Monday, May 24, 2010

Storm Over Greece

By Brian Brown

Between chronic borrower and chronic lender, no difference in
vice or virtue separates them

Judging from the intense swirl enveloping Greece these past weeks, the financial crisis has returned without having ever left. Greece verged on social combustion but for the joint EU/IMF trillion dollar bailout that also included three other nations along the European lip of the Mediterranean basin. The crash of their nation’s financial position and the chorus of European partners and international banks singing the tune of harsh austerity must have perplexed the average Greek. They did not know what befell their nation. Suddenly they felt like helpless props, steered by invisible forces toward an uncertain and perilous end. To understand what was happening, they should have peered into their past. Had they recourse to their famous ancestor, Sophocles the playwright, he would have instantly told them of the nature of events and their grinding inexorability. Sophocles would have informed his descendants the situation resembled one of their nation’s great contributions to western culture: the Greek tragedy.

The bailout pieced together by the EU and IMF plugged an imminent sinkhole that could have quickly devoured Greece and started the other troubled Mediterranean nations down its maw. However welcome the relief may be, it is just that. It is relief not resolution. The 2008 global financial crisis had two central factors. The most discussed was the excess speculation and debt leveraging afflicting the large financial houses. They wagered their honored solvency on a fanciful lark through the real estate market and the murky swamp known as derivatives. Governments took trillions of dollars out of taxpayer pockets and pocketbooks to give unguent to the banks whose self-indulgence defaced their integrity and that of the financial system.

The other contributing factor to the global crisis was scarcely discussed because its solution was even more evasive than the tricky matter of taming bank misconduct. Trade and capital flows in the global economy are substantially imbalanced. There are chronic surplus countries like China and Germany. While China is a much greater culprit, both nations are export-driven, suppressed domestic demand economies. They are neo-mercantilist. Favorable trade flows means currency surpluses. This sounds good but nothing occurs in isolation. For one country to register a surplus, another must fall into deficit. When one nation enjoys a protracted surplus, another must be perpetually in the red.

Our moral and ethical upbringing tends to look admiringly on the creditor and less charitably toward the debtor. However, in macro-economic terms, both are equally liable for the systemic disequilibrium. Imbalance leads to trouble in the long-term. Thus, both steep deficit and hardy surplus denote a situation that cannot endure. Both equally strain the economy because they are inseparable phenomenon. Caught between the flaming pit of excessive debt and crumbling pillar of excessive surplus, no one is safe.

The imbalance between Germany and its neighbors was bound to climax before the Sino-American discrepancy. The primary dumping ground for China’s goods is the U.S. economy, the largest in the world. The American economy has considerable dimension and capacity to carry debt as long as it remains the largest economy and its currency is globally preferred. In other words, China is running to catch the U.S. Loading the America with debt has a certain logic to it. In Germany’s case, the logic is inverted. Germany is the big boy on the euro block. Instead of absorbing goods from its smaller, poorer neighbors to the south, it ships the products of enviable Teutonic efficiency to them. The big boy runs unencumbered while the smaller ones are weighed down with a heavy saddle.

China chases the United States to close an economic gap. Germany runs far in front, widening the economic asymmetry between it and its less industrious cronies. Compounding this inconsistency is that stability of the eurozone is predicated on the macroeconomic operations of its members falling within a narrowing band of acceptable performance. The eurozone assumes the long-term convergence of economic performance among its participants. However, in macro-economic terms, Germany is running away from its lesser companions despite their explicit agreement to stay closely tethered by the common currency. German’s frugality, coupled with Greece’s libertine spending, is antithetic to eurozone stability.

When crisis hit, reactions were predictable. As such, they were more regrettable than useful. While ostriches are not native to Germany, the nation’s leaders did their best imitations of the long-necked fowl by placing their heads in the sand only to come up for air long enough to harangue the Greeks: “Well, you borrowed the money. Pay it up!” Greece had 50 billion euro in interest payments due and had not the funds to make the installment. Default of sovereign debt loomed. Financial markets quaked not because of Greece alone but fears that Portugal, Italy and Spain were standing closely behind it in the default line. Interest rates climbed, available funds dissipated and stock prices felt the effects of gravity. The present aroma of scorched financial deals was redolent of 2008. Something had to be done to stop impending collapse.

Logic called for the immediate restructuring of the debt coupled with a generous dose of financial discipline in Athens. However, the large financial houses did not want this route. It would have necessitated partial write-down in value of the Greek debt and possibly of its three other neighbors. The banks would have incurred significant profit loss. The banks were politically strong enough to persuade the political leaders. With restructuring off the table, other European nations reluctantly prepared to give Greece a flimsy string of a lifeline. Germany remained recalcitrant. Joined by the menacing troll known as the IMF, Germany wanted Greece to imbibe debtor’s hemlock by cutting government spending, freezing wages and raising taxes. Greece was to amputate more than 10 percent of its spending overnight. The measures it wanted Greece to adopt were beyond austere. They were draconian and would have ushered the nation into a decade or more of stagnation and possible depression. The Greek public literally rebelled at the prospect of being subjected to the type of emergency package usually hoisted on third world debtors. This attempted dose of creditor vengeance moved Greece breathtakingly close to the political and economic brink.

At the eleventh hour, the one trillion dollar EU/IMF bailout was cobbled together. Germany was persuaded the fall of Greece and the other nations would crimp German’s export driven economy. Financial contraction in these nations would shrink demand for German goods and thus slow the German economy. Despite initial moralizing about debtors paying what they owe, Germany begrudgingly realized it would incur great costs if Greece and others were forced to materially throttle their economies in order to pay debts. To keep the eurozone alive and thus continue reaping advantage from this regional free trade zone, Germany would have to apply some of its surplus to bolster the debtor nations from which much of the German surplus was derived in any case. This was poetic justice born of economic reason.

For a moment, markets rebounded because the precipice had been avoided. The euphoria was as deprived of value as a Greek treasury bond. When people examined the fine print, the workout was less than what first met the eye. The bailout is contingent on Greece and the others enacting significant deficit reduction measures. Exactly how much is significant appears left to chance. If the agreement is but softer, euphemistic language demanding the same brutal cuts that sparked last week’s riots, the EU just wasted a lot of people’s time. The proposed cuts are politically untenable. Any government that attempts them will find itself voted out at the next turn. While waiting to be run out of office, it will be busy staring social unrest squarely in the face.

More importantly, the bailout does not address the glaring inconsistency in the eurozone. Unless the vast gap between the fundamentals of German’s economic trajectory and the debtor quartet’s path is resolved, the eurozone will be likened to an aircraft with its nose and aft moving toward separate destinations. Dismantlement of the zone will become an inevitability like the rising of the moon.

The world financial system and the global real economy rest precariously on flawed recovery measures, themselves in need of rescue. Although the year 2008 is twice removed, the crisis it reckoned into our lives remains with us. The measures taken then to protect private banks saved them but did not reform them. They are back to their tricks of massive speculation and arbitrage that add nothing to economic productivity or genuine wealth. Now, the EU/IMF, with a little help for the American Federal Reserve, have papered over the fundamental inconsistency in the eurozone. Crises have been averted but not their causes. Beasts have been feed but not tamed or destroyed. They are bound to return but government’s ability to toss money at them is not boundless. Tough decisions about Germany’s role as the adhesive holding the eurozone together must be made. This means German will have to sacrifice its policy of economic maximization to some extent in order to enhance its political leadership.

Critical lessons are to be drawn from this episode. Those who believed the financial crisis is gone better think again. It is a predator lurking in the shadows. The international financial system is as vulnerable to shock and rapid diminution as it was the day before the 2008 crisis erupted. Great prudence is required to prevent a massive aftershock that in the injury exacted would be indistinguishable from the initial quake.

This episode also brings into question the propriety of establishing a monetary zone comprised of a large number of nations of significantly different sizes, economic characteristics and political cultures. The eurozone was formed at a time of relative economic bliss. All was optimism. Thus, its structures were not designed in contemplation of dealing with a situation where the very fundamentals of key members’ economies become diametrically opposed. The events should force any region or nation contemplating a large monetary union to pause and ask if this is the right approach.

Nigeria and Africa should not too soon forget 2008 by allowing its financial systems to become arenas of speculation and brusque profiteering. The natural tendency is for investors to believe the storm is over. They will want to get back into the game, eager to recoup what was previously lost. Any sign that markets are again firm and lucrative will be over-read. This is how post-crisis bubbles are made and twin crises are born. The recent drama warns us the evil spirits are still on the loose. Countries allowing their financial systems to sprint unguarded will almost dash into trouble. There was almost a Greek tragedy this time. There is no need to have an African one. We have been warned.

No comments:

Post a Comment