The news that some sort of bailout plan for Greece is in the works is bad, for the Europan Union, the euro and not least for European citizens. The decision, if carried through, would mark the end of the euro, and probably of the European Union as we know it.
It all looks very kind, and it has worked before, sortof. Countries have been saved from the humiliation of bankruptcy by the International Monetary Fund, and now the European Union is contemplating creating a similar "European Monetary Fund" to finance similar bailouts of countries that cannot live up to their debt obligations. This is going to fail, utterly. The question is: How bad will it be?
Saving Greece
The situation in Greece is an acute problem. Bankers and politicians are trying to talk it down, but the facts on the ground are hard:
Greece needs to renew a significant (€ 20 billion) amount of debt that mature in April, May 2010.
That is done by selling off sovereign bonds (bonds issued by a nation, not a corporation) on auctions, where the highest bidder for each lots determines the effective rates this debt will carry. If bidders are reluctant, interest rates will be high relative to the amount of money taken in. Thus, Greece needs friends to talk up its position ahead of the auctions. This is precisely what happens:
Prime Minister of Luxembourg, Jean-Claude Juncker, states that Greek support is likely to be bilateral loans.
Hold on to that for one minute: 'Bilateral' means country-to-country, for the obvious reason that banks are no longer willing to take on more risk in Greece. Clear enough: If Greece is too risky for commercial lending, the friends in other states will be willing to help out. This, unfortunately, creates more problems than it solves:
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It's not their own money. Banks, investment funds etc. are risking money that are either their own or that of their clients. Politicians use money of the taxpayers, which cannot be withdrawn.
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The countries have no money. All major eurozone countries are deep in debt already, and sinking. There is nothing they can lend to Greece, except by taking on more debt themselves.
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Moral hazard will be created by any bailout. While not directly measureable, other countries like Italy and Spain will relax, increasing the risk that further bailout will be needed.
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It insults productive citizens. While Germans are used to being blasted for working hard and creating value, using their surplus to bail out the lazier Greeks is an insult to productive behaviour.
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This is extreme risk. Governments worldwide blasted commercial banks for excessive risk-taking leading to the 2008 crisis. How can it be that governments are now willing to take risks that banks refuse to touch?
Money-printing in spades
(Readers not interested in technicalities could skip this section)
Issues (2) and (5) above are related. There is one common reason that governments can lend money without having saved any, and that they are able to take on even more risk than they blame the commercial banks for taking: Money-printing at the ECB. It was pointed out by a few years ago that the ECB through its 'unconventional' measures simply prints money:
The ECB is effectively the money market now," said Dario Perkins, senior European economist at ABN Amro in London. "Banks can get as much money as they need from the ECB so that in itself isn't the problem. In theory it can do that as long as necessary.
Further, while the ECB thoughens collateral requirements for other banks, it slackens those for itself. Since the ECB issues money itself, that translates into: "Dear member states: Don't bother borrowing second-hand money from elsewhere, get them freshly printed from us."
The mechanism is simple: If a state has a credit rating by international agencies in the 'A' range, the ECB will provide loans with sovereign bonds from that state as collateral, effectively monetizing government debt. This has been tried before, like in Weimar Germany (full book), usually leading to disasterous results. The idea of depositing bonds as 'collateral' in the central banks indicates a willingness to later pay back the money 'borrowed', thus eliminating it from the markets at some later point in time. That, unfortuantely, doesn't happen too often.
The ECB doesn't make risk assessments itself. It relies on rating agencies, and if those agencies approve the creditworthiness of a particular country, ECB monetizes its debt, no questions asked. Since the money from ECB is printed, not earned, there is theoretically no limit to this, and Greece has richly taken advantage of the opportunity, for instance to make a pension age of 55 possible.
Now Greece is in trouble due to reckless borrowing, and in a free markets, investors would flee. Greece is the vanguard of reckless borrowing, but other eurozone countries are not far behind, making for a cumulative debt burden at around 88 % of the eurozone GDP. That's a lot of money, and no plan for repayment is in sight.
This causes a steady growth in the euro money supply. The core money supply (M1) of euro is rising at roughly 12 percent on an annual basis (data can be found at ECB). The wider money supply (M3) is stagnant, which fits with the fact that consumer prices are stable at the moment. The significantly higher M1 growth sets the state for inflation to hit us in the future.
The total amount of government debt in the eurozone is € 5,418 billion as of January, 2010. This has been growing at the rate of € 30 billion a month.
What I have not been able to find a direct source for is the crucial question: How much of this is monetized by the ECB?. The data is out there somewhere, and Anatole Kaletsky in his classic article How the ECB's fig leaf has completely withered away quotes figures of $ 1.5 trillion, roughly € 1.000 billion, but provides no direct source for his data. He says of the situation:
In effect, therefore, the ECB has been lending money by the shed-load to governments, with commercial banks acting merely as a fig leaf for what would otherwise be seen as a blatant monetisation of the most insolvent European countries' public debt.
An exercise for the reader:
Finding hard data on how much government debt the ECB holds. This is a sincere request. An answer will be most appreciated.
Back to Greece
Technicalities aside, what happens right now is that Greece needs a solution, and needs it fast. It is rather unclear what the eurozone governments have in store for Greece, split between the desire to help their friends in Athens and the unwillingness of their own citizens to pay for it. A typical quote from Jean-Claude Juncker in EUobserver:
"What will happen if necessary, and we're still convinced it won't be necessary, is that we'll reach an agreement in the eurozone to offer bilateral support in a co-ordinated form," he told journalists late on Monday evening, adding that the Greek authorities have not yet asked for financial support.
Clear statements are not the habit of these people. What he says here will be heard by more than one audience:
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The Greek government and public, strongly desiring a hard promise of a rescue.
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Investors, who will look for signs that determine the risk of Greek debt.
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Ordinary citizens, who widely resist sending money to Greece when they themselves have trouble making ends meet.
These objectives are mutually contradictory, thus the mealy-mouthed statement. Further unclarity:
The group's wariness in providing greater details or definitively signing off on a bail-out mechanism is symptomatic of domestic constraints and concerns over sending the wrong message to financial markets, say observers.
'Domestic constraints' is an euphemism for several problems, the most significant being that governments have no money to lend, and that taxpayers are not in a mood to pay for fixing Greek problems.
All told, Greece is stuck between a rock and a hard place. It has no clear plan for paying back its debt - none at all - only to cut deficits to a still hefty 8 percent of GDP. Strikes and riots have been rampant in Greece, there is little chance that the government will tighten up more than absolutely necessary. While the EUROGENDFOR could in priciple be deployed against rioters, that would effectively turn the European Union into a police state. That seems an unlikely development, a greater money supply is more likely. Thus:
Enter the EMF
A proposed solution to the Greek problem, as well as to funding future bailouts of bankrupt states, is the EMF. German Finance Minister Wolfgang Schäuble says that details will be revealed 'soon', and that it will be as powerful as the IMF.
Where would that power come from?
Now, such organisations are usually not planned in ways open to the public. Details are scarce, for knowledge of such details could be profitable to investors and 'speculators', who look for market signs in order to make the best of their money, a trade frequently frowned upon by politicians.
One idea is that it would take our gold, as the German goverment is said to have suggested. By having solid assets taken from the national banks of the participating states, it would have a solid grounding for its bailout business and would not need to resort to the SDR money-printing tactics of the IMF. The German Central Bank, however, resists having its 3,407 tonnes of gold used for this purpose. As the bank ('Buba') in principle is independent from the German government, this could turn into an interesting power struggle.
A common notion is that an EMF should stop the Greek fires spreading, which implicitly lays the whole of the blame on Greece, as if the crisis was some sort of disease that can either be contained in Greece or run amok elsewhere. This is of course not the case - the Greek problems are caused by Greek deficits, problems in other countries are caused by their own deficits, not by the Greek mess.
The negotiations regarding an EMF are clandestine by necessity. If they were open to public scrutiny before an agreement is reached, economists and journalists would analyze each proposal and point out how every single funding model possible would somehow harm hard-working, productive people and companies. Such debates would kill of the idea in its infancy, a risk that EU leaders do not want to take. The EMF probably will be created, and the funding model will likely be inflationary, as this is the most diffuse way to bring about the means needed for its operation.
Now, when introducing the common European currency was planned during the Maastricht Treaty process, a clear promise (not least to the Germans) was: "No bailouts!". That is actually written into the treaty, and any acute bailout of Greece would have to dodge that rule. That is probably a main reason that 'bilateral, coordinate' solutions are found. If this was done formally as a common action, citizens might bring a court case for treaty violations, which would be unpleasent for the EU. Dodging the rules through bilateralism is much more workable.
On a similar note, creation of an EMF would require changes to the Maastrict Treaty, and since an EMF would aquire some of the sovereignty usually held by the member states, at least an Irish referendum would be needed, and possibly several others, like in Denmark. That is another source of fear for the EU leaders, and the mere prospect of this just might kill off the EMF in its infancy.
"Trust us, we know what we're doing"
What noone taking part in these negotiations seem to understand, is that any bailout of Greece would lead to the full and irrecoverable demise of the euro. The cause would be simple: Death by moral hazard.
Any bailout would save Greece the humiliating agony of a real bankruptcy, which would indeed have dire consequences, not least for Greek pensioners as well as for all public services. Greece could be forced to become a minimalist state in a very short time, unruly and messy, with lots of suffering to follow.
But that might not be the worst of options. Noone wants these problems for the Greek, they have brought it upon themselves by means of extravagant spending for years, aggravated by the dubious methods Greece applied
Doing so would constitute a clear statement, and not only to Greece. Italy, Spain, Portugal and others would take heed, and with the example of Greece in hand be in a much better position to rein in public deficits. Which they will have to do eventually anyway, for no economy can live with endless deficits and ever-mounting debts.
On the other hand, bailing out Greece and continuing the ECB policy of printing money to lend, would set European leaders in a position where they cannot deny future requests for help, as doing so would trigger a reaction in the tone of: "But you helped Greece! What are you guys, racists or what??"
The endgame for the euro
This mess will likely end with the demise of the euro, in an avalance of uncontrollable inflation. Before that, we will see more emergency measures, more bailouts, and more business failures. Rampant unemployment, rapidly rising government debt, as well as extensive riots. If the European Union and the ECB wants to save the euro as the strong currency it was supposed to be, this is the last chance:
Don't help the undeserving Greeks!
As it stands now, however, it looks like our inept politicians will rather save their Greek friends than save the euro.
