Believe those who are seeking the truth. Doubt those who find it. Andre Gide

Monday, May 3, 2010

Why Greece is Worth Saving (?)

According to CNBC News, the answer is here: Greek Bailout Deal Closer.

So it looks like we're talking about a $146,000,000,000 bailout (Greek population is around 11,000,000). Who knows what these numbers mean...except to say that they are large.

In return, the government is promising "enormous austerity measures" (tax hikes, wage cuts, etc.).

But why is Greece worth "saving" at all? Well, I love this part. The reporter says "Well just look around...Greece is a huge export market for Germany...just look at all the Mercedes, BMWs, and Audis parked around here!!" (He is in Greece, with the Parthenon in the background as he is saying this).

Now, just hold on there a sec and let's see if I have this right.

German workers bust their butts manufacturing automobiles. Rather than ride them around themselves (an act of consumption), they prudently decide to export all these fancy cars to Greece (an act of saving). Greeks can't manufacture these automobiles themselves (or produce enough olive oil to pay for them) because...well, you can't do this and expect to maintain a decent tan, perhaps. So, the Greeks borrow the cars (an other goods, of course, like suntanning lotion and skimpy German-made thongs perhaps). Greece issues a collective IOU to pay for these things.

But now Greece is having trouble paying back its debt to the Germans. If they default, they won't be able to afford any more German-made automobiles! The German export market will dry up, leaving German auto workers idle!

And to prevent this from happening, the German government stands prepared to tax its citizens to pay for (or at least subsidize) Greek debt, i.e., the German cars it sends to that German workers can retain the privilege of working hard and shipping even more cars to Greece? What is this guy thinking (he is not the only one I hear speaking in this way)?

I don't get it. But then again, perhaps this is one reason why I don't get calls from CNBC soliciting my opinion!


  1. I'm sure I won't be the only person to compare this to the China-US relationship.

  2. Pointbite,

    Would the U.S. be Greece, then? Public spending is certainly increasing as a percentage of total spending - and not simply because of some stimulus package(s). U.S. debt is increasing very quickly - some might say it's higher than could conceivably be paid back out of future income, particularly if growth is compromised by the (expected) tax increases.

  3. Pointbite,

    Yes, things are similar in the sense that the Chinese are financing U.S. consumption (primarily via purchases of U.S. treasuries). On the other hand, U.S. treasuries are not the same creature as Greek debt (you do not, I think, see the Chinese purchasing Greek bonds --although I could be wrong).

    In any case, could you imagine a scenario where the U.S. has trouble paying back its debt, and then having some CNBC commentator explain why it is in China's interest to bail out Americans (i.e., to preserve an important export market for China)?

  4. Actually I think such absurd comments are quite common.

    "Second, its economic interest would be served because successful US efforts at rescuing its financial sector could help avert an economic downturn, protecting China’s exports, its growth engine."

  5. What do you think of the role of ratings agencies in all of this? For example, what do you think of this?

  6. I suggest marrying a greek,issue some IOU's then stroll down to the beach and get a tan.

  7. Pani Pani: Well, I basically agree with the article that something needs to be done about the power of rating agencies. I do not necessarily blame the rating agencies themselves. Rather, it is their government supported oligopoloy regime that may be more of a problem. (e.g., pension funds can only invest in certain products rated highly by a limited set of rating agencies...who makes these laws...and do they make sense?).

  8. One part of the answer is that banks in the Eurozone hold Greek government bonds; if the Greek government defaults on its debt, the repercussion to the credibility of the Eurozone’s commercial banks could be shaken; in such a case, member-state Central Banks and the ECB may seek for another costly bailout. Scenarios about banking domino effects are quite popular since the bankruptcy of Lehman Brothers. So, a usual metaphor is “think of the Greek Government as another Lehman Brothers”.

    The puzzle of why Greece can play the role of Achilles’ heel for Europe cannot be completed if we fail to understand the special circumstances surrounding the Greek problem. Since October 2008 commercial banks worldwide have a serious problem: toxic assets. As long as interest rates are low, the toxic-assets problem is well hidden, but it has not been eradicated. And it is a mistake to think that worldwide interest rates can remain low through artificial means only, such as monetary or fiscal policy. If anything, the 2007 crisis has taught us that a steep rise in oil prices can trigger a worldwide increase in demand for liquid assets driving interest rates up. High interest rates will urge banks to sell toxic assets leading to another banking crisis. But will there be resources and tools to bail out banks next time? Markets do not exclude such catastrophic scenarios from their bidding rules, and this is why it takes perhaps a “whisper” to shake the stock value of commercial banks nowadays. A default of the Greek debt would be more than such a “whisper” of disaster for Eurozone banks.
    Given these special circumstances surrounding the Greek debt problem, any scenario with Greece departing from the Eurozone in the short run could cause a banking domino effect, too. So, it is rather annoying to Europeans that they cannot isolate and sterilize the Greek fiscal problem at once.

  9. Another story, apart from credit rating companies is credit default swaps (CDS). Many investors (investment banks, etc.) now hold CDSs, which is insurance in case the Greek, Portuguese, Spanish, etc. government bonds fail to pay back coupons and face values. Yet, the same investors may not hold such government bonds at all. So, holding a CDS for assets you do not hold is similar to having insurance in case your neighbor's house catches fire. Yet, the reason you do that is: if your neighbor's house indeed catches fire (i.e., another bank, well invested in such bonds), then while your neighbor's house is 20% burnt, he will still buy your CDS even for 90% of his house's value in order to minimize damage (save, say, 10% of his investment).

    The tough thing about CDSs (which are the reason spreads go up so steeply) is that in a world where (the legitimate) lack of transparency on the toxicity of assets held by commercial banks is a source of unknown unknowns, anyone can set a government's credibility into flames through news and rumors: "government A won't manage with its fiscal problem, the country will be in political unrest, the recession will last 10 years, the country's banking system may collapse, etc."

    Again, it is important not to forget that in October 2008 we did realize that commercial banks have been misplacing wealth over the course of 13 years: they have been committing the public's savings and future labor efforts households will have to put for private debt repayment into a non-growing stock of houses (housing supply) projecting that housing demand would grow at breathtaking rates and that interest rates would stay low forever. What is worse is that this bubble has been insured in itself through the leverage magic of overcollateralization.

    The misplacing of wealth and its commitment to toxic contracts is not something that will correct itself while the world economy is frozen. You need a new-new economy for these contracts to change signatures without triggering a process that will shake the financial system again. If there is no growth due to something new to invest in, then a simple speculative attack on oil will raise interest rates (there will be at least one for sure: if all expect that oil will be more expensive in the future, either because oil reserves are depleted or because China/India's oil demand continues to grow fast, many will increase demand for oil in futures markets, leading to a self-fulfilling prophecy about oil prices, the same story we experienced in 2007-08). The reason is, the more we depend on (more and more expensive) oil, the higher will be the need for liquidity, which will lead to oversupplying illiquid assets (such as government bonds that will become too cheap). With high interest rates driven by government bond prices, home owners will, again be in trouble having to pay expensive mortgage, and banks will have to resort to foreclosures and auctioning of houses that will devaluate their own assets.

    It seems to me that the only thing that can be done is to go after the new-new economy: to go after developing the electric car (a hug market), or the energy efficient house (which will create jobs by boosting the supply (at least the quality supply) of homes), and it will sterilize houses (and cars) from their dependence on oil. Plus, the real value of houses will go up, which will beef up the non-existent previous (bubble-driven) house valuations that are (still) the ticking bombs in commercial banks' balance sheets...

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  11. we have a nice saying in my country: "The crazy one is not who eats the cake but the one who gave it to him"