Greece should leave the Euro, but for jobs, not to get away from the vultures

In a lengthy response to Ann Pettifor's call for Europe to abandon the Euro's "fetters of gold", the author disagrees with almost everything, except for the conclusion that Greece should leave the single currency

Michael Bullen
6 June 2012
It is a tried and tested formula on openEconomy to win approbation by beating up the private sector, in particular private sector investors, but I wonder if it is entirely clear that Ann Pettifor's support for "convergence, prosperity, unity and peace" (is there anyone who does not want the latter three?) and call for an end to "anti-Gold Standard-type policies" is her way of saying that Greece should leave the eurozone? And if Greece, why not others?

Ms Pettifor's article initially focuses on the dangers of moral hazard, ie where the risks of investments are taken by parties other than investors. In respect of the eurozone crisis moral hazard was first seen when the Irish government had its arm bent into guaranteeing that Irish bank debt investors, including numerous German, Swiss and other mainly continental European banks and hedge funds, would get their money back. Remarkably, those investors were not even expecting to get all their money back, but Euro-politicians, supported by the ECB, made clear that they would rather make bailout loans to Ireland than have to bail out their own domestic banking systems.

The €436m Greek repayment that Ms Pettifor specifies is a very different case. €436m was paid to private creditors - Ms Pettifor identifies that 90% was paid to one investment firm - who earlier had refused to take part in a EU/IMF 'voluntary' debt write-down that was accepted by 97% of private investors and which had cost those investors more than half of their investment, or €107bn. The €436m situation is very different, firstly, because in the context of total Greek government debt €436m is tiny, ie little more than 1/1000th of total debt outstanding. A debt restructuring, or indeed any deal at all, that manages to gain agreement in a ratio of 32:1 between the ayes and the nays must be counted a success; politicians usually can only dream of that level of concensus. Secondly, any 'over-payment' was even smaller than 1/1000th of total debt outstanding; and thirdly because the repayment fell at a time, post-election, when Greece was without effective government and was trying to avoid a dispute. According to 'a senior Greek official' (who declined to be named) the decision to repay was 'above all Greek'. A local Greek ( ↑ ) website indicated that Papademos, the interim Prime Minister, was opposed to not making the payment because "such a move would have serious political and economic consequences."

In short, a tiny handful of private investors decided to take their chances and push for full repayment. Had the payment date not fallen by chance in the immediate post-election period, with no clear winner, an elected Greek Prime Minister may have come to a very different decision. There is certainly no guarantee, when an elected Greek government is in place, that they will treat other members of the '3% club' (ok, we can call them 'vultures') so generously. Notwithstanding that this tiny percentage managed to obtain significantly preferential terms, and I daresay it sticks in the throats of a lot of people (not least of all the 97% of investors who did accept the write-down), it is nonetheless misplaced to claim a "new, distorted economic order....enforced on behalf of private wealth by unelected EU, IMF and ECB officials and elected EU politicians...(who)...insist that Greek and EU taxpayers should shield private sector risk-takers from the consequences of their risks...."

The Greek bailout was very different to the Irish bailout in another key way. As of mid-February 2012 (and I have seen nothing since to change matters) Greek bond holdings held by the ECB, acquired in the emergency bond-buying programme launched in May 2010, are protected against losses. The ECB's holdings, acquired at an average of around 70 cents on the euro, if held to maturity, will be redeemed at par and will thus make substantial profits which will be remitted to national central banks. What they do with the profits will be up to them. The 97% of private investors left nursing significant 'voluntary' losses must be left wishing they were so lucky; contrary to Ms Pettifor's view, they do not seem to me to have been "shielded" at all: "shafted" is perhaps more apposite. To the extent that some creditors are 'preferred', that heaps further misery on those that are not. However, the decision to protect ECB holdings may return to haunt policy makers; private sector investors have long memories and may be reluctant to acquire government bonds of other countries knowing that, in the event of financial difficulty, they will again be treated as second class citizens. It is also perhaps worth noting that Greek bonds held by the ECB dwarf those held by the '3% vulture club'.

Ms Pettifor laments that "financial vultures" threaten Europe as a whole with the "consequences of disintegration." This seems to be rather over-egging the pudding. A tiny percentage of private investors in Greek bonds (let us gloss over the ECB's fortunate position) managed, in exceptional circumstances, to get one over on other investors and indeed the Greek people and government, but with the exception of Ms Pettifor I have yet to encounter anyone who thinks that Europe as a whole now is at risk of "disintegration". It definitely faces challenges, not just in respect of Greece, and certain commentators place particular odds as to whether Greece will or will not, much less should, remain in the eurozone, but even were Greece to return to the drachma - and Greeks seem resolutely against the idea - the possibility of their leaving the EU is surely anathema and the future of the EU unlikely to be imperilled.

Ms Pettifor writes of the Lisbon Treaty that it "obliges EU states to rely on the private, globalised bond markets for finance." She compares this with Britain, Japan and the United States. However, in matters of finance, to the extent that nations do not fund themselves through tax revenues, Britain, Japan and the United States are all in exactly the same position, relying on private, globalised bond markets for finance. The United States has the biggest bond market in the world, with a greater percentage held by foreign investors than any other major economy.

Indeed, it may be said that EU states are in a relatively favourable position because they have an option that is not available to Britain, Japan and the United States; namely, that the ECB acts as a buyer of last resort for EU bonds, thereby spreading risk across eurozone nations. It is possible that Ms Pettifor was thinking here of seignorage, but the ECB shares seignorage profits with member states on a pro-rata basis. The euro is a reserve currency, a status the drachma gave up a number of centuries (if not millennia) ago. It is a stretch to imagine that Greece could make greater seignorage profits from a revitalised drachma than they do from the euro, though I could be proved wrong.

Ms Pettifor complains that politicians have hobbled the ECB's powers to provide affordable finance to sovereign states. The ECB's vast (protected) holdings of European bonds indicate the reverse, namely that the ECB has utilised every power, probably over-stepping a few (and certainly much against the instincts of the Bundesbank, the model central bank that other nations wished to emulate prior to the euro) in its efforts to support provision of finance to EU governments and that this can only have been done with the approval of politicians.

Ms Pettifor's comparison of the situation in Greece to that of the Weimar Republic under Chancellor Bruning seems to me, again, to be over-egging the pudding. The very unique circumstances of enforced war reparations approximating to 100,000 tonnes in gold (at current prices about 5 trillion US dollars, more than half the gold ever mined - Keynes was a noted critic and resigned from the Treasury in 1919 in protest) does not seem to me to have very much in common with an economy 80 years later that became mired in debt through its own profligacy.

Greece is not in its present economic state because the ECB has been denying cash to the Greek government and not even because of the actions of a tiny number of 'vulture' investors. Greece is in its present state because, with a hard currency and low interest rates for the first time in recent history, if not ever, Greek politicians took advantage of questionable accounting techniques and low interest rates to spend money that Greece did not have. Greece (and other nations) admired the strong deutschmark and wanted to align such a currency with their own economic objectives. What they failed to take into account was that the deutschmark was strong, not by accident, but because of the economic policies that go along with having a hard currency. The merger of West and East Germany should have been an object lesson for Greece in how to manage the nascent years of its membership of the euro. Germans accepted very low wage increases for several years after reunification while huge swathes of the former East Germany, and indeed West Germany, were privatised. Economic growth was relatively poor in that era, with the economy dipping in and out of recession, but a fixed fiscal plan (carefully monitored by the central bank) and favourable industrial relations, under the famed German 'social contract', together with other aforementioned policies enabled the combined German economy gradually to rebuild its competitive position. Instead, Greece treated low interest rates as a bonanza, racking up large debts pursuing a spendthrift agenda. It is difficult to envisage Greece building a successful future within the eurozone without implementation of policies closer to those adopted in post-reunification Germany and the current political situation in Greece suggests that may be a very daunting task.

Ms Pettifor implores European leaders to be "as bold as Keynes and Roosevelt." It is not clear where she thinks the money will come from to pay for her Keynesian policies but the scope for pump-priming is surely very limited in today's highly indebted world. With respect to Greece, perhaps she has in mind some sort of Marshall Plan funded by those euro-nations that can afford it; although funds must inevitably be made available, even Germany, with debt/GDP of 82% (the UK and France are at 86%, Italy 125% and Spain perhaps surprisingly low at 69%) does not have a bottomless pit of cash. All major EU nations have deficits that are still expanding and potentially significantly under-stated; most have yet fully to take the pain on their banking systems, notably Spain, which has toxic property-related loans of close to €200bn. I have yet to hear a plausible explanation of how Keynesian policies might be funded were investors to lose confidence in remaining 'safe haven' bond markets. At the start of the '30s, US debt was little more than 10% of GDP, 20% at the close; that provided much more room for Roosevelt to play with than currently is available in Europe. Moreover, such a 'Marshall Plan' would come at a cost; the German Chancellor will require from Greece a greater commitment to prescribed policies (such as privatisation) than Greece has shown stomach for thus far.

Ms Pettifor writes of a "yearning" for EU membership and that Greek public opinion is firmly in favour of remaining within the eurozone; I am not convinced that she squares this with her call for European leaders to lose the "gold fetters" but the litmus test for any social/political/economic system must be what it does for the people who live within its boundaries. Greece's experience of the eurozone has not had a happy outcome and their desire to remain in the eurozone but to be left to pursue their own economic policies is not realistic: it would represent little change to the circumstances that led to the current crisis in the first place and in any event it is unlikely that other European (notably German) policy makers will leave that option on the table. Greeks are likely to be left with a) aligning their economy more along the lines of the German economy or b) trying their luck outside of the eurozone.

Whichever they choose, re-adjustment will be painful; however, I am not one of those who consider the situation to be beyond redemption. For all their economic travails, Greeks are well educated and work the longest hours in Europe. It is here that anti-"Gold Standard-type policies" Ms Pettifor and I may find agreement, though from very different starting points: what Greece requires most is to find a way of generating jobs, quickly, and I do not see that happening within the eurozone. My view is that Greeks will be best served by reverting to the drachma, assisted by ongoing EU support and the opportunity for inward foreign investment that would follow devaluation. I do not pretend it would be easy - the first year in particular would be ugly - and many big questions remain, including the extent to which Greeks could expect to benefit from continuing EU support in that eventuality and the cost (in terms of prescribed policies) that would be exacted. Nonetheless, I believe it to be the least worst option available.

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