Topic: Finance, Banking & Monetary Policy

Greek Marxists versus the IMF

With the failure of the Greek government to make a scheduled payment to the International Monetary Fund (IMF), we have moved from high drama to low farce. The Marxists who are running the show in Athens have scored a first: Greece is the first so-called advanced economy to miss an IMF payment in the Fund’s 71-year history.

It was all so predictable. The Marxists in Athens did what Marxists do: they ramped up the rhetoric. Yes, the IMF became a “criminal syndicate,” certainly not the type of organization that the current Greek government would dare to pay.

As for the IMF, it drew a line in the sand after realizing that it had been way too lenient and generous with Greece. Under normal conditions, the IMF is supposed to be limited to lending up to 200% of a country’s quota (each country’s capital contribution made to the IMF) in a single year and 600% in cumulative total. However, under the IMF’s “exceptional access” policy there are, in principle, virtually no limits on lending. For example, the loan made to Greece in May 2010 was worth an astounding 3208% of Greece’s quota – by far the highest percentage recorded for a loan made to any member country.

So, the high drama of the past few months had to end in a farce – and it has.

Greece Is Being Taxed to Death

American news stories about the Greek financial collapse frequently echo complaints of government employees and their supplicants about “budget cuts.”  In reality, Greek government spending rose from 44.6 percent of GDP in early 2006 to 54 percent in 2010 and 59.2 percent in 2014 (although this is partly because private GDP fell even faster than government spending).  Military spending is particularly lavish in Greece, second only to the United States within NATO as a percentage of GDP.  

What is rarely mentioned in all the one-sided confusion about “austerity” is the other side of the budget–namely, taxes. 

As if Greece didn’t have enough troubles, the Troika (International Monetary Fund, European Commission and European Central Bank) has promoted capital flight and a brain drain (exodus of skill and talent) by offering more and more loans to Greece in exchange for an increasingly suicidal blend of brutal taxes on both labor and capital.  The table shows what happened to key Greek tax rates in the past few years. 

  Current Previous
Corporate Tax Rate 26.00 20.00
Personal Income Tax Rate 46.00 40.00
Sales Tax Rate (VAT) 23.00 18.00
Social Security Rate 42.01 29.05

Greece: Central Government Bloat

It’s hard to find anything written or spoken about Greece that doesn’t contain a great deal of hand wringing about the alleged austerity – brutal fiscal austerity – that the Greek government has been forced to endure at the hands of the so-called troika. This is Alice in Wonderland economics. It supports my 95% rule: 95% of what you read about economics and finance is either wrong or irrelevant.

The following chart contains the facts courtesy of Eurostat. The central government in Greece is clearly bloated relative to the average European Union country. The comparison is even starker if you only consider the 16 countries that joined the EU after the Maastricht Treaty was signed in 1993. To bring the government in Athens into line with Europe, a serious diet would be necessary – much more serious than anything prescribed by the troika.

Central Government Exenditure Per Capita

It’s Time To Add More Than A Second

To avoid clock drift, the world’s computer clocks will gain an extra second at midnight Greenwich Mean Time, as June turns to July. This adjustment is necessary so that computer clocks can remain synchronized to Universal Time and to the time it takes the earth to rotate around the sun. Don’t worry, you probably won’t notice anything. But, since it takes milliseconds to make a flash trade, the one-second adjustment allows for enough time for problems to arise.

And speaking of time, let’s go beyond the leap second adjustments, and consider meaningful time reform. Since January 2012, my Johns Hopkins colleague Prof. Richard Conn Henry and I have advocated abolition of all time zones, as well as of daylight saving time, and the adoption of atomic time — in particular, Greenwich Mean Time, or Universal Time (UTC), as it is called today. The embrace of UTC would be beneficial.

For example, the adoption of UTC would give new flexibility to economic management in the vast east-west expanse of Russia, for example: everyone would know exactly what time it is everywhere, at every moment. Opening and closing times of businesses could be specified for every class of business and activity. If thought desirable, banks and financial institutions throughout the country could be required to open and to close each day at the same hour by the UTC. This would mean that bank employees in the far east of Russia would start work with the sun well up in the sky, while bank employees in the far west of Russia would be at their desks before the sun has risen. But, across the country, they could conduct business with one another, all the working day. This would have a second benefit: at least in the far east and far west, the banks would be open either early, or late, convenient for those who are working “sunlight hours,” such as farmers.

With UTC, agricultural workers, critically dependent on the position of the sun, could rise with the sun, without producing any impact on other aspects of cultural and economic life. The readings on the clocks would be the same for all. But, times of work would be attuned with precision to Russia’s local and national needs. China already has adopted a single time zone for the same purposes. And all aircraft pilots, worldwide, use UTC exclusively, for exactly the same reason that we are advocating its broad adoption, as well as for obvious safety reasons.

Greece: A Financial Zombie State

Banks in Greece will not open their doors Monday morning. Greece has been moving towards this dramatic final act ever since it was allowed to enter the Eurozone with cooked fiscal accounts in January 2001 – two years after the euro was launched. One Greek government after another embraced the idea that it did not have to rein in fiscal expenditures to match revenues because Brussels would cover any shortfalls. That idea appeared to have worked, until other members of the Eurozone realized that the entire European project would fall apart if it became a transfer union.

This realization was brought into sharp focus by the bailout demands of Prime Minister Alexis Tsipras and his left-wing coalition government. Brussels finally realized that if the demands of the Tsipras government (read: Europeans must pay for Athens’ largesse) were met, the Eurozone would morph into a giant moral hazard zone. So, Brussels was forced to throw down the gauntlet: enough is enough.

Where does Athens go from here? Well, to quote former President George W. Bush, as he observed the unfolding financial crisis in 2008: “If money doesn’t loosen up, this sucker could go down.” Well, “W” had a point. Changes in the money supply, broadly determined, cause changes in nominal national income and the price level.

Since October 2008, until the Syriza party took power, the broad measure of the Greek money supply (M3) contracted at an annual rate of just over 6%. And as night follows day, the economy collapsed, shrinking by over 25% since the crisis of 2008.

Since the Tsipras government took the helm, the monetary contraction in Greece has accelerated. This means that a Greek depression of even greater magnitude is already baked in the cake.

And that’s not all. It is going to get worse. The total money supply (M3) can be broken down into its state money and bank money components. State money is the high-powered money (the so-called monetary base) that is produced by central banks. Bank money is produced by commercial banks through deposit creation. Contrary to what most people think, bank money is much more important than state money. In Greece, for example, bank money makes up just over 84% of the total money (M3) supply.

With banks so wounded, Greece is destined to become a financial zombie state.

Speaking of Greece…

If you think that the Fed isn’t involved in the Greek mess, you may want to think again. Paul-Martin Foss, our good friend at the Carl Menger Center, wrote a very nice post a few days ago concerning how the Fed may be getting itself tangled-up in an impending Greek default, through its swap lines with the ECB.

According to the Federal Reserve Board of Governors, those swap lines were first established in December 2007 “to improve liquidity conditions in U.S. and foreign financial markets by providing foreign central banks with the capacity to deliver U.S. dollar funding to institutions in their jurisdictions during times of market stress.”

Those original swap facilities, never meant to be permanent, were shut-down in February 2010. But — wouldn’t you know it? — similar facilities were announced in May 2010 in response to “the re-emergence of strains in short term funding markets in Europe.” Those facilities were also supposed to be temporary, but then, in October 2013 — what do you know! — they were made permanent. According to the Fed, that step

further supports financial stability by reducing uncertainties among market participants as to whether and when these arrangements would be renewed. This action results from the ongoing cooperation among these central banks to help maintain financial stability and confidence in global funding markets.

What has all this got to do with Greece? Here is Paul-Martin:

If you want to get a sense of the Fed’s involvement in Europe, watch the swap lines. Swap line data is published every Thursday afternoon on the Fed’s balance sheet, the H.4.1 release. If you look at the St. Louis Fed’s charts and data on swap lines, you’ll see the huge amount of swaps during the financial crisis, and then a smaller but still significant increase in swap lines during the first iteration of the Greek financial crisis back in 2012. While swaps have been relatively non-existent this year, there was a small blip back in April, likely Greek-related, and more importantly, another blip this week. While the amount, $114 million, is a drop in the bucket compared to what it has been in the past, this number needs to be watched. It could very well be an indicator of the Fed getting involved in Europe again. And if the doomsday scenario ends up taking place next week, expect that $114 million figure to skyrocket. The Fed seems to want the conversation to revolve around a possible upcoming interest rate hike, so it’s been relatively silent on the topic of Greece and its involvement in bailing out Europe. But even if the Fed doesn’t say anything about Greece, its money-printing to pump up the swap lines will do plenty of talking.

That was on June 19th. Well, the CMFA’s champion Fed watcher, Walker Todd (who you will be hearing from shortly on these pages) has been keeping a sharp eye on those swap lines. On June 11th — a week before the transaction showed up on the Fed’s own H.4.1 release — Walker reported that “Someone in Europe drew a small amount on a dollar swap with FRBNY”:

ECB website today has details below on a swap line drawing this week against the US dollar swap line with FRBNY. It says that there was one bidder; one wonders whom. Amount is $113 million. There has been no swap line activity for several months now. These numbers should show up on FRBNY next week (due to timing of swap drawings and time zone differences, there usually is a one-week lag between a drawing in Europe and the FRBNY report of the same drawing).

(The $1 million difference between the numbers mentioned by Paul-Martin and Walker reflects a Bank of Japan draw of that amount.)

The day after Paul-Martin’s post came out, Walker alerted us to another transaction that had not yet been reported by the Fed:

It won’t show up until next week in Fed statistics, but ECB statistics show that an unnamed entity (one suspects the same one as last week) borrowed again for a week under the dollar swap line for $115 million. The drawing was $113 million the last time I checked. As a purely hypothetical example, a Greek bank could be borrowing dollars under the swap line. Other than a token $1 million to $2 million that Bank of Japan borrows from time to time to reassure itself, this is the only borrowing outstanding under the Fed’s swap line, according to FRBNY statistics. The notable thing is that it is still there and growing.

Today the swap was rolled over yet again.

Stay tuned…

[Cross-posted from]

Europe’s Hard Choice

In Monday’s Financial Times, columnist Gideon Rachman presented a grim outlook for Greece and the European Union. He argues there are no good outcomes. There are three options. First, the EU can make concessions to Greece. Second, the EU can stand firm and allow Greece to leave the Euro. Third, the Greek government can accept the EU’s terms.

The first option represents a near-term victory for the Greek government. It also creates moral hazard within the broader EU. Governments in other countries implementing austerity measures would come under pressure. Populist parties would make further electoral gains across Europe. Consensus rule within the EU would become impossible.

It is feared the second route would put pressure on other countries, e.g., Spain and Italy, viewed as being vulnerable to the economic woes besetting the Greeks. That is an argument for “contagion.”

The third outcome may offer no long-term solution. Even were the Greek government largely to accept what the EU, the ECB and the IMF want to impose on it, that would likely not solve the Greek problem in the long run. Greece’s debt level would still likely be unsustainable. It is not clear that any government can implement the far-reaching economic reforms needed to put the Greek economy on a sustainable growth trajectory.

Richman’s analysis is cogent, if bleak.