[Marxism] Paul de Grauwe: Greece is solvent but illiquid. ECB has caused banking crisis.

Dayne Goodwin daynegoodwin at gmail.com
Fri Jul 3 21:31:14 MDT 2015


Greece is solvent but illiquid: Policy implications
by Paul De Grauwe
VOX, July 3
<http://www.voxeu.org/article/greece-solvent-illiquid-policy-implications>
Centre for Economic Policy Research <www.cepr.org>

[ 10 minute audio interview with Paul De Grauwe
<http://media.bloomberg.com/bb/avfile/News/Surveillance/vCthvJn_uyC4.mp3>
Professor of international economics, London School of Economics, and
former member of the Belgian parliament ]

*Greece’s debt is 180% of GDP, which seems to make it insolvent
without large primary surpluses. This column argues that since
restructuring lowered the interest burden to just 2% of GDP, Greece is
solvent – or would be with nominal GDP growth of just 2%. The ECB’s
misdiagnosis has caused an unnecessary banking crisis. The solution is
to accept that Greek debt is sustainable, so the austerity programme
can be relaxed and liquidity support provided to the Greek banking
sector.*

 . . .
>From the preceding it follows that the effective debt burden of the
Greek government is lower than the debt burden faced by not only the
other periphery countries of the Eurozone but also by countries like
Belgium and France.

This leads to the conclusion that the Greek government debt is most
probably sustainable provided Greece can start growing again.

Put differently, provided Greece can grow, its government is solvent.
 . . .
Austerity is certainly not the way to do it. Greece has been the
champion of austerity with a cumulative increase of the discretionary
primary surplus of 18% of GDP since 2009 (based on Eurostat). This has
been instrumental in producing a cumulative decline of GDP of 25%.
. . .
The ECB follows the Bagehot-principle, which states that the central
bank may lend money only to those institutions that are solvent but
illiquid. The ECB assumes that the Greek government with a headline
government debt of 180% of GDP is not solvent. Therefore it is not
willing to involve the Greek government bonds into its OMT- and
QE-programmes. [Outright Monetary Transactions and Quantitative
Easing]

In contrast, the ECB is ready to buy government bonds of other
countries in the Eurozone, which have a higher effective debt burden
than Greece, both in the context of its OMT- and QE-programmes. The
refusal by the ECB to treat Greece the same way as the other
member-countries of the Eurozone is erroneous and is based on a
misdiagnosis of the nature of the Greek debt.

The misdiagnosis by the ECB matters: An unnecessary banking crisis

This misdiagnosis by the ECB now has dramatic effects on the Greek
banking system, and thus on the Greek economy as a whole. The ECB
takes the view that the Greek banks which hold Greek sovereign debt
are now becoming insolvent themselves, and therefore cannot profit
from lender of last resort activities.

Since the (restructured) Greek government debt is most likely
sustainable, the Greek banks should be allowed to use their Greek
government bonds as collateral to obtain additional liquidity support.

By refusing this, the ECB has caused an unnecessary banking crisis.

This crisis will deepen the recession, increase unemployment and
dramatically deteriorate the Greek government budget, transforming a
liquidity crisis into a renewed solvency crisis. In doing so the ECB
helps keeping Greece in a bad equilibrium. This may force Greece out
of the Eurozone. The ECB would bear a huge responsibility for this
outcome.

Greece is solvent but illiquid: Policy implications

Paul De Grauwe 03 July 2015

Greece’s debt is 180% of GDP, which seems to make it insolvent without
large primary surpluses. This column argues that since restructuring
lowered the interest burden to just 2% of GDP, Greece is solvent – or
would be with nominal GDP growth of just 2%. The ECB’s misdiagnosis
has caused an unnecessary banking crisis. The solution is to accept
that Greek debt is sustainable, so the austerity programme can be
relaxed and liquidity support provided to the Greek banking sector.

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Recent Vox columns on the Greek Crisis
Richard Baldwin

The issue of restructuring of the Greek debt is at the centre of the
negotiations about how to resolve the Greek crisis. Since the start of
that crisis the Greek sovereign debt has been subjected to several
restructuring efforts.

First, there was an explicit restructuring in 2012 forcing private
holders of the debt to accept deep haircuts.

This explicit restructuring had the effect of lowering the Greek
sovereign debt by approximately 30% of GDP.

Second, there were a series of implicit restructurings involving both
a lengthening of the maturities and a lowering of the effective
interest burden on the Greek sovereign debt.

As a result of these implicit restructurings, the average maturity of
the Greek sovereign debt is now approximately 16 years, which is
considerably longer than the maturities of the government bonds of the
other Eurozone countries.

Resulting reduction of interest rate burden

These implicit restructurings have also reduced the interest burden on
the Greek debt, as can be seen from Figure 1, where we compare the
effective interest payments of Eurozone governments as a percent of
their GDP.

We observe that since 2011 the interest burden of the Greek government
has been cut by almost half to reach 4% of GDP in 2014,1 while the
interest burden of the other periphery countries (Ireland, Spain,
Italy and Portugal) increased.

Since during this period the debt to GDP ratio of Greece increased
significantly, this implies that the effective interest burden as a
percent of the Greek government debt declined even more. We show this
in Figure 2.

Since the peak year of 2011 the interest payments as a percent of the
Greek government debt declined from more than 6% to 2.2% in 2014.2

As a result of these implicit restructurings the headline debt burden
of 180% of GDP in 2015 vastly overstates the effective debt burden.
Various estimates based on the net present value of future interest
payments and debt repayments suggest that this effective debt burden
of the Greek government is less than half of the headline debt burden
of 180%.

Figure 1. Interest payments (% of GDP)

Source: Eurostat.

Figure 2. Interest payments as % outstanding debt (Greek government)

Source: Eurostat.

Greece’s debt situation is better than it looks

>From the preceding it follows that the effective debt burden of the
Greek government is lower than the debt burden faced by not only the
other periphery countries of the Eurozone but also by countries like
Belgium and France.

This leads to the conclusion that the Greek government debt is most
probably sustainable provided Greece can start growing again.

Put differently, provided Greece can grow, its government is solvent.

The latter point is important. We show this in Table 1. It presents
the effective interest rate on the government debt and the nominal
growth rate of GDP. The last column presents the difference between
the two. It is well-known that if this difference is positive there is
a dynamics that leads to an ever increasing debt to GDP ratio.3

What is striking is that Greece has the lowest effective interest (r)
burden on its debt but also the lowest nominal growth of GDP (g). As a
result the difference (r – g) achieves the highest value in Greece,
producing an unstable dynamics. Thus, more than in the other countries
the key to stopping this dynamics is to stimulate nominal growth.

If Greece can return to a nominal growth (inflation + real growth) of
only 2% it can stabilise its (relatively low) effective debt burden.

Austerity is certainly not the way to do it. Greece has been the
champion of austerity with a cumulative increase of the discretionary
primary surplus of 18% of GDP since 2009 (based on Eurostat). This has
been instrumental in producing a cumulative decline of GDP of 25%.4

Table 1. Interest rate and nominal growth (2015)

Source: Eurostat and European Commission, Spring Forecast, 2015.

The logic of the previous analysis is that Greece is solvent provided
it can return to relatively low nominal growth rates. Today Greece has
no access to the capital markets except if it is willing to pay
prohibitive interest rates that would call into question its solvency.
As a result, it cannot rollover its debt despite the fact that the
debt is sustainable.5 Thus I conclude:

The Greek government is most likely solvent but has become illiquid.

What are the policy implications of this surprising finding?

The first one is that creditors must stop imposing austerity programs
that assume the debt is still 180% of GDP.

While it may make sense to impose gradually increasing primary budget
surpluses of 1% to 3%, when the debt to GDP ratio is 180%, it does not
make sense to impose such austerity when the effective debt to GDP
ratio is only half that number. When the debt to GDP ratio is 180% a
country has to generate primary surpluses for a long time so as to
reduce the debt to GDP ratio. When the debt to GDP ratio is only half,
the need to reduce it is considerably weakened. As a result, austerity
can be relaxed.

Put differently, given the relatively low effective Greek debt burden,
all what is needed is a programme that would allow to keep the primary
budget balance at its present level (which is close to zero).

Such a programme is likely to generate a higher nominal growth rate of
GDP. As we have seen, a nominal growth rate of 2% would be sufficient
to stabilise the government debt burden.

A second implication of the fact that the effective Greek debt burden
is sustainable has to do with the European Central Bank.

The ECB follows the Bagehot-principle, which states that the central
bank may lend money only to those institutions that are solvent but
illiquid. The ECB assumes that the Greek government with a headline
government debt of 180% of GDP is not solvent. Therefore it is not
willing to involve the Greek government bonds into its OMT- and
QE-programmes.

In contrast, the ECB is ready to buy government bonds of other
countries in the Eurozone, which have a higher effective debt burden
than Greece, both in the context of its OMT- and QE-programmes. The
refusal by the ECB to treat Greece the same way as the other
member-countries of the Eurozone is erroneous and is based on a
misdiagnosis of the nature of the Greek debt.

The misdiagnosis by the ECB matters: An unnecessary banking crisis

This misdiagnosis by the ECB now has dramatic effects on the Greek
banking system, and thus on the Greek economy as a whole. The ECB
takes the view that the Greek banks which hold Greek sovereign debt
are now becoming insolvent themselves, and therefore cannot profit
from lender of last resort activities.

Since the (restructured) Greek government debt is most likely
sustainable, the Greek banks should be allowed to use their Greek
government bonds as collateral to obtain additional liquidity support.

By refusing this, the ECB has caused an unnecessary banking crisis.

This crisis will deepen the recession, increase unemployment and
dramatically deteriorate the Greek government budget, transforming a
liquidity crisis into a renewed solvency crisis. In doing so the ECB
helps keeping Greece in a bad equilibrium. This may force Greece out
of the Eurozone. The ECB would bear a huge responsibility for this
outcome.

*There is a relatively simple solution to the Greek problem*

Accepting that the (restructured) Greek debt is sustainable opens the
door to both a softening of the austerity programme and to liquidity
support of the Greek banking sector. This solution assumes that
creditors accept reality. They must acknowledge that their claims on
the Greek government have a significantly lower value than their face
value. They should make clear to their citizens that the losses were
incurred in the past. Admission of this reality must be the first step
to solve the problem of the Greek debt.

I am aware that this solution creates political problems.

First, politicians prefer to live in a fictional world allowing them
to pretend no losses have been made so that they can hide the truth to
their own taxpayers.

The solution proposed here demands that these governments come out
with the truth.

Second, in order for this solution to be applied the insatiable desire
of some creditor countries to punish the Greek for their misbehaviour
must be overcome.

This moral hazard idea looms large over the negotiations. Given that
the Greek population has suffered so much and has paid a very high
price for past mistakes, it is time to repress these desires to go on
punishing a whole nation.




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