum. Doesn’t this show commitment?

No more cathedrals in the (Italian) desert

Amid the latest (irrelevant) round of downgrades by Moodys (see my previous post) and the excitement (or lack thereof) for the Republican primary season, a little piece of news seems to have gone unnoticed in the U.S. media, yet it is worthy of attention: Italy’s technocratic prime minister, Prof. Mario Monti, today decided that Italy (and Rome) will NOT put forward a candidacy to host the summer Olympic games in 2020.

This decision is good news, news that the vast majority of Italians wholeheartedly approve, news that signals a considerable shift in the mindset of the Italian public administration toward public money and the public good.

Some background may help. Over the last year, local and national politicians, as well as sports bureaucrats, vociferously proposed Rome’s candidacy to the 2020 Summer Olympics, undeterred by the negative business and financial climate and the woes of the Italian government. Interestingly, because of a series of circumstances (including a less than exciting field of competitors), Rome’s candidacy appeared to have a good shot at succeeding.

This candidacy had the unsurprising support of (nearly) all of the Italian political parties, from left to right. What marvellous opportunity for political patronage, they must have thought! After setting up a Rome 2020 committee (at the cost of $1.6 million a year for Rome’s City Hall) and collecting approvals from sports figures and corporate sponsors, the Olympics machine passed each obstacle toward the goal line. Last step, the necessary signature of the Italian government, for the CIO (the International Olympics Committee) requires national governments to provide written insurance that financial obligations will be fulfilled and cost overruns will be paid for were it to assign the event to the candidate city.

In the past, this approval would have been a sure thing. Italy has most recently hosted the FIFA World Cup in 1990 (a financial and logistical failure), the 2006 Winter Olympics (a great event but a financial failure nevertheless), and the 2009 Swimming World Championships (on which the italian courts are still laboring). Yet, once again the Monti government displayed the pragmatism and enlightening transparency that has earned it the praise of most. The government cabinet examined the finances of the most recent Olympic events around the world. What did it discover? All of them ended up costing way more than promised, making it nearly certain that the government would have to step in later to the rescue. For instance, this summer’s Olympic games in London overran their initial budget by nearly 100%; the Olympics in Athens in 2004 are likely to have accelerated Greece’s dramatic path toward insolvency; and the list goes on and on. As importantly, it found that most of the facilities built for these events end up accumulating dust and rust while being un-(or under-)utilized, at further cost for the taxpayers.

Thus, Monti said NO, an unequivocal NO, a mature NO, lucidly explained to the approving citizenry of Italy. Basically Monti said that he refused to burden Italy’s future generations (including its future politicians) with this massive expense. How refreshingly mature! If ratings agencies were doing their job, rather than recycling old information in their ratings, they would have waited for this decision before pronouncing their latest verdicts.

Amid crisis in Greece Maastricht Treaty turns 20

euro

Amid crisis in Greece that brought about days of social unrest and paralyzed Athens, the European Union celebrated 20th anniversary of the Maastricht Treaty last week. The Maastricht Treaty enabled the creation of the euro and was designed to ensure that member states follow a common baseline: price stability, sound public finances, sustainable public finances, durability of convergence and exchange rate stability. It instituted convergence criteria: low inflation, low long-term interest rates, government deficit not above 3% of GDP, and accumulated public debt not above 60% of GDP.  Many believe that if Eurozone countries implemented the Maastricht criteria in the first place the current financial crisis could have been avoided. The EU is now preparing for a new treaty to ensure tighter fiscal cooperation. Two countries out of 27 member states, UK and the Czech Republic, will not sign the treaty.

Two rules for understanding economic debate

1. No matter how open-minded or critical the commentator, opinions will mostly be predicted by the passport that commentator carries. If the Financial Times and New York Times often seem to be publishing in alternate worlds, what hope is there that the FAZ and Le Monde and La Vanguardia, let alone bar talk and genuinely popular media, will be communicating the same agenda? Globalization is overstated.

2. Everything you think about who is up and who is down was wrong eighteen months ago and will be wrong again. Germany’s unemployment rate is dropping- but so is its GDP growth. Does anybody really think we will be listening to, lectures from the German government in mid-2013?

EU and Danish Ambassadors to US to visit Michigan

On January 20, Mario Monti’s government adopted a deregulation plan for the Italian economy designed to remove obstacles for growth. Italy is the eight-largest economy in the world and country that many are keeping an eye on in 2012, as the debt crisis in Europe deepens. In the referendum on January 22, the Croatians voted to join the European Union. Croatia is expected to become a member of the EU on July 1, 2013. European Union finance ministers are meeting in Brussels this week to discuss restructuring of Greece’s debt and find compromise on the Eurozone bailout fund, the European Stability Mechanism (ESM), ahead of the EU Summit on January 30. The Center for European Studies at the University of Michigan will host a mini summit on January 26, as it welcomes European Union Ambassador to the United States João Vale de Almeida and Danish Ambassador to the United States Peter Taksøe-Jensen. Denmark assumed the six-month rotating Presidency of the Council of the European Union on January 1, and its goals include a more responsible, dynamic, greener, and safer Europe. Ambassadors Vale de Almeida and Taksøe-Jensen will discuss the current crisis, institutional questions, presidency priorities, and the green sustainability agenda.

Farewell to Vincenzo Consolo

Vincenzo Consolo, a great writer and a passionate chronicler of his native Sicily, has died at age 78. Leoluca Orlando – ex-mayor of Palermo; he visited UM in 2009 to talk about his own struggles against the mafia – wrote: “The death of Vincenzo Consolo is a major loss for the culture, the literature, and the conscience of Italy. His book The Smile of the Unknown Sailor is a true masterpiece, in continuity with the paintings of Antonello da Messina and with the theatrical writings of Luigi Pirandello: all profoundly Sicilian, all authentically universal. Vincenzo Consolo has been, for so many of us, an almost-transcendent point of reference, like a spiritual father, a priest, a lay pastor. He leaves, for our nation’s historical record, a number of splendid books and the witness of a man of intransigent ethical focus.”

Consolo was representative of a generation of writers who walked the tightrope between regionalism and universal values. It remains to be seen – in a new era of federalism without a true sense of confederation – whether the writers of the new millennium will follow their path. The universal values, though debated, remain; will writers of the next generation recognize the importance of linguistic and geographical distinction, and maintain the strong sense of place as the rosette at the center of the moral compass, that informed the fiction and poetry of regional writers like Consolo?