Monday, July 6, 2015

A Simple View of Greece and Grexit

This was originally written for my grandchildren to explain the messy world we live in, It's a terribly simplified view, but why not see what the world thinks.

Who pays for Greece's past follies? To greater or lesser degrees we all will. The farther we are from Greece the smaller the impact. Just as waves that hit us coming from a pebble dropped in a pond. In the US, we are far from the pebble, in Europe the waves will be bigger. To the citizens of Greece they will be monstrous, crushing and their personal pain will be long lasting. But INFLATION is the ultimate solver of tragic imbalances between countries and the world and it will handle this one too. How?

We live in a global financial world that could be finite, but is not. It could be finite if all governments stopped printing currencies. Inflation would be 0 but we'd have difficulties to adjust to trade imbalances and making economic adjustments because "the pie" is getting bigger. We need tiny inflation for slack and room to grow.

If governments create money gradually and moderately we have limited inflation, we know what will happen with the currency's value in the future and can plan for it. When printing new money gets out of hand, as periodically in Argentina, the government is effectively buying the citizens' good will with pensions, contracts, low taxes, etc., the sweet cookies of governments. Unfortunately inflation sets in like a hangover after the party. 
In this scenario, to try to control money printing, the government also borrows from bankers in the country and outside to finance the party. The largest world banks have huge departments that do nothing other than government loans or bonds work.
 The apparent good life continues, but inevitably the government becomes more of a beggar at which point hedge funds and private investors come in for the high yields that are commonly paid by deadbeat borrowers. 
The lending process eventually requires repeating re-negotiations to push the deadbeat to pay for longer and longer, frequently with more debt added on. So long as it works everyone is happy. Bankers get high yields, government employees keep their fat jobs, pensioners enjoy their golden years starting at 60, etc.. To keep the populace of non-government-employees also happy, unions demand and get pay comparable to cushy government jobs (if they get it why not me?). 
Unfortunately future generations are saddled with the cost of the party,  economic efficiency suffers, jobs go elsewhere and the whole castle of cards eventually falls. Argentina defaulted, the bankers took their losses and a new currency is typically created. Other countries, Cyprus, Italy, and more did something not as drastic but close enough.  In all those cases the countries had their own currency and the mess stayed within the borders, so outsiders cared little. Eventually domestic inflation of 20% or more always clears the tables and the losses are passed out to all citizens (not equally).

Greece, now, was a whole new model.  Before the Euro Greece repeatedly did the same as Argentina and no one outside cared much. People vote and get the government they deserve, outsiders don't feel the pain and don't care.  When Greece joined the Euro, however, its government gave up the ability to bribe its own citizens with its own money. It could have RETRAINED its citizens as other Southern European countries are doing, to work as long and hard as Germans and Finns, or to retire as late as the Belgians (67). Instead Greece continued to bribe the Greeks with early pension (60), bloated government bureaucracy, inefficient labor markets, non-existent tax collection, etc. 
So, how could Greece pay for the party since Greece has no money because of its incompetence to collect taxes and money printing was out of reach? Bankers to the rescue, of course. This time it was all financed with IOUs. The bankers then should take the losses. True, except that the biggest lending banks are government banks and their losses would go, you guessed it, through inflation to the hard working and late retiring Europeans up North. Bad news for Mrs Merkle.

Alternatively a renegotiation that would save face for the government leaders and money to the bankers, but that saddles Greece with debt repayment until Kingdom-come AND the Greeks would continue with their happy life of fat government handouts. This has been a non-starter to the German voter (they are the biggest holders of Greek debt), because it would allow the Greek Party to continue. In their shoes we'd get the idea.

This has been the conundrum of Greek exit from the EU Grexit or exit from the Euro

But financiers are very bright and politicians are ingenious. Here is one way out they may come to like:

Greece stays in the EU and in the Euro. 
Greece defaults on its debt and stays in the Euro for all its international trade and whatever domestic trade may exist at the end of this mess. 
The Greek government goes back to printing New Dramas (ND) to pay employees and contractors, etc. 

The exchange rate ND/Euro will be horrendous, BUT all Greeks have some euros now, and their deposits are ensured by Bank of Europe even if the Greek banks fail. That currency stays safe as to value.
Why would anyone accept ND? Because government pays employees and contractors only in NDs, government facilities (hospitals, tax collection offices, parking tickets, ferry boats) can only be paid in NDs.
Greek inflation will be horrendous and people on fixed income will pay the highest price.
A dual currency state will exist, (I saw it in Canada in the '70s, where all banks would open US$ accounts for the asking, and so long as both currencies are stable, it causes no problems). Price tags will be in ND and E as they were for a year before the Euro started. Note: without the past debt, the ND, if managed properly, would be far from a worthless currency. Over time Greece might learn to run a country and gradually go back into the Euro on par with other European nations.  

WHY this way? Because the debt in foreign hands will be written off and a new page will be turned. We do this to bankrupt people all the time: turn the page and prove yourself again.  The private banks, the speculators will take their losses, as big boys should. European Bank, government banks, IMF and all international institutions will take their losses, one hopes a few deserving heads will roll, and the losses will be distributed to their citizens through, you guessed it, INFLATION. 

So we all will pay a little for this Greek tragedy, and, may be, learn something from the experience. In the US we might just re-evaluate the idea of "banks too big to fail".

Update: MUST READ A rather more complicated and technically correct view from M. El_Erian, one of the brightest minds in the investors camp  

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