My big fat Greek bailout

Greece was bailed out for the second time in four months. Or did it default? Well, a bit of both, I guess.

All bondholders are equal. But some are more equal than others. If you are the ECB, your Greek bonds were exchanged, par for par, for new Greek bonds, and you can go on pretending that they are worth their principal amount. You won’t have to report a loss for now. But if you are a ‘private’ entity – and that is a rather loosely used term these days as it includes the banking industry which is either now partially owned by the state or to a considerable degree dependent on ongoing support from the lender-of-last resort – more than half your Greek investment was wiped out. So Greece defaulted. But as you ‘agreed’ to the ‘haircut’ it was in fact a ‘voluntary restructuring’, although you really had no choice.

Bankruptcy is not nice. Everybody loses. The creditors take a hit as they will have to write off most of what they lent. The borrower takes a hit as he will now be cut off from new credit and will have to live of whatever sources of income the creditors could not lay their hands on. Chances are he will not get a penny of new credit for a while. In that respect Greece is not doing badly at all. Although it just defaulted on €107 billon of private credit, Greece immediately gets another €130 billion taken from taxpayers in other countries. And these new loans plus the ones that were agreed at the time of the last bailout were just made cheaper. They now only cost 2 percent per annum after 3.5 before the restructuring.

So on some level it all looks pretty swell for Greece. It defaulted on its ‘private’ lenders and got more money at lower rates from its official lenders. Only problem is, these official lenders have just made clear that they do not like to agree to haircuts, and they are demanding that Greece gets its fiscal house in order…and REPAY!

ECB, photograph by Florian K

This seems to be the point that gets everyone so excited, and even angry, including many commentators in the media. There is an almighty whinge-fest going on in the press. A distraught Ambrose Evans-Pritchard in the UK’s Daily Telegraph speaks of ‘ever-escalating EU demands’ that condemn Greece to decades of economic depression and oppression. Is all this austerity forced onto Greece not going too far? Are the spending cuts not pushing the economy deeper into recession and will this not aggravate the debt problem? Would Greece not have been better off staying outside the euro? Should it leave the euro? And what happens to Greek democracy?

I guess we shouldn’t lose sight of the fact that Greece’s economic model is fundamentally unsustainable, whichever way you cut it. Greece has been living beyond its means for a long time, and has managed to do so by flying under air-cover of the EMU project and with the tailwind of cheap credit and easy money. Spending by the Greek state accounts for more than half of registered economic activity, and a third of the workforce is employed by the public sector. ‘Activities’ are being subsumed under the heading of ‘Greek GDP’ that nobody would voluntarily pay for, that are to a large degree wasteful, and that are simply unaffordable under anything but the most bizarrely generous credit conditions, i.e. precisely those that Greece enjoyed from 2001 to 2008. Easy money has been used to paper over grave economic imbalances. Some of what is generously labelled ‘GDP’ should be discontinued – and fast.

To even suggest that such an economic model would be manageable if Greece, a country with about three quarters of the population of metropolitan Los Angeles but with less than half of L.A.’s GDP, only had its own paper currency and could inflate and devalue to its heart’s content, is economically illiterate. No country ever prospered by running budget deficits funded by the printing press or by creating domestic inflation. Devaluing your currency may give your exporters a shot in the arm – for about five minutes. But it scares your domestic savers away for years to come and severely diminishes your ability to keep or attract capital, the backbone of any sustainable economic model. To even try and attempt to ‘inflate away’ a debt load worth 160 percent of a generously calculated GDP would cause economic damage of gigantic proportion. One must have swallowed the Keynesian mythology of deficit-spending whole to believe that the country could borrow and print itself out of this mess. A proper default on its existing debt and rebuilding from a lower base – but with a hard currency – are the better options.

The economic commentators in the media seem to only ever see the superficial and short-lived benefits of devaluation. They forget that nobody wants to hold a currency specifically issued for the purpose of debasing it, and that includes the locals. Greek savers are pouring money into gold and London real estate and German banks not only out of understandable concern over the health of Greek banks but also out of fear of devaluation which always means robbing the savers. Leaving the euro now would be complete disaster for Greece, in my view. And even had Greece never entered monetary union and kept its currency, its economic model would have equally been on the way out by now. In any case, adopting an inflationary currency does not make running budget deficits and a bloated state apparatus harmless or even sustainable. It only means the country would add the dislocations from monetary debasement to those it already incurs from a bloated public sector and government directed resource use. (This is not to say that the euro is or will be a hard currency. It is a soft currency and will go the way of all paper currencies. But the frequent suggestions for Greece to exit the euro are obviously founded on the premise that an even weaker currency would be good for the Greeks. This is wrong.)

Photograph by M. Bartosch

That printing your own paper money provides your domestic economic policy with extra degrees of freedom is a dangerous fallacy. It is precisely this fallacy that is at the core of this entire global mess. It seemed to work for a while but even that was largely an illusion. There are no free lunches, and the bill for decades of habitual monetary debasement is being presented now. Everywhere, not just in Greece. Once the overall debt load reaches a certain level and the private market loses faith in the possibility of this debt ever being repaid, the game is up. It is now up for Greece, and it will be soon up for others.

There is no alternative to shrinking the Greek state drastically. It may not be nice for the Greeks to get told so by the Eurocracy – who run equally unsustainable models in their respective home countries, even if they have not been found out by markets yet – but that can change quickly. I guess it would have been better for Greece to default properly, that is fully and on all bonds, rather than only on 53% of what the ‘private’ sector held. That would have meant a lower debt load going forward but also no access to new money, and I think this would have been an less politically charged way of shrinking the Greek state than having the cuts superimposed on the electorate by other countries’ politicians. But maybe not. In any case, I consider it more likely that the present measures are not far-reaching enough.

That the coming shrinkage of the Greek state – and it will happen, one way or another – will cause hardship to many ordinary Greeks, nobody can deny. But what are the realistic alternatives and who is to blame? I see no alternatives and as to the blame, this falls squarely on the modern social democratic welfare state, a model that is now collapsing everywhere around us under the weight of its own economic absurdity. Large sections of Western society have for decades been lulled into accepting as a fact of modern life that the state would always look after them, that politicians could offer them secure employment, high and rising living standards, secure pensions and top-notch yet affordable health-care – all delivered by an ever-expanding state bureaucracy funded through rising taxes on productive activity, cheap money from the fiat money central banks and ever more debt. The final bill was supposed to be deferred forever. This irresponsible political theatre is coming to an end. Greece is just the first domino to fall.

And what does it mean for democracy? – This is a well-meaning question but do those who ask it imply that tough measures would be more acceptable if they came from local politicians, or do they imply that the Greeks could vote themselves a less harsh reality?

“The landslide has started. It is too late for the pebbles to vote”, as a character in the TV series Babylon 5 says.

Whatever happened last week is unlikely to be the end of the Greek crisis but, more importantly, far from the end of the global financial crisis either. Greece is not the only country with an unsustainable economic model obtained under the fair-weather conditions of the 1971-2007 Great Fiat Money Expansion. Modern habits of governance seem to be founded on the illusion that states qua states have unlimited credit lines and could never go broke. Fact is that the debt trajectories of all major countries are pointing in the same direction. Sooner or later, everywhere is Greece.

And if printing lots of money is not a solution for Greece it will not be one for the others. This week the ECB will conduct another round of QE, although it calls it LTRO – long term refinance operation. The ECB will give hundreds of billions of new money to the European banks. When describing these operations, many economists and journalists are naively (or astutely?) sticking to labels such as ‘liquidity provision’ or ‘stimulus’, which sound harmless and are thus misleading. ‘Liquidity injection’ sounds like the ECB was doing nothing more sinister than adding a bit of grease to the economic machinery. And ‘stimulus’ makes it appear as if the ECB was only applying a gentle kick to the backside of Europe’s economic mule.

Nothing of the like is going on here. In fact the ECB is providing funding to the overextended banks that they could never obtain from savers in the private market, so that the banks, rather than shrink and consolidate, can provide more cheap money to the various debt-addicted European states, to keep yields on their debt at artificially low levels and to allow them to maintain the appearance of solvency. LTRO/QE is a policy of price fixing, market manipulation and all-out make-believe – - let us all pretend this entire charade is funded voluntarily by a free market.

This is not about stimulus or liquidity, this is about maintaining a system a tad longer than has run out of private savings, private trust and private credit, and that is – despite being officially brain-dead – now on the life-support of never-ending LTRO injections. There is no exit strategy here. This will have to go on – forever.

Of course, ‘forever’ it won’t last. “When they (the non-central banks, that is) stop buying bonds the game is over.”

In the meantime, the debasement of paper money continues.