The black swans of Greece

I have spoken about Greece many times before. It is a country in all kinds of trouble economically caused by fiscal mismanagement and monetary  incompatibility. What has always amazed me is that for some reason, ignorance or delusion or a bit of both, anyone who expected to be paid on their Greek debts thought that applying massive austerity to the country would somehow help the outcome.

I have previously talked about the macroeconomic issues with Europe, you can read some of my previous statements here, but to recap.

… the PIIGS will flounder from bail out to bail out but ultimately it will make little difference because they are currently tied to an economic model that neither supports them or allows them to make the necessary changes to alter their economic course.  That is not to say that they are not to blame for many of their own woes, they certainly are, but it is by no means as clear cut as you will read in the mainstream media.  The PIIGS were always going to be in trouble as soon as there was an economic downturn because they are trapped between the domestic policies of Germany and the inflexibility of the monetary system they signed up to when they joined the Euro.

It was obvious from the outset of the PIIGS crisis that forcing austerity on those nations without addressing the fundamental issues would turn the entire process into a slow moving train wreck. I stated exactly that when the Greek government decided to take the IMF/EU path.

.. if you think you can cut your GDP by 11% and suddenly your economy will be all roses you are utterly delusional.

If Greece cannot improve its current account balance ( which is nearly impossible given that it threw away control of its exchange rate when it joined the EU), then simple maths states that Greeces’ private entities need to reduce their current net saving position by 11% of GDP over the next three years. Realistically this means , more unemployment and probably debt deflation.

Just to make it clear, it is impossible for Greece to have deleveraging of both the public sector and the domestic private sector at the same time, because it does not run a trade surplus. The only ways they could turn their trade balance around is to suddenly start producing a revolutionary new product the world must have, or for the Euro to fall much further so their export goods become cheaper to non-Euro countries. Given we can’t think of any up and coming greek products ( although we hear they have a lot of uranium ) and given that a fair percentage of their trade is intra-European and their currency is tied to other bigger countries that have stated they will do “anything” to keep the Euro high then this seems impossible.

History is also against them in regards to deleveraging of the private sector. People usually want to spend money ( ie. lower savings , take on debt ) at times when the economy is good and/or their is a speculative bubble that urges them to move their money from cash savings. I think it is pretty fair to say that Greece is not going to suddenly see a tech/housing boom anytime in the near future and it is obviously that its economy is not good.

Also note that as unemployment rises ( one of the inevitable outcomes of this policy position ) then the government will need to provide the private sector with more unemployment and other benefits, this works against the exact thing they are trying to achieve ( less govt spending ).

The only conclusions that we can see is if Greece actually attempts to reach its imposed IMF targets then either private sector have to spend savings and take on debt , as we said above not something people usually do when the economy is in the cr*pper, or nominal private income will deflate.

It is therefore quite possible that they are heading for a “debt deflation” cycle because as the private sector attempt to pay down debt they are indirectly lowering their nominal income which leads to even more indebtedness.

We are not sure where George is getting his financial advice but he currently seems hell bent of making his countries problems worse not better.

There are a few things that can be done at a macro level in an attempt to “balance the books” when the country does not have a sectoral balance.

  1. Deflate your currency and hope that renewed exports offset the losses caused by foreign borrowings and imports.
  2. Attempt to increase productivity.
  3. Take on more debt.

Obviously by being in the EMU Greece could not do 1. 2 is politically difficult – smashing the unions etc. Which only leaves 3, the option that Greece quite obviously took. Given that Greece is not a sovereign  nation in terms of currency it must borrow from the external sector and that is the problem with applying austerity to this nation. The value of their currency is out of whack with the value of their production, so to compensate they took on debt, and this isn’t just a government issue.

As you can see the private along with the public sector were expanding debt to compensate for the fact that the value of the currency didn’t match their productive output. By implementing an austerity program the government’s compensation is now falling, this has led to a contraction in the private sector, which in turn is slowly killing off real production, which is the exact thing you need to improve the economy.

More recently the IMF has asked it to start selling public assets, but this is simply a band aid over the issue. Greece is now a sitting duck, on the edge of default waiting for a black swan to kick it over the edge because the fundamental issue has never been addressed by those who are supposedly there to “fix” the country.

The thing about black swans is that you never can tell where they will appear or what form they will take, and the latest one is a real surprise.

The probability of Greece defaulting or restructuring its debt has increased since the arrest of International Monetary Fund head Dominique Strauss-Kahn, Pacific Investment Management Co.’s Mohamed El-Erian said.

“Don’t underestimate how important Dominique Strauss-Kahn was in coordinating action” among European nations, El-Erian, the chief executive officer of Pimco, said in a Bloomberg Television interview on “In the Loop” with Betty Liu. “It’s the worst possible time to lose your general. You need the IMF to coordinate this global healing.”

European finance ministers for the first time have raised the possibility of talks with bondholders over extending Greece’s debt-repayment schedule, saying that last year’s 110 billion-euro ($156 billion) rescue has failed to restore the country to financial health. Europe would consider “reprofiling” Greek bond maturities as part of a package including stepped-up sales of state assets and deeper spending cuts, Luxembourg Prime Minister Jean-Claude Juncker said late yesterday.

“He has been getting everybody to play from the same sheet of music,” said El-Erian, a former deputy managing director of the IMF. “Without him it will be much more difficult to coordinate European governments.”

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  1. I would hardly call Greece defaulting a ‘Black Swan event’ once you consider the history of Greece. The EU didn’t bail out Greece : they’re merely bailing out their own EU banks and then pushing the bill onto the Greek taxpayers, the few that pays taxes anyway.

    The ‘massive austerity’ being imposed is nothing compared to what will happens if Greece defaults, since a government cannot run a fiscal deficit when it can’t print money not borrow money. If Greece get out of the Euro and reintroduce their own currency, it will become the ‘biggest short-selling feast’ in the history of mankind. The massive capital outflow will probably see Greece’s GDP shrink by a lot : 30%? 50%? 80%? Nobody really knows.

    The Greek no longer have any choice except to obey their EU masters.

    • Alex Heyworth

      Spot on, Ronin. Greece has been in sovereign default more years since 1820 than it has not been in default.

    • Alex Heyworth

      I have previously referred macrobusiness readers to that excellent article, which is one of a series (others are on Iceland and Ireland). One of Lewis’s key insights is that Greece’s problems are at least as much cultural as economic.

    • I am in complete agreement, I have read the vanity fair article previously it is a great read.

      This post is simply a statement about the inevitable outcome that will occur due to the fiscal and monetary position Greece is in, and what has occurred since Greece joined the Euro from a fiscal perspective.

      The ‘black swan’ moment wasn’t a reference to the fact that Greece will default, it was a reference to what will finally cause that default. You can see from my series of articles I consider some kind of default inevitable. But you can also see that the Macro settings are simply incompatible, so they will return time and time again for more money.

      In reference to Ronin’s comment

      >The Greek no longer have any choice except to obey their EU masters.

      I actually think that this is now a political issue, not an economic one. What actually happens in the future will not be governed by economics. The days of rationality in that context are long gone.

      • Alex Heyworth

        Good response, DE. Whatever possessed the Germans to think that their economic and social perspective could ever be compatible with that espoused by Greece? Were they thinking they could achieve by stealth what H***er could not achieve by force? Surely not.

        **** to avoid Godwin’s law.

  2. I have been keeping up with news broadcasts from my home country and they show the politics at work here.

    The austerity measures probably have two goals: One is to force Greece to do something about tax evasion and mismanagement, the other one is to sell the massive bailout to the German/French/Dutch/etc population.

    You can now notice a shift in the commentary (by experts and politicians) on European television. People are being prepared for the fact that some of the money will probably not come back ever. The commentary now focuses on the fact that ‘allowing’ Greece to default would not only have consequences for other memberstates, it would also do away with a very effective stick to get Greece to get its act together.

    No matter how you look at it, austerity measures are needed if Greece is ever to have a functioning economy. The fact that this a cultural issue means that only outside forces can bring change about and that this is a long-term issue.

    Don’t think politicians are absolutely clueless in this regard. They know a default is coming. They are now trying to prevent another one 20/30/50 years from now.

    IMF calculates Greece can raise approximately €50bln if it sells state-owned companies such as utilities, like many other countries have already done… would improve the situation quite a bit.