Greek Citizens Vote “No” on a Bailout Offer that no Longer Exists
An exercise in futility has just ended in Greece, with its population voting down an offer that has expired almost a week ago already. Given the futility of the referendum, its outcome was actually irrelevant from a formal perspective – once the verdict was in, Greece and its creditors would be exactly back where they were half a year ago already: at square one.
In one sense the referendum’s outcome was of course not futile: It has solidified the current Greek political leadership’s grip on power. It merely hasn’t brought it any closer to a solution. Greek voters want Greece to retain the euro, but they cannot vote on how much money governments (or rather, taxpayers) of other countries should hand to Greece or under what conditions. They can also not vote on whether the ECB should resume lending to technically insolvent banks.
Cartoon by Ilias Makri
There are of course powerful reasons why the EU is indeed interested in implementing another can-kicking agreement. For instance, as Carl Weinberg has pointed out in Barron’s, a Greek default is a very costly affair, as what were hitherto contingent liabilities will have to be reflected in government budgets:
“Greece is on the verge of defaulting on 490 billion euros ($540 billion) in loans, bond obligations, central-bank liquidity assistance, and interbank balances. Who will bear those losses? Greece’s creditors, which are all public entities across the euro zone, and that are on the hook for some €335 billion in loan guarantees. How will those losses be covered? Bonds will have to be sold that will roughly equal the increase in annual debt purchases by the European Central Bank announced last January.
Consider the ESM, Greece’s biggest creditor. Under its previous name, the European Financial Stability Facility, it loaned Greece €145 billion. If Greece defaults, the ESM, a Luxembourg corporation owned by the 19 European Monetary Union governments, will have to declare loans to Greece as nonperforming within 120 days. Accounting rules and regulators insist that financial institutions write off nonperforming assets in full, charging losses against reserves and hitting capital.
Here’s the rub: The ESM has no loan-loss contingency reserves. Its only assets—other than loans to Greece—are loans to Ireland and Portugal. Its liabilities are triple A-rated bonds sold to the public. How do you get a triple-A rating on a bond backed entirely by loans to junk-rated sovereign borrowers? Well, the governments guarantee the bonds, and because they are unfunded off-balance-sheet liabilities, they aren’t counted in their debt burdens—unless borrowers default.
If Greece defaults hard, governments will be on the hook for €145 billion in guarantees on those loans to the ESM. We expect credit-rating agencies to insist that these unfunded guarantees be funded. After all, unfunded guarantees are worthless guarantees.
A hard default would produce other losses to be covered. The ECB would have to be recapitalized after it writes off the €89 billion it has loaned the Greek banks to keep them liquid. The ECB would need to call for a capital contribution from its shareholders—the governments.
And don’t forget that Greek banks owe the Target2 bank clearinghouse, a key link in the interbank payment system, an estimated €100 billion. The governments are on the hook to make good that shortfall, too. The cash required to cover these contingencies would have to be funded with new bond sales.”
This in short are the major reasons why the euro-group is undoubtedly prepared to bend over backwards to keep Greece aboard. Naturally there are other reasons as well, such as the fact that a Grexit would disprove the alleged “irreversibility of the euro”. The IMF seems to want to approach things differently though, as it has no doubt become extremely wary of ever having agreed to take part in the bailout. Evidently, it wants to improve its chances of getting paid back.
In the week before the referendum, it published a paper on the sustainability of Greece’s debt (pdf) that came to the conclusion that all previous calculations were no longer applicable in the face of the Greek economy’s downturn this year. Ironically, the paper seems to have strengthened Syriza’s hand in the referendum, but perhaps that is what the IMF wanted. While the paper publicly declared what everybody knew already (namely that the debt can’t be paid back, and yet another aid program will be necessary to keep the charade going), one point it makes seems to have been overlooked.
The IMF points out that significant concessions by the euro-group are necessary to make a new aid program at least theoretically viable, but also notes that if agreements regarding Greek budget surpluses are loosened or certain reform measures are not imposed, these concessions will have to be even greater. If Greece applies to the ESM for a new bailout program (this appears to be the plan), the European Commission and the ECB must certify the recipient’s debt sustainability before any new aid can be granted.
Not only that, the lenders and Greece would have to come to an agreement before Greece has to repay bonds held by the ECB on July 20. Before a new agreement can result in funds being made available, national parliaments in the EU have to approve the new package. There are less than two weeks to do all of this, as it is hard to see how the ECB can keep maintaining ELA funding even at the current level if Greece defaults on its debt to the central bank as well. Greek savers and depositors who have left their money at the banks may well end up deprived of a significant percentage of their deposit money.
Greek two year government note yields decline in early trading on Monday (!), via investing.com
As noted above, the incentives to do something are great – after all, the EU would still have to at least provide emergency aid if the Greek banking system were to become entirely insolvent. Since the lenders need parliamentary approval, their leeway is limited though. Admittedly, we have no idea what they will end up doing; possibly they will decide on implementing another stop-gap measure, while leaving Greece weighed down with capital controls so as to put further pressure on the Greek government.
A boat in stormy seas …
Cartoon by Martin Rowson
The Canary in the Coal Mine
Frankly, we are a bit tired of writing about the seemingly never-ending Greek drama. However, Greece is an important test case in many ways, and can be seen as a kind of canary in the coal mine. Mises was of the opinion that while it might be legitimate to issue short term government debt in an emergency, long term government debt was alien to a market economy. He also noted that:
“The financial history of the last century shows a steady increase in the amount of public indebtedness. Nobody believes that the states will eternally drag the burden of these interest payments. It is obvious that sooner or later all these debts will be liquidated in some way or other, but certainly not by payment of interest and principal according to the terms of the contract. A host of sophisticated writers are already busy elaborating the moral palliation for the day of final settlement.”
As we can all see, these days massive attempts to simply inflate all sorts of debt away are underway (in the process expropriating savers). This is done under the cover of “economic necessity”, but we should call a spade a spade. When central banks like the Fed, the BoJ and the ECB create billions from thin air every month to buy up government debt, they are ultimately attempting to inflate debt away.
The debt-financed welfare/warfare state system is coming to an end. Greece’s inefficient and corrupt bureaucracy and political class and its insane economic policies have merely brought about its downfall somewhat earlier. We should however expect that most governments of industrialized nations will be able to “muddle through” for a very long time, at least as long as some extent of net wealth creation is still taking place in the economy.
Consider that it took even the Bolsheviks seven decades to consume the last crumb of previously accumulated capital before they folded – and they had to make do with a stunted, very rudimentary system of economic calculation, based on prices they were able to observe in the surrounding market economies (without that possibility, their economy would have imploded much faster). The “middle of the road” system should survive a lot longer, but its problems should become more and more obvious as time passes.
There are two possibilities when the end game arrives, and it is unknowable which one governments will eventually opt for: outright default (which would have deflationary consequences), or default via inflating the currency into oblivion. Prior to that they may try to implement more blunt wealth confiscation schemes than the ones currently in train, such as grabbing 10% of all private savings overnight (as the IMF has proposed in a paper last year, see: Is a Large Wealth grab on its Way? for details).
The crappen has been released …
Cartoon by Nate Beeler
We all are creditors to the banking system and to governments , whether or not we have bought government bonds outright. Every bank depositor is de facto a creditor of banks, who in turn are major creditors to governments. Through their share in pension funds and investment funds, most people are creditors to governments as well (many are so unwittingly). In other words, debt haircuts and government defaults, regardless of which shape they take, will redound on a large part of society in some way. When the time comes, government creditors will lose the bulk of their claims. Historical experience unfortunately indicates that even such catastrophes routinely fail to invite systemic reform.
It becomes ever more difficult to fund the basic promises of welfare states in light of demographic effects and economies severely impaired by a succession of boom-bust cycles of ever greater amplitude. Generational conflict is a certainty, as fewer people are enjoined to pay for a rising number of dependents and at the same time, a shrinking population also means that the economy’s knowledge base contracts. The more people there are who are focused on discovering market imbalances and putting them to profitable use, the more the economy’s inherent “information deficits” decline to the benefit of all. In short, ever larger costs must be funded, while the economy’s ability to create wealth (that can be partly confiscated by taxation to fund welfare state promises) is under attack from many sides at once.
The demographic problem illustrated – via 9gag.com
The Greek problem remains unresolved – the referendum couldn’t resolve it, although it may have influenced the ultimate outcome. However, Greece’s situation is a good reminder. Neither banks nor welfare state government can keep up the pretense of solvency without the backstop provided by the printing press. As long as there is wealth that can be redirected this seemingly works, but there is a limit to this. The events surrounding Greece are in this sense also a strong reminder that faith in central banks and their power remains the central issue for financial markets.
Just as we finished writing this, it was reported that Greek finance minister Yanis Varoufakis has resigned, apparently because he doesn’t want to jeopardize further negotiations with his presence:
“In a statement Varoufakis said: “Soon after the announcement of the referendum results, I was made aware of a certain preference by some Eurogroup participants, and assorted ‘partners’, for my … ‘absence’ from its meetings; an idea that the Prime Minister judged to be potentially helpful to him in reaching an agreement. For this reason I am leaving the Ministry of Finance today.”
Slide show of Yanis Varoufakis’ career as Greece’s finance minister
Cartoon by Marian Kamenski
You may have noticed that our so-called “semiannual” funding drive, which started sometime in the summer if memory serves, has seamlessly segued into the winter. In fact, the year is almost over! We assure you this is not merely evidence of our chutzpa; rather, it is indicative of the fact that ad income still needs to be supplemented in order to support upkeep of the site. Naturally, the traditional benefits that can be spontaneously triggered by donations to this site remain operative regardless of the season - ranging from a boost to general well-being/happiness (inter alia featuring improved sleep & appetite), children including you in their songs, up to the likely allotment of privileges in the afterlife, etc., etc., but the Christmas season is probably an especially propitious time to cross our palms with silver. A special thank you to all readers who have already chipped in, your generosity is greatly appreciated. Regardless of that, we are honored by everybody's readership and hope we have managed to add a little value to your life.
Bitcoin address: 1DRkVzUmkGaz9xAP81us86zzxh5VMEhNke
One Response to “Greek Exercise in Futility”
Most read in the last 20 days:
- Speculative Blow-Offs in Stock Markets – Part 1
Defying Expectations Why is the stock market seemingly so utterly oblivious to the potential dangers and in some respects quite obvious fundamental problems the global economy faces? Why in particular does this happen at a time when valuations are already extremely stretched? Questions along these lines are raised increasingly often by our correspondents lately. One could be smug about it and say “it's all technical”, but there is more to it than that. It may not be rocket science, but...
- Speculative Blow-Offs in Stock Markets – Part 2
Blow-Off Pattern Recognition As noted in Part 1, historically, blow-patterns in stock markets share many characteristics. One of them is a shifting monetary backdrop, which becomes more hostile just as prices begin to rise at an accelerated pace, the other is the psychological backdrop to the move, which entails growing pressure on the remaining skeptics and helps investors to rationalize their exposure to overvalued markets. In addition to this, the chart patterns of stock indexes...
- India: Still the Fastest Growing Large Economy?
India’s Currency Ban - Part X It has now been four months since Narendra Modi declared about 86% of monetary value of currency illegal. Linked here is the last in my series of updates, which was written soon after the deadline to deposit the demonetized currency. Most of the banned currency was eventually deposited, making a mockery of Modi, who had claimed that unaccounted money would not reach the banks. Perhaps 3% of the cash never reached the banks. A cunning plan...
- Gold Sector: Positioning and Sentiment
A Case of Botched Timing, But... When last we wrote about the gold sector in mid February, we discussed historical patterns in the HUI following breaches of its 200-day moving average from below. Given that we expected such a breach to occur relatively soon, the post turned out to be rather ill-timed. Luckily we always advise readers that we are not exactly Nostradamus (occasionally our timing is a bit better). Below is a chart of the HUI Index depicting the action since the January...
- They're Worried You Might Buy Bitcoin or Gold - Precious Metals Supply and Demand
Bitcoin Mania The price of gold has been rising, but perhaps not enough to suit the hot money. Meanwhile, the price of Bitcoin has shot up even faster. From $412, one year ago, to $1290 on Friday, it has gained over 200% (and, unlike gold, we can say that Bitcoin went up — it’s a speculative asset that goes up and down with no particular limit). Bitcoins are a lot less tangible than this picture implies, but they are getting a lot of love recently...
- Welcome to Totalitarian America, President Trump!
Trump vs. the Deep State If there had been any doubt that the land of the free and home of the brave is now a totalitarian society, the revelations that its Chief Executive Officer has been spied upon while campaigning for that office and during his brief tenure as president should now be allayed. Image adapted from the cover of “Deep State #5” - depicting an assassin from the future President Trump joins the very crowded list of opponents of the American...
- The Long Run Economics of Debt Based Stimulus
Onward vs. Upward Something both unwanted and unexpected has tormented western economies in the 21st century. Gross domestic product (GDP) has moderated onward while government debt has spiked upward. Orthodox economists continue to be flummoxed by what has transpired. What happened to the miracle? The Keynesian wet dream of an unfettered fiat debt money system has been realized, and debt has been duly expanded at every opportunity. Although the fat lady has so far only...
- Boosting Stock Market Returns With A Simple Trick
Systematic Trading Based on Statistics Trading methods based on statistics represent an unusual approach for many investors. Evaluation of a security's fundamental merits is not of concern, even though it can of course be done additionally. Rather, the only important criterion consists of typical price patterns determined by statistical examination of past trends. Fundamental considerations such as the valuation of stocks are not really relevant to the statistics-based trading...
- Searching for Truth
Heresy or Truth? RANCHO SANTANA, NICARAGUA – In the fifth century, Christian scholars counted 88 different heresies. Arianism. Eutychianism. Nestorianism. If there was a way to “offend” God, they had a name for it. One group of “heretics” argued that there was no such thing as “original sin.” Another denied the trinity. And another claimed Jesus was not divine. Which one had the truth? Depiction of the first Council of Ephesus in 431 AD, convened by Emperor...
- Why the 21st Century Sucks - Turtles All the Way Down
A Truly Sucky Century BALTIMORE – What an awful century! Worst we’ve ever seen. Household incomes are down. Employment is down, with 7 million people in the U.S. of working age without jobs. Productivity growth is down. GDP growth is down – to only about 0.5% per capita last year. Even life expectancies are down. Drug overdoses are up. Suicides are up. One out of every eight children lives in a family getting food stamps. One of out every eight adults takes psychoactive drugs...
- Gold and the Fed's Looming Rate Hike in March
Long Term Technical Backdrop Constructive After a challenging Q4 in 2016 in the context of rising bond yields and a stronger US dollar, gold seems to be getting its shine back in Q1. The technical picture is beginning to look a little more constructive and the “reflation trade”, spurred on further by expectations of higher infrastructure spending and tax cuts in the US, has thus far also benefited gold. From a technical perspective, there are indications that the low at $1045.40,...
- India: The next Pakistan?
India’s Rapid Degradation This is Part XI of a series of articles (the most recent of which is linked here) in which I have provided regular updates on what started as the demonetization of 86% of India's currency. The story of demonetization and the ensuing developments were merely a vehicle for me to explore Indian institutions, culture and society. The Modimobile is making the rounds amid a flower shower. [PT] Photo credit: PTI Photo Tribal cultures face...