Provopoulos, the governor of the Greek central bank has just done a speech which sounds eerily like the words you expect come from Yanis Varoufakis, a proud socialist.
Before I get into the nitty-gritty you must watch this video to really understand the dynamic of the Euro and what really happened.
I’ll highlight the errors in Provopoulos’s speech piece by piece. After watching the above video you probably don’t need to listen to me but I’ll go ahead anyway.
He gets off to a good start by stating something which is correct – “as David Marsh points-out in his book on the euro, European monetary union was undertaken to make the kind of crisis that occurred impossible. ”
He continues hitting the nail on the head – “The dominant view at the founding of the EMU was that current-account imbalances among countries in the monetary union would become as irrelevant as they are among regions of individual countries. ”
Just like the poorest regions of England use the same currency as City of London bankers, so can countries with varying wealth.
So that is Provopoulos’s introduction to the Euro and then the wheels come of his speech completely.
“The markets mis-priced credit risk, ” – okay, but how? As Baguss explains in the video, the markets mispriced risks because the ECB was monetising the debts of governments which should not have been able to borrow. ie Greece,Italy,Spain. The exact same thing is happening in the USA now.
He continues to blame the markets for reading the signals that the ECB and the central banks were putting out
The reduction in spreads led to a relaxation of the budget constraints that the peripheral countries faced and made it difficult to distinguish between those countries that were performing well in terms of policy adjustment and those that were performing poorly.
To make matters worse, the current-account deficits in the periphery were financed through sources of volatile capital, such as debt securities and bank loans, rendering the periphery vulnerable to sudden reversals of capital flows.
Again, all this capital that the Provopoulos is talking about was financed by the ECB and the central banks.
He then moves on to criticise the people who founded the Euro
Third, the founders of EMU underestimated the importance of financial stability in a monetary union. Thus, whereas they focused on the prevention of fiscal imbalances and inflation, they made no provision to deal with private credit booms and busts or with the feedback loops between banking crises and fiscal crises.
Booms and busts did not start with the Euro and if anything the Euro would have reduced the size of booms and busts if the ECB were not pumping money into governments that could not afford it.
The banking crises in the Eurozone have come from banks buying government debt and selling it on to the ECB. Again, the governments were only able to run up this debt because the ECB was willing to pay cash for their bonds.
The fiscal crises are an inevitable consequence of what happens when you lend more money to someone than they can afford to pay.
If the founders of the Euro are guilty of anything it is in thinking the ECB would act normally and rationally.
He then goes on to blame the national governments
Under the original architecture, national authorities were solely responsible for banking supervision, resolution, deposit insurance, and financial stability.
Okay, this is the same situation as before the Euro. I fail to see his point.
The combination of a lack of adequate fiscal rules, the absence of market-enforced discipline, the lack of attention to the interconnections between the banks and the sovereign, and increases in public and private indebtedness financed by volatile capital inflows was toxic.
This sentence is extremely rich considering it is coming from the head of the organisation that was bypassing the “market enforced discipline” by printing money! And yes, the printing of money was toxic!
And I am not sure how he can say there was a “lack of attention to the interconnections between banks and sovereigns”. The banks and the sovereigns were directly dealing with each, where was the lack of attention? He cannot say the lack of attention was coming from central banks because they were the ones monetizing the debt the banks had just bought of government.
He must mean the “market” was not paying attention. Just like in the USA now.
Broadly speaking, the euro-area crisis has consisted of two separate crises — a sovereign-induced crisis and a banking-induced crisis, as I will explain. A sovereign debt-crisis mainly occurred in Greece.
What the crisis countries — Cyprus, Greece, Ireland, Portugal and Spain — have had in common was large current-account deficits prior to the crisis. In the run-up to the outbreak of the crisis, Ireland had a current-account deficit of around 5 per cent of GDP. That was small relative to those of the other crisis countries. In Cyprus, Greece, Portugal and Spain, the deficits ranged between 12 and 15 per cent of GDP.
He makes a good point but it also takes him back to something he said at the start. There is no reason why countries using the same currency will be different to using the same currency between regions inside a country.
As money flowed out of the countries the cost of living in these countries would reduce. The price of food, energy and housing would reduce as there is less money chasing them and manufacturing inside the country would become more attractive as land, wages and energy dropped in price. You can see this today with Greek businesses relocating to Bulgaria and Romania.
Just like the a pound buys you more in the north of England than it does London. So a Euro would buy you more in Greece than in Germany.
The initial tremors of the euro-area crisis occurred in Greece in the fall of 2009 following news that the country’s fiscal deficit would be much higher than had been expected by the markets. The country suddenly found itself at the center of a sovereign-debt storm, and interest-rate spreads began a relentless upward climb. The outbreak of the Greek sovereign-debt crisis took the markets by surprise. It should not have done so.
It was not a surprise to the “market”.
What surprised the market was that the central banks would leave the country high and dry. But now Draghi has said he will do everything it takes so we are back to square one, back to the policies that created the problems.
Greece joined the euro area in 2001. From that year until 2009, large and growing fiscal and external imbalances should have sounded loud warning alarms in the financial markets.
Funded in large part by the massive expansion in government, again, bank rolled by the ECB. The ECB and the central banks created the imbalances, as Provopoulos stated, the problems should have not have surprised the market and they did not. The markets knew Greece was a basket case but the “market” was not the one sending out the signals that everything will be okay.
You see the same thing happening in the USA now.
Investors see that The Fed is prepared to print as much money as required and investors are putting their money into the stock market based on this information. When The Fed pulls out to stop inflation, the USA will have the same problem as the Greek government.
To illustrate my point Provopoulos says the following
The widening of the fiscal deficits was mainly expenditure driven; the share of government spending in GDP rose by 9 percentage points — to 54 per cent.
The share of government debt in GDP rose from about 100 per cent at the beginning of the period to 130 per cent at the end of the period.
And when you have money flowing into the country for no good reason ie no productivity gains, you have inflation in everything including labour costs.
Greece’s competitiveness, measured in terms of unit labour costs against those of its major trading partners, deteriorated by 30 per cent.
The erosion of competitiveness, coupled with growth rates generated by consumption and an unsustainable fiscal expansion, led to a widening of the current-account deficit.
So Provopoulos understands what happened and what the consequences were but you can not expect the governor of the Central Bank of Greece to admit his bank and the ECB were the ones that caused the entire problem.
Provopoulos then turns into the Monday morning quarterback
Upon becoming Governor of the Bank of Greece in 2008, I began to publically warn the government — in not very subtle terms — that it needed to urgently take measures to address the fiscal and external imbalances. My warnings were overlooked.
So he could see that the government was spending well above its means but for some bizarre reason he could not see where the money was coming from. Maybe The Ben Bernank/Yellen will say the same thing “we were buying billion of dollars of US debt in order to keep the government afloat but we never imagined that the resulting low bond prices allowed the government to borrow even more”
What am I saying? The Fed is probably going to say the same thing come judgment day.
Provopoulos then takes the biscuit
Once the crisis started in late 2009, it rapidly became self-reinforcing. The sovereign-debt crisis spilled over to the banking system, even though the banking sector had sound fundamentals
So he was warning the government had massive debt problems at the beginning of 2008 and yet he did not realise that the banks in Greece had billions of Euros of this debt on their books???????????
He must believe this is the case because he says the Greek banks had “sound fundamentals”!!!
As a result of the crisis, over the period from the end of 2008 until the end of 2013 real GDP contracted cumulatively by 25 per cent, intensifying the debt dynamics and contributing to the self-reinforcing nature of the crisis.
Yes the GDP contracted and banks stopped lending money. I am not sure who the largest banks in Greece hoped were going to pay off existing loans. If they did not continue to lend money into the system there would obviously be less money available to pay off the old loans.
When you look at it this way, the largest banks in Greece compounded their own problems by not continuing to lend money. You could say they did it and are doing it deliberately because even if you have an A1 credit rating and assets, more than likely you still can not get a loan in Greece.
Provopoulos then changes the direction of his speech and starts to drive at an agenda
To explain why this happened, consider the following difference between banks in the United States and those in the euro area. Although the largest banks in the euro area and the United States are of roughly the same size in terms of euro-area GDP and U.S. GDP, respectively, the largest euro area banks represent a much larger share of any individual national economy compared with the situation of U.S. banks.
I think what he is saying is that Germany’s largest bank is close to the same size the largest bank in the USA. The difference being the German bank is largely confined to within German borders, at least when it comes to the location of its branches.
Okay, but the banking crises was not about high street lending, it was about investing in derivatives worldwide, like it still is.
Investing in derivatives is a multinational activity so the location of the banks is completely irrelevant. After all, the US banks had just a big a problem as the European banks so again, I struggle to see the point Provopoulos is trying to make.
Consequently, banking crises in individual euro-area countries placed large fiscal burdens on governments, calling into question their solvency and making the use of counter-cyclical fiscal policy infeasible.
What exactly does he propose? Would he prefer Greeks bore some of the responsibility for problem with German banks despite the fact that the German banks do not lend to Greeks as per his point of German banks not having a presence in Greece? Or would he simply prefer the banks were smaller?
A crisis-induced economic adjustment
The euro-area crisis served two vital purposes. First, it acted as a wake-up call to policymakers in economies that had become uncompetitive. Second, it brought to the surface fundamental weaknesses in the EU’s institutional structure.
He is certainly correct on point one and certainly wrong on point two.
The Euro exposed the weakness in government’s ability to manage their own finances without the helping hand of inflation.
Make no mistake, in Greece, the only difference the Euro made was stopping the 20% annual inflation. The Greek government needed this inflation to keep afloat. The Euro took away the rampant inflation and showed that the emperor had no clothes.
There was no weakness in the Euro system. Ultimately the market was forcing the government in Greece to reform. The Troika and the ECB are not helping the situation by keeping the Greek government afloat.
It is ironic that the ECB was the source of the problems in Greece and when the opportunity came to force the Greek government to reform the ECB stepped in again and stopped that from happening.
The ECB has a track record of doing exactly the wrong thing.
Provopoulos then goes on to pat the Greek government on the back for doing something that would have happened anyway if it had defaulted.
Consider, first, fiscal adjustment. From 2009 to 2013, the fiscal deficit was reduced by some 13 percentage points of GDP. The structural fiscal deficit — that is, the deficit that corrects for the business cycle — has shrunk by 19 percentage points of GDP. The primary fiscal deficit — that is, the deficit that excludes interest payments — was 10½ per cent of GDP in 2009. Last year it swung into a small surplus. What makes these achievements especially impressive is that they have taken place despite a contracting economy, which creates moving targets for fiscal consolidation.
Again, the “elites” use the “primary surplus” when referring to the government’s finances because if they included interest the world would realise the Greek government still has the same problems as before, except now the government is giving money to foreigners instead of giving back to Greek taxpayers because of massive interest payments.
And I also like the way he says the Greek government has achieved something. The only thing the Greek government has done is increased taxes and cut the money it gives to the oldest people in Greece.
This is not an “achievement” to be proud of. An achievement would be the government not raising taxes, cutting the workforce and paying the pensions it promised it would.
The achievements in Greece have been the achievements of the Greek taxpayer and the Greek citizen. Thank god the Greek government can force people to pay higher prices for an inferior product because we all know what would have happened if Greeks had a choice!
He then goes onto to say how the Greek government is going to cut the workforce this year
The new measures place emphasis on expenditure cuts to reduce the size of the government sector and allow the tradables sector to expand, so that exports can help generate growth.
He obviously did not see this headline
The speech then turns to fantasy
Since 2010, the situation has been reversed. As of the end of last year, the entire loss — and more — had been recovered. Competitiveness is also being promoted through structural reforms which have increased the flexibility of labour and product markets.
There has been no structural reforms in the labour market. And as of now, there have been no structural changes in the product market.
The cost of labour may have reduced slightly but not because of any reforms of the government because of the rate of unemployment. The competition for jobs has allowed employers to pay the minimum allowed.
If a high unemployment rate is the way Provopoulos recommends to lower the cost of labour, then yes, mission accomplished!
The contrast to this lower labour cost is the higher cost of living. So Greeks are being paid less and yet the cost of living has increased massively. On a cost as a percentage of income basis the cost of living has doubled if not more.
As a result of these improvements in competitiveness, a rebalancing of the Greek economy is taking place. The share of exports of goods and services in GDP rose from 18 per cent in 2009 to 28 per cent last year. This share continues to rise. The current account, which was in deficit to the tune of 15 per cent of GDP in 2008, moved into surplus last year.
It is interesting that Provopoulos choses to frame the trade deficit/surplus in percentage terms rather than in nominal terms. Could it be that the Greek trade account has balanced not because of increased Greek exports but because of reduced imports due to the population having less money to spend?
Two factors about the improvement in competitiveness stand out. First, it has been achieved without the benefit of a nominal exchange-rate devaluation. Reflecting extensive labour-market reforms, it has been based on reductions in unit labour costs — an internal devaluation.
Provopoulos has addressed point one twice already. As he stated at the start, the exchange rate is irrelevant. Again, I am not sure why he brings it up.
All the increases in competitiveness has come from the private sector to say the rise in competitiveness has come from “labour” market reforms is an insult to the Greek taxpayer and business person. Labour reforms have NOT happened in any meaningful way that would explain lower wage costs.
As I have stated above, the Greek government has become massively less efficient than it was in 2008. The government now takes much more in taxes and gives much less back to the taxpayer. This is a text-book definition of a reduction in efficiency.
The banking sector
Let me now turn to the restructuring of the Greek banking system. It has been enormous. With the deepening of the crisis, the Bank of Greece stepped in to preserve banking system stability. Our efforts focused on two fronts:
• Preserving banking system liquidity, and
• Restoring capital adequacy.
Ample liquidity was provided to banks, both through monetary policy operations and emergency liquidity assistance.
Personally I question to the actions of the Greek Central Bank. The Greek banks, in the name of the crises, can now get money from the ECB instead of having to make loans to the population of Greece. What motivation do the Greek banks have to carry out their prime purpose, ie lend to people and businesses
Non-viable banks, which were unable to raise private capital, were resolved,
Before the crisis, the Greek banking system comprised almost 20 banks. Today we have four well-capitalized, viable pillar banks and a few smaller ones.
Give that Provopoulos has already said in his speech that big banks in a small market are a big problem in the European Union, it is confusing to then hear him say that having four mega banks instead of 20 smaller banks is a good thing.
It is also interesting to note that every single one of the 20 smaller banks were deemed unviable.
This stage involves a new banking model that will allow banks to repay state aid and finance the recovery of the Greek economy. Having acquired the clean portfolios of resolved institutions.
This is slightly bizarre. Provopoulos is now stating that the unviable banks and had some “clean” portfolios. If only part of the business was viable, what happened to the bad parts of these portfolios?
A “code of conduct” for banks’ dealings with distressed borrowers is being drawn up and will be implemented as of 2015. It has two objectives: first, to ensure the maximum repayment of non-performing loans; second, to alleviate pressures on borrowers whose ability to repay their debts is at present reduced.
One can only imagine what “alleviate pressure” means. Perhaps it goes like this “let me alleviate the pressure by taking your house”. Again, a subject that I have discussed before
Experience shows that fiscal consolidation programmes based on spending cuts lead to smaller economic contractions than those based on tax increases.
Again, something else that is interesting, not a month ago Provopoulos was quoted as pushing the government to increase taxes.
For this reason, I have been calling for fiscal adjustment comprised of two-thirds expenditure cuts and one-third revenue increases — mainly generated by expanding the tax base — since the inception of the programme.
And yet having said in the previous paragraph that tax increases were less effective than government spending cuts he condones tax increases again. Either tax increases and counterproductive or they are not.
Another point to note is that Provopoulos does not specify what form spending cuts should take. Given the massive variety of ways that governments spend money, surely this point is worth clarifying. I suggest he read this article if he is having trouble identifying what government cuts are effective and which are completely counter productive.
Presently, the debt-to-GDP ratio stands at about 175 per cent and it is projected to decline to 110 per cent in 2023
He does not hint at where this money is going to come from. I have highlighted the absurdity of the 175 and 110 figures before.
If the government is cutting its spending inside the country, if interest payments on the government debt is due to increase and if bank lending flatlines rather than fall as it is now, where exactly does he imagine the money is going to come from to pay for this cut in debt? Or perhaps this is where a Greek bail in would come in.
Initiatives at the EU level
What about the policy responses to the crisis? They have included actions in both the ECB’s monetary policy and in EMU’s architecture.
The actions of the ECB have been decisive. The ECB has kept policy rates at historically-low levels; it has satisfied the liquidity needs of banks
ECB keeping rates historically low and printing money to give to banks. This is an initiative? Provopoulos has not been paying attention. These are the exact same measures that created the Euro crisis in the first place.
Banking union is being designed to break the negative feedback loops between banks and the sovereign, as well as to create an integrated, stable and well-capitalised banking sector. The Single Supervisory Mechanism, which will become fully operational this November, will lead to the transfer of the supervision of almost 85 per cent of total euro-area bank assets to the ECB.
85%? Of “assets”. That sounds like a lot to me.
I would like to offer some concluding remarks. For too long, the countries at the euro’s periphery sacrificed long-term gains for short-term gratification. We have seen the results.
Yes but where did the periphery governments get the money for this short-term gratification? You know the answer.
The twin deficits have been transformed into twin surpluses.
Again, if you exclude interest payments on the massive debt, then yes…..
Greek citizens, like the citizens in the other crisis countries, have had to undergo tremendous sacrifices during the past few years. These sacrifices are now bearing fruit
If you hold Greek government debt, it is bearing fruit. If you’re a Greek citizen having a hard time paying your taxes and you see that the government is planning to increase taxes even further I think it would be hard for you to say your sacrifices/achievements are bearing fruit.
Greeks need to remember that Provopoulos thinks that the government can reduce its debt from 175% of GDP to 110% of GDP by 2023. That is a 117 billion Euros as of today.
As I mentioned earlier this money is not going to come from inflation and it is not going to come from an increase in bank lending.
The 117 billion Euros is going to be extracted from the Greek taxpayer. 117 billion divide by the 10 million population of Greece comes to 11,700 Euros per person, or 1,170 Euros per man, woman and child every year for the next 10 years.
Now you may think that sounds realistic but remember that reduction in government debt does not include the taxes that Greeks already have to pay to cover the interest costs and to keep the government afloat.
Greeks do however have 160 billion Euros in the bank, can anyone say bail in? And yes, if I were invested in Greek government debt the thought of those bank deposits may have me salivating slightly.