The Power and the Money

Internal devaluation does not work very well

So I read in the New York Times that Greek private sector salaries fell a punishing 22.5% in 2011 in real terms.  That stunned me. So I went to Eurostat. Their figures for nominal labor costs were slightly less impressive, but still shocking. (2008 = 100.)

Internal devaluation at work! Sure, Greece is still working off earlier excessive wage gains, but that should presage an export boom, right? Cheaper workers, cheaper vacations for foreigners, more tourism, more exports.

Except ... well, according to OECD data, output is declining along with wages. (See below; 2005 = 100.) Unit labor costs are down, but not when seasonally adjusted, and really not relative to Germany or the rest of the Eurozone. Maybe that’s not relevant. After all, as long as output per worker in potential export sectors isn’t falling, then economy-wide unit labor costs should not matter ... but only for those industries. They will matter a lot in other industries, which are seeing demand (foreign and domestic, as proxied by the value of output) drop as fast as their wage bill.

Add to that (1) rising debt burdens for Greek workers, since debts aren’t indexed to wages; (2) rising taxes on Greek workers; (3) people’s desire to save in euros (outside Greece or in cash) in the face of a possible Grexit; and (4) the awful awful feeling that comes with people as they watch their nominal incomes plummet.

Put it together, and it isn’t clear to me that the rather surprising unstickiness of Greek wages is going to produce much of a quick recovery even if wages fall substantially more. (There have been a lot of reforms to Greek labor law in the last few years.) Of course, the Argentine experience implies that a Grexit won’t be better ... Argentine GDP plunged 15% in the year after the devaluation, and recovery took place in the context of strong external demand.

I am not optimistic.

Postscript: see “Is Increased Price Flexibility Destabilizing?” by Brad Delong and Larry Summers. (Also found here.) See also “The Barber of Buenos Aires.”

Greece steps closer to Eurozone exit

 I recommend the Sober Look blog. If you want something scary, go here. The short version is that the European Central Bank has completely lost control of the Greek money supply. It can print euros and buy loads of Greek assets, but all the liquidity drains right out of the country. Basically, nobody wants to hold deposits in Greece. On the flip side, nobody outside Greece wants to lend to a Greek company. In the words of a commentor, “The Greece analogy to a state in the U.S. no longer applies.”

A while ago, Doug Muir and I had a debate about Eurozone exit. We agreed that if the banking system collapsed and capital flight went out of control, then the costs of exit would no longer apply ... because the bad effects of exit would have already happened. The implication of a collapse in the Greek money supply is that absent more fiscal help from the rest of the Eurozone, there is no longer any reason for Greece to stay in.

Other than, of course, warm and charitable Greek feelings towards the rest of the Eurozone.

This would be a painful way to end European union

 Over the last two months, family business has kept me away from blogging. Before that, I was in the throes of finishing a first draft of a book manuscript. The family business is over and I’m now in the far more relaxed process of fixing the manuscript, so this time I think I think we’re really back!

In December of 2010, I made a bet with Doug Muir and Omar Serrano that the eurozone wouldn’t make it to March 25th, 2013. If any of the big eurozone economies leave the single currency, I win. The bet is structured so that I will lose even if Ireland, Portugal, and Greece all abandon the euro; it has to be Spain or Italy. The loser will either fly across the Atlantic to meet the winner, or pay for the winner to fly to meet them, and then buy them a steak dinner, with port and cigars.

The big question, of course, is how a government could leave the eurozone. Now, Nick Rowe has proposed a way. “Eurozone governments and banks that cannot pay their obligations in euros may end up paying their obligations in a scrip that is not pegged to the euro. A scrip issued by each national government that is worth whatever people think it is worth. And if people start using that scrip as a medium of exchange, and medium of account, it becomes a new money. Sure, Greek supermarkets might prefer payment in euros, but if their customers can only pay in New Drachmas, then it’s either accept New Drachmas or let the vegetables rot on the shelves. And the supermarkets’ suppliers might prefer payment in euros, but it’s either accept New Drachmas or let the vegetables rot in the fields. And the workers picking the vegetables might prefer payment in euros, but it’s either accept New Drachmas or nothing.”

Sounds almost painless! Matt Yglesias implied so. But it wouldn’t be! It would be a mess and cause the economy to cycle the drain until the government defaulted on its debts anyway. Moreover, it would not cause the scrip to drive euros out of circulation.

Consider, for a moment, what Spanish obligations consist of. In part, they are debt payments. Spain’s debts, however, are denominated in euros and will remain denominated in euros no matter how many nuevas pesetas are printed unless the Spanish government withdraws altogether from the European Union. Rather, the obligations which the Spanish government can insist on paying in nuevas pesetas are the obligations that it owes to its own citizenry: salaries, pensions, unemployment benefits, etcetera. The nueva peseta would trade at a discount against the euro, of course, but that is the idea.

Except ... the incomes of Spaniards would drop in terms of euros. They would be increasingly earning in discounted nuevas pesetas. The problem, of course, is that they would then be paying less taxes in terms of euros. But the Spanish government owes debts denominated in euros! The debt burden would rise. The more the debt burden rises, the more the government needs euros to pay it. The government would, of course, trade nuevas pesetas for those euros. That would increase the discount on nuevas pesetas, further driving up the size of the debt burden, further increasing the discount on nuevas pesetas. (While this is going on, the interest rate on Spain’s euro debt would skyrocket, of course, unless it is by then owed to the European Union rather than private investors. In that case, however, it is very unlikely that Spain would be going around issuing scrip to pay salaries.) At the end of the story Spain’s income in euros falls enough to force the government to default on its euro debts, but only after setting off an inflationary spiral.

There’s a second problem. Rowe wrote, “Greek supermarkets might prefer payment in euros, but if their customers can only pay in New Drachmas, then it’s either accept New Drachmas or let the vegetables rot on the shelves.” That, however, isn’t correct. Government employees might be paid in new drachma, or nuevas pesetas, but they can exchange those pesetas for euros. The supermarket cannot be required to accept those pesetas unless Spain leaves the eurozone. If the owner insists on being paid in euros, then the customers will swap their pesetas for euros in the market and he or she will be paid in euros. This is a process that has occurred in many high-inflation countries, where people abandoned the local currency for the dollar ... and in most of those countries, the dollar was not legal tender! In short, the logic breaks down at that point: it is not clear why the pesetas would replace the euro as a medium of exchange ... except, of course, to make tax payments.

Of course, it isn’t clear that Spanish government employees (or pensioners, or students, or the unemployed) would want to receive devalued nuevas pesetas in lieu of euros. They would, quite rationally, perceive it as a pay cut. Anyone who owed money would be doubly hit: their debts would still denominated in euros.

Finally, such an action would be perceived (correctly) as a prelude to formally leaving the eurozone, precipitating the mother of all capital flight. Without leaving the eurozone (in fact the country would have to leave the European Union altogether) the government would have no way of combating that flight.

In short, introducing scrip would be a terrible way to exit the eurozone. It would run a high risk of triggering a depression, and it would certainly worsen the country’s debt burden. Professor Rowe is, I think, incorrect. History bears this out: the issuance of patacones (or créditos) in Argentina around 2000 did not result in the creation of a new Argentine currency or stave off default. Rather, they contributed to the depression, and quickly inflated away.

There are many ways in which the eurozone could fail. The issuance of a parallel currency for any length of time strikes me as one of the worse ones. Is there a hole in my logic?

“What do the Greek rioters want?”

 Thanks to reader BPH for catching a major bonehead error in comments. The mistake is now fixed. Apologies!

The title of this post is a question asked me today yesterday by a Columbia student Guy Tower. The correct answer is probably, “to express an unfocused floating rage,” followed by “a miracle.” In fact, the last time Amma and I were in Greece, the place had just been hit by riots. That said, there are three possible concrete things that a tear-gas-dodging rock-throwing rioter might actually want the Greek government to do.

  

In order of reasonableness:

(1) Make sure that rich Greeks pay there fair share of the adjustment burden. Sure, taxes amount to only 32% of GDP ... and that assumes that GDP is properly measured ... but tax rates in Greece are not low.  Tax  collection is low. Considering how royally Greek governments have screwed up tax collection, anger at this would get me on the streets too. Raising VAT when you can’t collect a swimming pool tax? WTF? Bring in Crown Agents!

Don’t forget that Greeks are poor. (Albeit not as poor as in the first version of this post! Thanks again to BGH.) The below chart gives the bottom nine deciles of each country’s income distribution, in euros per year at PPP. The median Greek would fall below the Austrian, British, Danish, Dutch, and Swedish poverty lines. They would be in the bottom 30% of the income distribution in Belgium, Cyprus, Ireland, France, and Finland. The lowest tenth of the income distribution is poorer than anywhere else in the Eurozone except Italy, Slovenia, Spain, and a very few Cypriots. 

Source: Tárki European Social Report 2008, Chapter 3. Data from 2005. A larger version of this chart is available by clicking on it.

In short, Greeks have ample reason to suspect that rich people are getting away with murder, and ample reason to be angry about it. 

(2) Push back on the creditors. Yes, Greece has been irresponsible. Hell, it’s been malfeasant. But recent months show all the characteristics of a credit spiral, when bad things happen to good countries. (Or in this case, a badly-behaved one.) If were Greek, I’d want the Greek government to take a harder line with its creditors. Extend maturities, reduce interest payments, basically make ‘em take a haircut. Another way to think about this is that if Greece were a corporation it would be in bankruptcy protection right now. Greece would still need to make budget cuts (its interest payments are lower than its deficit) but they would be less painful and much more politically palatable.

(3) Get out of the euro.

Okay, that last one is crazy. What would Greece need to do to leave the euro? Well, it would have to freeze bank deposits, in order to prevent a flight of cash to the rest of Europe. The problem with that is that doing so would violate European law — Greece would need either a special mulligan from the European Commission (which would set an awful precedent) or quit the Union altogether.

Of course, it is possible that runs on Greek banks will happen anyway. Thing is, the ECB is moving to prevent that, by continuing to accept Greek bonds. Even if the ECB fails, rumors of euro-exit could produce something far worse than bank runs: consider what happened to Argentina in the run-up to its big devaluation. If Greece looked to be reintroducing drachma, nobody would want to spend euros. After all, they’d all be expecting the drachma-euro exchange rate to plummet the second the drachma became legal tender. The economy could go back to barter in the run-up. That happened in Argentina in 2001.

I’ll also add that a devaluation would almost certainly be connected to a default. I’m having trouble seeing Greece suddenly enjoy an Argentine-style export boom without a big drop in the nominal exchange rate. The problem with having a debt burden at 113% is that a big drop in the nominal exchange rate means a big rise in debt burdens, since Greek debts are denominated in euros. Either Greece redenominates its debts — a de facto default, unless the European Court decides doing so is illegal — or it will have to renegotiate them.

In other words, a Greek ejection from Euroland might be good for Greece ... in the sense of being terrible but better than some other possible outcomes ... but it seems to me that it would be rather bad for the rest of Europe. We have, in fact, seen a similar movie before.

Anyway, it seems to me that there are reasons to oppose the current government that go beyond simply wishing for a pony. The 1980s really weren’t really that great a decade. I would like to see more of (1) and (2), with a much more pro-active Brussels. Guarantees for Greek banks would help. (Make ‘em adopt Panamanian banking regulations, and I mean that quite seriously.) More quantitative easing from the ECB. An inflation target of 2%, not just a ceiling. Hell, a target of 3½ percent. British officials running around inside the Greek tax administration. Some of European version of the proposed Sovereign Debt Restructuring Mechanism; e.g., a bankruptcy procedure for E.U. countries.

None of which (except maybe implicit bank guarantees) is going to happen, thanks to Angela Merkel. So unless the Greeks want to flirt with depression and expulsion from the E.U., we are stuck with muddling through. And that means, at some point, a default. 

Good luck, madre patria.

A modest Greek proposal

 Greece may be facing a serious debt spiral. Governments of the Eurozone appears concerned for two reasons. The first and smaller reason is that many of their financial institutions may be exposed to Greek sovereign debt. A Greek default could therefore have repercussions across the Continent. In that sense, European governments are concerned for the same reason that the U.S. was concerned about Latin American defaults in the 1980s. This reason does not seem to be enough to account for all the concern.

The second reason is that they are terrified of contagion. We have a lot of evidence that investors panic and do bad things to good countries. (Consider the Argentine experience in 2001.) The Europeans might be terrified that a Greek default will drag down Portugal and Spain, possibly Italy and Ireland, countries that might muddle through in the absence of a panic-inducing shock. Large defaults would have two very bad effects. First, financial institutions in northern Europe are very exposed to their bonds; the risk of a super-1982 would be huge. Second, all of the PIGS right now are dependent on current borrowing to finance their government spending. If they defaulted, they would have no way to finance their deficits. Demand would collapse, plunging those countries into depression and dragging their trade partners down with them. (There may be a third reason to worry that I am missing.)

I will admit, however, that I am not entirely clear as to why these worries for northern Europe would be less in the absence of a currency union. Presumably the model is that (1) a country with a depreciating currency is less likely to default on its debt; (2) the loss in value from a default will be higher than the loss in value caused by depreciation; (3) foreigners would have held less sovereign debt in the first place in the absence of single currency; (4) the country would have been able to borrow in its own currency; and (5) the hit to the net exports of the other eurozone partners will be less in the case of a big depreciation followed (hopefully) by recovery than it would be in a depression caused by Hooverism. That seems reasonable to me, but I am not sure that I have it right.

So what to do?  Bail Greece out, obviously, with some sort of temporary low-cost finance. The problem, of course, is whether Greece’s fiscal problems can be solved. Well, it does seem as though tax evasion and inefficiency are a big part of the problem. Even without the crisis, these were bad things, as the linked paper demonstrates.

Well, there is an organization with expertise in managing tax-collection ... Crown Agents. They have an entire department dedicated to it. It would certainly be more palatable to Athens to have the Crown Agents denationalized (if somewhat British-heavy) workforce managing Greek tax collectors than it would be to bring in, say, Germans.

It is time for the E.U. to call them in.

Greece in recession

  The Greek economy is slowing, but it is not in recession.  Yet Athens looks like a city in the midst of a severe recession. 

Not in this picture, of course.  This picture is lovely.  Albeit not really because of Athens.

But on the drive in from the airport, you pass myriad empty storefronts, abandoned buildings, and what appear to be stopped construction sites.  

Downtown, you see much of the same.  Even brand-new construction looks empty.  When the storefronts are filled, you can spot tell-tale signs of empty offices.  And then there's the petty vandalism that haunts downtown:  graffiti on private structures, cracked windows, run-down buildings.  All the telltale signs of property owners who have decided for whatever reason that proper maintenance does not pay a sufficiently high return.  

If it had just been the central city, we would have concluded that Athens suffers from a European version of the American disease.  Or that it was just the after-effect of the December riots.  The thing is, the signs of economic distress are worse in the suburbs.  It honestly looks like someplace that suffered from a real estate bubble that has now collapsed. 

Of course, the central city doesn't look so good either.  It looks like someplace where rioters might indeed attack businesses with petrol bombs. 

That said, downtown Athens is not out-of-control the way much of New York City was in the 1970s and 1980s.  For example, when we got off the bus, the first thing that greeted us was a police raid against African street merchants selling counterfeit luggage.  Yet the prevalence of graffiti also suggests that the police (and the public) is fairly lax about enforcing standards; it's not something you see in Boston or London or Paris, not to the same extent, and not on private property.  (Although, once again, much of New York's outer boroughs looked like this back in the 1980s.) 

In other words, while the Greek economy might not yet officially be in recession, our careful powers of observation lead us to predict that the numbers are going to get much worse very quickly, as the statisticians catch up with reality.

So what's happening?  And what is to be done?

Sabiduría del occidente para los griegos

Doug recently wrote in A Fistful of Euros, “The Macedonia name issue is so stupid that it’s almost physically painful to write about it.” I have to agree. I made the mistake of scrolling down the comments thread. Jee-sus.

Viewed from the extranjero vecino, the whole thing is incomprehensible. Let me recap. A smaller weaker country on the northern border of another has the same name as a province of the latter. The larger stronger country fears that as long as its neighbor claims that name, it might also claim the province. How the whole smaller-weaker versus stronger-larger thing would be overcome is left unexplained.

Somebody from the Spanish-speaking part of this hemisphere needs to take a Greek minister aside at a U.N. meeting and say something like: “Listen, buddy, I understand your problem with northern neighbors and names. We have a larger stronger northern neighbor that claims our entire continent in its name. And, you know, periodically invades.  Like, recently, not umpty-scrump centuries ago. But you don’t see us making a public fuss about it, so will you get over yourself already?”

Conversely, they could just go with Alta and Baja Macedonia. Don’t even translate “Alta” and “Baja,” just transliterate ‘em. I’m sure they sound fine in Greek, exotic like. Be good for tourism. 

Doug, can it really be about the name?