From bad to worse for the IMF

For some time now I have been pointing out poor economic policy implementations within the European economy and how those policies are likely to effect the real economies of European nations. As I re-stated on Monday, my major concern with the current thinking from European economic leaders is their misguided belief that implementing austerity before credit write-downs/offs is a credible policy for a highly indebted, non-export competitive nation with a non-deflatable currency.

As I have explained many times before, this policy will fail because the deflationary effects of austerity will mean that the economy no longer has the ability to services its existing debts as it is not receiving compensation for that deflation via its export sector due to the non-responsive currency.

So, as I have been saying, all that will happen with the continued implementation of these policies is failing periphery economies which will require constant bailouts. Greece continues to demonstrate this outcome:

The International Monetary Fund sees the Greek economy deeper in recession in 2011 than the government expects and a wider-than-forecast budget shortfall, adding that the country has still a lot of work to do on reforms.

In a country review, the IMF said Tuesday the Greek economy is forecast to contract by up to 6% in 2011, versus Greece’s official estimate for negative economic output of 5.5%, ahead of a downturn in 2012 in the region of 2.75% to 3%. In its fourth year of recession, Greece has already revised lower its growth figure to 5.5% of output for 2011 from a forecast of negative 3.8% earlier in the year.

“The economy is trending notably lower than what was expected. Investor sentiments have not improved as hoped, given the unexpected turmoil in other countries in the euro area periphery, uncertainties among investors about the framework for a comprehensive policy response to the crisis, and also uncertainties about private sector involvement in reducing Greece’s debt,” it said.

“However, the most important factor has been the slowing pace of structural reforms this year.”

Among the changes the IMF said Greece needs to adopt in order to return to a growth path are shutting down inefficient state entities, reducing the large public-sector work force, cutting public wage and pension levels and stronger budget control.

“Greece is still well away from the critical mass of reforms needed to transform the investment climate.”

With the recession weighing on tax revenues and boosting spending on social welfare, the budget deficit this year is seen at about 9% of GDP, versus a recently revised government forecast of 8.5%.

So austerity is causing unemployment, which in turn requires the government to spend more on welfare, and therefore the government spending continues to rise which in turn means the “pace of structural reforms is slowing”. The fact that Greece is inside the Eurozone means there is no currency devaluation effect as the economy weakens which means that the only compensating factor for austerity is wages and employment. In other words, the nation will not be competitive again until the entire country takes a large pay cut, which wouldn’t be so bad if they weren’t also expected to continue to pay the debts they accumulated while receiving far higher wages.

Quite simply the policy is failing in every way. The nation isn’t becoming more competitive, every single macroeconomic metric is going in the wrong direction and on top of that there is simply no way creditors are going to get paid.  The most worrying thing is that instead of recognising, at least publicly, that the policy is failing the Troika continues to enact ever harsher austerity under the promise that “if we just do a bit more it will all get better”. The fact is it will not, because it can’t without significant debt reductions far beyond what the currently stalling PSI+ plan involves. ( See more on the PSI+ here ).

What concerns me now is that the IMF appears to be becoming increasing desperate to prove themselves right even in the face of obvious failure.  In separate article Poul Thomsen, the IMF mission chief in Greece was quoted as saying:

I think one of the things we have seen in 2011 is that we have reached the limit of what can be achieved through increasing taxes,” Poul Thomsen, the IMF mission chief in Greece, told reporters in a conference call.

Greece’s austerity program “has relied, in our view, too much on taxes and I think one of the things we have seen in 2011 is that we have reached the limit of what can be achieved through increasing taxes,” Thomsen said. “Any further measures, if needed, should be on the expenditure side.”

So the current policy has failed to produce the result that it was supposed to under the IMF’s ideology, as I said they would, because they didn’t begin the plan by writing down most of the existing debt and their other assumptions were completely misguided. As even the most junior project manager would tell you, the failure to make steps towards realising your original benefits is a sure determinate that your project is failing and should be halted pending a review to determine if its worth proceeding. But instead of using some basic project governance, the IMF continues to plough on in the opposite direction in what now appears to be a plan to start cutting welfare and services to the same people that the original failings forced into unemployment.

Europe continues to have everything back-to-front to the detriment of everyone involved. The banking system reforms are exactly the same.

As a macro-prudential regulator, the correct time to implement tighter guide lines on capital ratios is when the economy is strong and the banks are able to secure additional capital to support their risk-weighted assets without causing systemic risk. This should have been happening during the boom years when it was obvious that capital flows into countries like Spain and Ireland were leading to credit bubbles in the private sector that had a risk of strong and sudden reversal. But alas, no one did anything then.  However, now that the entire European economy is reeling from the after effects of such events and the entire banking system is on the verge of collapse, the EU expects the banks to recapitalise to meet Basel III requirements.  We have already seen evidence that this is pushing risk into east European economies as banks lessen their non-core exposure and repatriate capital back to home base.  We are now seeing this move to the next level with banks selling off profitable parts of their asset base:

European banks, under pressure from regulators to bolster capital, are selling some of their fastest-growing businesses to competitors from outside the region — at the expense of future profit and economic growth.

Spain’s Banco Santander SA (SAN), Belgium’s KBC Groep NV (KBC)and Germany’s Deutsche Bank AG are accelerating plans to exit profitable operations outside their home markets. Santander, which said in October it needs to plug a 5.2 billion-euro ($6.9 billion) capital gap, sold its Colombian unit last week to Chile’s Corpbanca for $1.16 billion. Deutsche Bank is weighing options including a sale of most of its asset-management unit, while KBC may dispose of businesses in Poland.

Such sales risk hurting long-term profit, just as Europe enters recession, investors say. It’s the unintended consequence of the decision by European regulators to make banks increase core capital to 9 percent by June instead of 2019. Unwilling to raise equity because their share prices are too low, lenders are selling profitable assets because they’re struggling to find buyers willing to pay enough for their troubled loans to avoid a loss that would erode capital. Investors say the sales risk leaving banks focused on a stagnant economy and deprive them of economic growth from outside the region.

The mismanagement of European economies continues to stun me. No wonder the ECB is offering long term repos on the European bank’s star wars figure collections, what choice have they got?

On a positive, at least the suicide pact appears to be stumbling.

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  1. Another great contribution DE. If amateurs like me can even understand what’s going on (in no small part due to your efforts), it beggars belief that European leaders do not. I guess there is a big difference between leadership and politics/management/bureaucracy (polimancracy?).

    Never underestimate people’s ability to stick to their guns in the face of overwhelming evidence to the contrary.

  2. The IMF and Greece always reminds me of the episode of the Simpsons where Grandpa Simpson (the IMF) is trying to get the other fellows( greece) beards out of the pencil sharpener,by turning the handle and dragging the beard further in and when that hasn’t worked turning the handle again.

  3. I’m sure the Greeks, Irish, Portuguese, Italians and Spaniards will find a way to repay the favour, with interest. Those countries have long memories. I suspect driving a BMW or Merc will be a most dangerous practise there.

      • That was not my point. Each country is unique but the resentment toward France and especially towards Germany will get deadly. Greeks know they need German tourists but the Italians don’t.

        I don’t know how this will work out but blood will be spilled.

        Italy has a problem with unions that makes our problems look tame. Any politician seeking to actually really reform labour law needs to confront the Mafia. He must send his wife and children abroad and accept that he will probably get shot or blown up. That is a real problem.

  4. Austerity doesn’t reduce capacity to service debt if the austerity takes the form of a holding tax on the values of indestructible, immobile, irreplaceable assets, such as sites (land). The holding tax forces the asset into productive use, because the owner must either generate income from the asset in order to cover the tax, or sell the asset to someone who will.

    Greece can easily reduce wage costs without reducing wages – by scrapping the huge social security tax (payroll tax) and replacing the revenue by raising or extending the VAT. Because payroll tax and VAT are similarly regressive, the redistributive effects of such a reform would be minimal. The point is that, whereas a payroll tax has a production/origin base, a VAT has a consumption/destination base. Hence, whereas the suppression of production due to one country’s payroll tax is concentrated within that country, the effect of a VAT on production is shared with the country’s trading partners and is therefore less detrimental to that country’s ability to generate income and pay its debts.

    • Unfortunately, that tax would fall on the wealthy asset owners whose capital values would fall significantly. Not sure what that impact that even faster declining asset values will have secured private debt.

      BUt generally, I support taxes on property rights for the reasons you suggest.

      • By itself, a holding tax on asset values would indeed cause a further decline in values, which by itself would further impair the associated debts. But if the country is also producing more, that by itself raises incomes, hence debt-servicing capacity and asset values. The net effect is what matters.

    • The Greek government have proposed property tax this year. Those who don’t pay will have their electricity cut off. Unfortunately, they cannot collect the tax due to popular opposition.

      Getting the Greek to pay the tax will be difficult. While economically sound, an increase in VAT will simply force all business transaction into the ‘cash economy’.

  5. Spot on again. What surprises me is that the IMF can’t see the problem. There are lots of economists at the IMF who know what the problem is. Is it because they know getting funding to the IMF is going to be a problem? More politics … as China will step up but they have demands that the IMF/EU/US don’t seem to want to agree to. So the EU could fail due to pride maybe??? I don’t know, but it’s a joke.

    I asked a question on MB yesterday about how long the ECB could fund the EU via bond purchases, and overnight FT Aplha answered it. This is worth a read, and it shows that accepting unsecured funding seems to be where this is heading. We’re heading for “Financial Voodoo” IMO.

    This EU post is worth reading as well:

  6. The IMF only have one book, and its the free-market dogma book. They’re not interested in any alternatives as that would challenge their entire reason for being.

    That this book has been shown to fail in almost every case they have ever tried seems to go unnoticed by a lot of people.

    They’re almost like old-style asset-strippers – get in there, sell any asset worth anything, slash costs, and look to get out before it gets too ugly.

  7. Always remember the IMF telling Malaysia what to do during the 97 Asian meltdown and Mathahir go telling them to bother someone else. Mathahir was right

  8. SkoptimistMEMBER

    “In other words, the nation will not be competitive again until the entire country takes a large pay cut, which wouldn’t be so bad if they weren’t also expected to continue to pay the debts they accumulated while receiving far higher wages.”

    Do you actually think that you would be able to implement a wage cut without the backdrop of the crisis caused by excessive debt?.
    Cutting the debt now would simply send the signal that if you do nothing all the problems will just go away (i.e. someone else will wear the pain).

    There is no pain free path out of this. Cutting debts early on won’t result in any real reforms. Only reforms brought about by the crisis are likely to lead to some form of debt forgiveness later on.

  9. Austerity is a religion. It will solve nothing. Its like a multi-decade prison sentence for the Greek people.

    At some point Greece will have to default and exit the Eurozone. The sooner the better.

    • SkoptimistMEMBER

      A religion is something that you can choose. Austerity on the other hand is something that the rest of the world imposes on you after an extended period of living beyond your means.

      Your comment suggests that the Greeks have a choice between an easy path and a hard one. The reality is that there is lots of pain ahead for them either way.
      If they default and leave, how will they rebuild?.
      Austerity is just the correction process via which Greece will return to a state that it can afford to support.

      The harsh reality is that most of the western world has lived beyond its means for quite some time and some austerity is ahead for us all, whether we like it or not.