Saturday, October 15, 2011

The Wicked Game

How Greece is being beaten into a pulp to force Europe’s banks to accept capital while keeping Italy et al in awe. 

Reliable sources tell me that the troika has drawn a surprising line on the sand: Either the Greek government agrees to force upon the private sector trades unions an immediate reduction in minimum wages with immediate effect (plus the dismantling of all awards regarding dismissal compensation and limitations), or the next instalment (or tranche) of EU-IMF-ECB loans to Greece will be withheld. Noting that even Mrs Thatcher took years before she could impose her iron will on the trades unions, it is clear that the troika is asking the Greek government to commit to a change that it may be both unwilling and unable to effect. If this is true, two questions arise:

QUESTION 1: Why do the representatives of the Greek state’s creditors gamble the progress of their loan agreement with the government of the day on an immediate diminution of wages and awards that concern the private sector? While the IMF has had a long held fixation with low-er wages (and has never left an opportunity to dismantle collective bargaining agreements unexploited), it is curious that the troika seems prepared to risk derailing an already hugely expensive Greek bail-out for the sake of such an ideological project. Granted that that the troika may think of the present moment as its golden opportunity to beat a demoralised Greek government into total submission (especially given that no Greek state bonds will mature until well into December), a question remains about the troika’s choice of target: Why aim at the already pitifully low private sector wages when there are so many larger fish to fry elsewhere within the Greek state (e.g. public procurements, pharmaceutical bills, fee-free Universities etc.)?

QUESTION 2: The second question concerns the troika’s very thinking: Can they really believe that a wage reduction for the lowest paid European workers (who are vying for this ‘honour’ with their Portuguese counterparts) will, in the midst of a rampant recession, help boost private sector economic activity? Do they seriously think that entrepreneurs will seize upon such a wage reduction to invest in the Greek economy handsomely enough to generate a modicum of growth? As I am loathe to impute inanity on other parties, I shall assume that they cannot possibly believe this. I shall, therefore, give the troika the benefit of the doubt and presume that they, too, understand that a further reduction in private sector minimum wages will (at a time of falling public sector wages and employment) lead to a further, reduction in aggregate demand which will, undoubtedly, maintain (if not accelerate) the current rate at which Greek national income shrinks and, naturally, generate lower future taxes, thus giving the remorseless wheel of recession another twirl.

If my assumptions above are correct, what on earth is the troika doing? Here is a scenario that I think captures nicely, in all its horror that is, much of what is going on at the moment. Three are the main protagonists in my scenario: (1) European bankers (mainly French and German), (2) the German government, and (3) the NYF member-states, where NYF stands for ‘not yet fallen’ (which includes mainly Italy but also Spain and perhaps Belgium). Having established who the players are, it is important to define their objectives and constraints.

BANKERS: The bankers know well that their banks are bankrupt. They have known it for some time  but have been hoping that the European Central Bank, together with their national governments (made up of politicians who truly value their cosy relation with the bankers), would keep their banks afloat and themselves in control of their banks. Unlike most businessmen/women who labour under the fear of bankruptcy, bankers face a different nightmare (since bankruptcy in fact increases their command of the surpluses produced by others, courtesy of the politicians’ infinite generosity with the taxpayers’ and the ECB’s money): Forced recapitalisation, is their worst-case scenario – of the sort that the American government introduced in conjunction with TARP (the trouble assets relief program). They fear a Euro-Tarp (of the type that we proposed in our Modest Proposal a year ago – see Policy 2) for the simple reason that recapitalisation of ‘their’ banks means that the bankers will lose the part of equity which has hitherto delivered to them control over the banks.

NYF member-states: Waiting on the sidelines, unable to utter a world (in case loose talk brings them greater disasters than their current situation), they are holding their breath hoping against hope for some decision from Berlin that might get them off the hook. With the bond markets treating them like the new pariahs, Italy, Spain and Belgium find themselves in a tight corner. They are damned if their do not adopt swinging cuts (since ‘inaction’ will be perceived as fresh evidence that their spreads will rise) and they are damned if they do (since austerity will further erode their nations’ anaemic growth; a development which will also push up interest rates). Deep down, their remaining hope revolves around some scheme that will see their sovereign debt come down in size, if not via a haircut then at least by means of a reduction of the interest payments due in the coming decade.

GERMAN GOVERNMENT: Berlin’s main concern is how to manage this crisis by means of minimal European integration. It disdains the idea of any type of continental consolidation which threatens the Principle of Perfectly Separable Debts (PPSDs, as I call it). After a long eighteen months during which Germany’s political elite struggled to remain in denial of the systemic nature of this Crisis, Mrs Merkel now seems resigned to the idea that the banking sector of Northern Europe (including of course Germany’s) is in tatters and in urgent need to capital infusions. German politicians seem to have grasped the importance of the fact that the liabilities of the eurozone’s banks is more than 300% the eurozone’s aggregate GDP (Nb. the relevant ratio in the United States, in 2008, was ‘only’ 200%). After a lot of huffing and puffing, Mrs Merkel and Mr Schaeuble have accepted the inevitable: About one trillion notional euros must be set aside for the banks. While they have not swallowed, as yet, that this must be done at the central EU level (as opposed to a government by government level), they are getting there, kicking and screaming of course. Two are sticking points for Germany: It does not want to refloat the banks (for the second time in three years) and have to pay Greece the money that Greece owes to the banks. In short, a Greek default is a political prerequisite for what is becoming a serial bailout of the Franco-German banks. The second sticking point is Italy and, more generally, the NFY member-states: Germany fears that if the NFY member-states see that Greece is allowed to diminish its debt mountain through a default that still allows it to remain within the eurozone, they may get ideas that a similar solution may be in the offing for them.

THE EMERGING STRATEGY: Germany knows that the banks will resist recapitalisation as long as Greece is being kept afloat by the troika. To gain leverage over the recalcitrant bankers, Berlin must push them over the edge with a Greek default. But, at the same time, to stop Italy and the remaining NFY member-states from getting dangerous ideas in their head, Mrs Merkel is determined to make an example of the one member-state that is allowed to default: Greece. It is for his purpose, and for reasons that have nothing whatsoever to do with Greece itself (its economy, its much needed structural change etc.) that the troika has embarked on a mission to make Greece so wretched, so poor and so unattractive that its default will give Berlin the bargaining power it needs with Northern European bankers while, at the same time, making it abundantly clear to the NFY member-states that they really do not want to even think of default as a way out of their debt crisis.

THE CATCH: This strategy might have worked if the Crisis were additive, quasi-linear and static; if it were possible, in simpler words, to use plain arithmetic to add Greece’s debts with other bad assets inside the banks’ books, then to juxtapose this sum against the (possibly leveraged) funds that the EFSF can throw at the banks, and so on… until this most peculiar Crisis Accounting yielded Germany’s optimal strategy. Unfortunately for all of us, no capital ‘c’ Crisis is  additive and quasi-linear. It is, rather, highly non-linear and violently dynamic. The attempt to ring-fence Greece will fail as surely as it did last year. Last year, in May 2010, the very creation of the EFSF was meant to ring-fence Greece on the basis of a linear, static logic. Unremarkably, it failed. Now, the great idea that Mrs Merkel seems to have accepted is to try again by turbo-charging the toxic EFSF (e.g. by using ECB leverage to turn its €440 billion into more than €1 trillion). What this stratagem is ignoring is that the problem with the EFSF type of approach (based as it is on the assumption that each country’s woes ought to be dealt with separately/sequentially – as opposed to at once, systemically) is not the size of the EFSF but its structure and logic. That byturbo-charging a toxic creation you get a monster.

In short, the plan seems to be to let Greece default in a big way, so as to scare the bankers into accepting new capital, while, at once, grinding the Greek social economy into a pulp to keep Italy and the rest of the NFY member-states in awe and keen to do as they are told. Our collective tragedy is that this plan, like all the others before it, will not work. Why? Because, like all the previous plans, it does not address the eurozone’s systemic Crisis systematically. Because, once again, the powers that be choose to ignore the interconnections between: (a) the banking sector’s insolvencies, (b) the lack of fiscal shock absorbers in case there is a run on the bonds of one or more member-states, and (c) the absence of a decent surplus recycling mechanism that directs surplus into deficit regions in the form of productive investments. As long as this form of  European denial remains, Greece’s reduction to a pile of ashes will only lead Mrs Merkel to a Pyrrhic victory over the banks. 

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