Yesterday, Nomura's Richard Koo presented one of the better assessments of the situation in Greece, when he said that the "IMF is slowly beginning to understand the Greek economy", which explains its strategic U-turn, one which now demands far greater debt cuts than what Europe, and Germany in particular, is willing to concede.
Koo further notes that "the reason is that Greece’s GDP has plunged because fiscal consolidation was carried out during a balance sheet recession, resulting in a destructive deflationary spiral that has devastated the lives of ordinary Greeks. While the nation may appear to be making progress when we view the data as a percentage of GDP, the raw data show an economy in collapse. This difference in perspectives widened the gap separating European creditors who thought everything is going well, and the Greek public who has been suffering serious declines in their standard of living. And this rift in perceptions was perhaps nowhere as evident as in the results of the national referendum on 5 July."
The observation of the Greek economic devastation is absolutely accurate, and is no surprise to our readers: it has been our base case that not only Greece, but the rest of Europe's peripheral countries would suffer an ongoing deterioration in living standards due to lack of an external rebalancing (thanks to the common currency) leaving internal devaluation (plunging wages, deflation, economic devastation) as the possibility to remain competitive in the Euro Area; however where our opinion differs from that of Koo is the "motives" behind the creditors' unwillingness to honestly interpret the situation on the ground in Greece.
Yes, it is true that it is the same creditors who were the next beneficiaries of some 90% of incremental debt-funded proceeds entering Greece (only 11% of the €220+ billion in Greek bailouts ever reached the general population), and as a result they may have had the impression that ordinary Greeks are also enjoying the spoils of their bailout.
They were not, as the events of July 5 showed.
But while the former Fed economist will surely attribute this "oversight" to mere carelessness or at best, stupidity, even if an entire nation of 11 million people is suffering more than ever in history as a result of what is, at best, a failed experiment, there may be a more ulterior truth to events in Greece in the past 5 years especially considering Germany's stern insistence on not writing off Greek debts despite what is now an accepted fact that without a major debt haircut Greece simply is unviable.
Meet Bernard Connolly.
Barnard is a British economist whose rise to prominence started when he worked for many years at the European Commission in Brussels, where he was head of the unit responsible for the European Monetary System and monetary policies. In other words, if any one was familiar with what the ascent of the Euro would lead to, it would be him.
We say "eventual" because he was terminated by the Commission in 1995. The catalyst may well have been his book "The Rotten Heart of Europe: The Dirty War for Europe's Money, a negative treatment of the European Exchange Rate Mechanism" which Eurocrats did not take too very lightly.
However, Bernard is more notable not his books, or his employment in Brussels, but where he went next and what he did there.
After ending his relationship with Europe, Bernaned worked at Banque AIG, the Paris-based financial arm of the infamous AIG whose collapse together with that of Lehman, was the primary catalyst for the great financial crisis. Bernard however was not in the front office and did not trade CDS, but was the global strategist. Here is euro skepticism flourished and culminated in a report on May 30, 2008, months before the GSEs and Lehman failed, and AIG was bailed out.
The report was titled "Europe - Drive or Driven", and it should have been a must read for all Greek (and Europeans) some 7 years ago as it not only lays out precisely why Greece is now on the verge of not only sovereign capitulation but total collapse, but presents what may be the true motives behind Europe's perpetual crisis and why it almost appears as if the core European countries demand that the sick men of Europe, because Greece is just the first of many, remain and keep Europe in a state of perpetual turmoil.
And since this report is as relevant now as it was 7 years ago, we lay out some of its key highlights again.
From May 30, 2008
The Global Economic Crisis and the EMU Crisis
- The global crisis is the result of intertemporal misallocation (Greenspan; EMU).
- In effect, there has been a global Ponzi game.
- In Europe, this was intensified by the myth that “current accounts don’t matter in a monetary union”: EMU is the biggest credit bubble of them all.
- The treaty says that government should have the same credit status as private sector borrowers.
- Monetary union means greater economic instability.
- These two factors should mean a worsened credit standing in EMU, yet government bond spreads actually diminished in EMU and ratings agencies actually upgraded governments
When the bubble bursts…
- A collapsing credit bubble in the world means collapsing domestic demand in deficit countries (e.g. US, Britain, Balkans, Baltics – and several euro-area countries)
- In the US, and to some extent Britain, domestic demand is being supported by rate cuts and, in the US, by a fiscal stimulus
- In the affected euro-area countries, it isn’t
- In the absence of support for domestic demand, affected countries will be forced into an improvement in net exports via improved competitiveness
- In the US and Britain, this is happening through currency depreciation; in the euro area it isn’t.
[ZH: it is now, but for Greece it is far too late, plus any incremental "support" merely makes the European debt bubble even greater as we have shown recently]
And the implied real exchange rate movements are enormous…
- Obstfeld and Rogoff saw a need for perhaps a 65% real effective exchange rate move for the US if current account adjustment were sudden (e.g., after a housing collapse).
- The effect is linear in the size of the current account deficit relative to the size of the traded goods sector, so for the four
large euro-area deficit countries we get the required real exchange rate movements as:
- Greece: 94%
- Spain: 55%
- Portugal 36%
- Italy: 9%
- France 15%
…meaning huge required inflation differentials between blocs within the euro area
- If the ECB tries to avoid depression in the deficit bloc (i.e., keeps its inflation rate at, say, 3%) and the deficit countries as a bloc (equivalent to about 2/3 of euro-area GDP) have to improve competitiveness by, say, 30%, over a five-year period, then that would involve euro depreciation of 50% and (with1/3 passthrough into German Bloc CPI) a rise of 17% (almost 3½% a year) German Bloc price level, taking German Bloc inflation to around 6½% for five years.
The ECB did not. Instead it chose the following, which is also why youth unemployment in the periphery is about 50%:
- If instead the ECB tried to keep euro-area inflation at 2% (and no change in the euro), all the competitiveness change would have to come from Latin Bloc deflation; that would almost certainly involve a horrible depression, financial chaos, widespread default, social distress and possibly political instability.
- But this would mean substantial euro-area deflation, too, so hitting the euro-area target must involve substantial euro depreciation and a substantial increase in German Bloc inflation.
- These are all first-round calculations – they do not take account of wage-price spirals in the German Bloc as economies overheat.
And this is where it all comes home for Greece:
Things are even worse for individual countries
- If the ECB decides to avoid depression, deflation and default in the weakest country (Greece), the required depreciation of the euro would be enormous and German Bloc inflation would be well into double digits for several years.
- If weak countries have, individually, little political influence, it will be hard for them to get the ECB to bail them out via low interest rates and a weak euro.
- But if there is no ECB bailout, vulnerable economies face catastrophe.
That's not only how it all played out, but it has also led - as we have seen - to Greece which clearly had "little political influence" to lose it all, and is now on the verge of abdicating its sovereignty to an oligarchy of unelected political bureaucrats and German industrial interests (remember: German exports account for 40% of GDP and a weak EUR is far, far more valuable than a strong DEM).
In further retrospect, the above assessment and the current events also explain Wolfgang Schauble's cryptic statement to Welt am Sontag in this 2011 interview:
Schauble: "We decided to arrive at a political union via an economic and currency union. We had the hope - and we still have it today - that the Euro will gradually bring about political union. But we're not there yet, and that's one of the reasons why the markets are distrustful.
Welt am Sontag: "So will the markets now force us into a political union?"
Schauble: "Most member states are not yet fully prepared to accept the necessary constraints on national sovereignty. But trust me the problem can be solved."
And, thanks to Greece, we are about to see precisely how.
So is there an other way out? The answer is yes - and it is precisely the basis for Varoufakis huge "game theory" gamble over the past 6 months, a gamble which was all about "who has more leverage" as we explained in January. However, thanks to the arrival of QE just in time, it allowed the ECB to set and control market prices (markets which no longer had to discount adverse outcomes and merely frontrun a central bank) of equities and bonds, in the process crushing all Greek leverage.
- Current account deficits can be closed without a corresponding reduction in the trade deficit if current transfers are big enough.
- The treaty prohibits a takeover of a country’s public debt, but does not prohibit additional transfers to support private spending.
- The ECB is in effect already helping some banking systems by accepting increasingly risky collateral (but note that this may be helping German, Dutch/Belgian banks as well as, say, Spanish banks – note public disagreement between Mersch and Weber).
- But the numbers involved in a complete fiscal bailout would be staggering: eliminating current-account deficits within the euro area by fiscal bailouts would require the surplus countries (the German Bloc) to make payments equivalent to 16% of their total government revenues (7% of their GDP).
Yes, Varoufakis was right, and will be right in the end: the cost of a Grexit would have been too great in the future. However he did not anticipate that Europe has a just as powerful counterweapon: locking up Greek deposits indefinitely right now.
Which brings us to the final question: What Europe Wants?
Here is Connolly's answer:
To use global issues as excuses to extend its power:
- environmental issues: increase control over member countries; advance idea of global governance
- terrorism: use excuse for greater control over police and judicial issues; increase extent of surveillance
- global financial crisis: kill two birds (free market; Anglo-Saxon economies) with one stone (Europe-wide regulator; attempts at global financial governance)
- EMU: create a crisis to force introduction of “European economic government”
And there it is: in four simple bullet points laid out in a 7 year old presentation, a prediction which is about to be proven right. Because once Greece folds, next will be Italy, Spain, Portugal, and so on, until the European Economic Government, also known as the "European Empire", controlled by a handful of "northern" European players and the bankers financially backing them, shifts from mere vision to reality.
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Full presentation below