Greece is a model of economic mismanagement

I note that we still haven’t heard from the Euro group meeting about what the exact plan is for Greece. As I said, my expectations are that a ‘deal’ will be stitched together at the last minute to ‘kick the can’ further down the road because I can’t see northern creditors having the political will to admit to their own taxpayers that real losses are inevitable at this time. The big question is whether the IMF is going to accept whatever the ‘deal’ ends up being. But if they are going to stick to their policy that the program needs to credibly deliver a government debt to GDP of 120%  by 2020  it hard to see how they can.

Today I thought it was timely to have another look at the Greek economy from a sectoral balance perspective which will hopefully provide some clarity on exactly what we are seeing in Greece, but just as importantly also provide some broader context to the likely outcomes for other Eurozone periphery nations with similar economic dynamics.

As you maybe aware, my overall assessment of the current Troika programs is that the policy implementation is far too one-sided and simultaneously forcing large fiscal adjustments on euro-bound nations that are already highly indebted and possess structural current account deficits is likely to be counterproductive without significant debt write-downs.

The premise for the Troika programs is that internal devaluation will make supported nations more competitive and therefore lead to an export driven recovery. This however, ignores two points.

Firstly, without investment in the tradeable sectors to support the structural transformation and increased productivity the only point of adjustment is wages and employment which means that servicing existed debts held by the private sector becomes impossible ( I discuss this point here ). Secondly, if large sections of each countries export sectors are all attempting the same thing there will be significantly lower external demand to support this adjustment.

The likely outcome therefore, as I’ve covered previously in terms of sector flows, is:

So with the external sector in this state and the private sector unable and/or unwilling to take on additional debt as it attempt to mend its balance sheet …  the only sector left to provide for the short fall in national income is the government sector. If it fails to do so then the economy will continue to shrink until a new balance is found between the sectors at some lower national income, and therefore GDP.

It may appear logical to you that this must occur, and I don’t totally disagree, but that doesn’t change the fact that under these circumstances there is simply no way that the private sector will be able to continue to make payments on the debts it has accumulated during the period of significantly higher income. This is a major unaddressed issue.

If we look at the data in the case of Greece this is exactly what we see.

As you may notice we are now seeing a reversal in the external balance which means the current account is starting to move out of deficit. In fact over recent months the Greek government has been reporting a current account surplus:

Greece’s current account balance showed a surplus for the third month in a row in September, when it reached a surplus of 775 million euros, compared to a deficit of 1.1 billion euros a year earlier.

“The trade deficit fell by 700 million euro, as a result of a 512 million euros decrease in the trade deficit excluding oil and ships, as well as declines of 68 million euros and 120 million euros in the net import bill for oil and ships, respectively,” said the Bank of Greece in a statement on Monday.

“The trade deficit excluding oil and ships shrank due to the considerably reduced import bill (down by 726 million euros or 30.3 percent), despite the fact that export receipts fell by 213 million euros or 15.9 percent in September 2012.

This sounds positive but , as always, concentrating on a single metric can give false impressions and it is important to understand exactly what is occurring “under the hood” as it were.

What you may have noticed from the sector chart above is that Greece has had a fairly long running current account deficit, which started to accelerate in the second half of the 90s. This corresponded with the move to a negative net saving position by the private sector and also a marked increase in GDP growth. What this implies is that the private sector began to take on increasing levels of debt funded through external borrowings, which also allowed government deficits to begin to fall over the same period while the economy grew.

Followers of the Australian economy may recognize this dynamic as similar to the “Howard years”. The problem is, of course, that this is GDP driven firstly by a dis-saving in the private sector and, if continued, increased private sector indebtedness. As we know, again from Australia, this can continue as long as direct investment, portfolio flows and net lending to the financial system from foreign sources continues, mostly via surplus recycling, and the private sector is willing, and able, to continue on this path. This is a major concern for Australia in terms of the end of its capex boom (I discuss this here) but a point of difference is that Australia has a cushion of a floating currency in regards to its creditors, Greece does not.

As you can see from the chart this all came to a screaming halt around 2007 when the GFC struck and Greece’s private sector was forced to re-enter a state of net saving. This was initially met by an increase in government deficit but austerity programs quickly turned this around and, as I explained above, this led to a situation where the only possible outcome was a fall in GDP while the sectors found a new equilibrium.

Debt of GDP is quite obviously governed by two factors of the level of debt and GDP growth and with the later falling rapidly ,and transfers from the private sector to the government made impossible by existing indebtedness, the only possible outcome is what you see in the chart below:

So what does this tell us?

Firstly, it shows that the Greek crisis was not just an issue with the government sector, but was likely caused by a long running structural issue in which economic growth was being funded by increasing foreign borrowing by the private sector.

Secondly, although the current account is now approaching surplus it is nowhere near the required magnitude to drive economic growth. Without renewed private sector indebtedness or an increase in foreign investment, both unlikely, GDP will continue to shrink driving national debt to GDP higher. Although the current Troika plan hinges on a growing current account surplus led by exports, subdued external sector demand from Greece’s existing trade partners make this unlikely.

Thirdly, given that both the government and private sectors have been net debtors to the external sector the write-down of existing debts or the transfer of non-financial assets is really the only way meet the current parameters of the Troika program.

Fourthly, Australia can learn some lessons from this woeful episode of financial mismanagement.



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  1. Australia can indeed learn a lesson or two from this debacle. But I doubt it will; because Australia is different…….

    • I doubt if Australia will learn a thing from it.

      Too many people terrified of thinking
      Political system geared to short term expediency
      The mining and Real estate crowd (on different issues) sirean wailing for the punters

    • Australia *is* different. It has a low debt-GDP ratio and is actually attempting (badly, admittedly) to get back to a surplus. It’s entirely possible that unlike Greece we could actually run a surplus *and* have economic growth.

      Oz also has a flexible currency, which admittedly is being pushed up by external forces, but could be manipulated downwards by the RBA.

      It’s being very ZeroHedgeian to try and compare Australia to Greece IMHO

      • “Australia *is* different.It has a low debt-GDP ratio”

        Low Govt debt to GDP ratio….very high private debt to GDP. Overall we have high debt and most of our industries and assets already sold off.

        We’re just lucky we’ve had so many natural resource assets to flog off to fund our over-consumption. The Greeks didn’t. The Greeks had the Eurozone which is, as outlined by DE and others, now failing.

        Nevertheless the low Aus Govt debt we have has been made possible by the borrowings of the private sector and by asset sales to foreign interests.

        “Oz also has a flexible currency, which admittedly is being pushed up by external forces, but could be manipulated downwards by the RBA”
        If the currency falls then our economy will be revealed for what it is…. We will get immediate very high inflation which if accompanied by appropriate interest rates would destroy the whole house of cards.

      • I read last night that Australia’s debt is about 277% of GDP so that is quite high. Remember that when you look at debt to GDP you have to look at both the private and government debt.

        • yep
          when it comes to debt it’s incredible how fast capitalism turns into communism. All debt becomes our debt before you know it.

      • Well, yes there are difference as I noted in the post a floating currency relative to our creditors is a big one.

        The fact that we are a sovereign issuer of our own currency and the fact that our treasury and central bank are obviously well-aligned in terms of policy is another.

        But, that doesn’t change the fact that our economic structure is based on a similar dynamic to what is shown in Greece pre-2007, because our GDP growth is based on a recycling of trade deficit back into “direct investment, portfolio flows and net lending to the financial system” by our creditors.. Zerohedgian or not.

      • ZH is the ultimate uber bear doom & gloomer website I agree, but don’t let some of the nutjobs detract from some of the very uncomfortable statistics that are produced on a wide variety of matters that are echoed on MB e.g.

        – problems of ageing population demographics;
        – the toxicity of debt in all forms (private, public) above certain thresholds as a ratio to GDP;
        – risks of either outright deflation or hyperinflation in the event of a collapse in aggregate demand and possible massive sovereign defaults and/or private sector debt restructuring;
        – the joke that are central banks today and their actions to prop up the entire financial system cartel;
        – the joke that is bailing out the thieving financiers, despite all their arrogance and hubris in having caused the financial calamities we face today (mega debt);
        – mal-investment on massive scales in useless Ponzi assets around the globe (particularly housing assets which are a DEAD consumption item that are constantly deteriorating);
        – etc

        There is value in many different views irrespective of the paradigm.

        I also note that some neo-classical ideas are constantly put forward by some commentators on this website and are not challenged, despite serious critiques existing for these economic theories e.g. equilibrium theory, ‘rational behaviour’ by actors in financial markets, normative biases and so forth.

  2. I interviewed about 30 senior economists (state sector banks, global bodies) in Europe about the sovereign debt issues of the EU about a year ago – indeed I had been in contact with some of them on the same subject for about 2 years prior.

    Not a single one of them thought there could be any outcome other than Greece defaulting.

    Aiming at (as is currently the case) a Govt debt to GDP icirca 170% in 5 years time is simply pathetic.

    But it isnt just Greece which has been/is being economically mismanaged. It is the whole Eurozone.

    At the moment they have a bailout fund in the EFSF which is unpderpinned by Germany (on ratings downgrade watch) Holland (on ratings downgrade watch) Austria (on ratings downgrade watch) and France (being downgraded). The trajectory of demand and economic growth across the Eurozone is down (contraction, whatever you want to call it).

    To have nation after nation imposing fiscal austerity is simply exacerbating the issue. Sure Greece is also reducing its current account deficit, but simply because it is wiping out demand across the board. Why the Greeks havent pulled the pin on the EU already is anybodies guess. To try and same thing with the Portuguese and Spanish (particularly the latter) is insane.

    At some point

    • Greece has not pulled the pin because the vested interests that get most of the media attention are scarring the masses into submission. But that is only just working, and when it fails, not only will you get Greece defaulting, you will most likely give rise to the 4 Reich and see a surge in violence which by what I can from history always happens and what we can see within Greece is starting to happen.

    • If Greece pulls the pin it gets an immediate drastic bordering on catastrophic reduction in living standards.

      Politicians and Govt are trying to avoid that scenario. I guess banksters et al wouldn’t like it much either. However let’s not pretend that a Greek exit from the Euro is going to be painless.

      • flawse said:

        If Greece pulls the pin it gets an immediate drastic bordering on catastrophic reduction in living standards.

        The experience of those who have “pulled the pin” says otherwise. For starters, you might try taking a look at Argentina and Iceland.

    • “Why the Greeks havent pulled the pin on the EU already is anybodies guess”

      I can explain it, because I’ve heard the answer to this question from greek people countless times.

      Fact 1: greece is run more or less by a mafia. 10-20 families in close collaboration are or own everything: politics, business, banks, media, even soccer teams. Everybody knows this, Greeks certainly know it, and they hate it because they feel they’re permanently stuck between capitalism and feudalism. But how do you change it? why dont the vote against them?

      a) Because they dont think there is a viable alternative in the political scene at the moment. The existing anti-troika parties are basically the type of wackos that organise session of tomato-throwing-to-german-ambassadors. So, in the absense of anything better, most people actually enjoy seeing the management of the country being transferred more and more to the German Ministry of Finance, they view it as a good thing, because anything is better than the 10 family mafia.

      and b) Greeks are scared of “communism” (the Radical Left Coalition that currently gets 30% in the polls), because they’ve seen “communism” right next to them (bulgaria/Albania/Yugoslavia) and they didnt like what they saw.

      Fact2: 8 years of euro-fuelled credit expansion has left a big big sandbag. Currrently and after 3-4 years of financial disaster, greek households still have about 200bn Euro (AUD$250bn) of deposits, about 2/3 in the greek banking sector and 1/3 overseas. About half of it belongs to HNWIs and the rest is a curve: some people have nothing and are already suffering, but there’s still a good part of the population who feels they can ride it out, even without a job, as long as the euro holds and Merkel keeps their banks afloat somehow. Thats the only two things they care about and the last thing they want to see is their savings converted to drachmas and they’re willing to sacrifice everything to avoid it.

      Pretty huh?

  3. If Greece pulls out of the Eurozone, then the mechanism that transfers Euro’s from the alphabet-soup funds to Greece’s creditors (Eurozone banks) will cease to exist – am I right?
    If Im right then I can see why Greeks will not be allowed under any circumstances to leave the Eurozone.

  4. let me get this straight.. we have insolvent sovereigns selling bonds to insolvent banks who are being bailed by said insolvent sovereigns and the whole thing is backstopped by a funding mechanism which is supposedly funded by the same insolvent sovereigns..

    you couldnt make this shit up…

    • +1

      The ‘alphabet soup’ of funding mechanisms can only fool some of the people some of the time.

    • Not only that, as Nigel Farage has pointed out, you have one sovereign with high external debt being forced to borrow on the market at 7% in order to provide funding at 3% to another sovereign with high external debt.

      Crazy doesn’t begin to capture it.

  5. Barcelona.

    Had a drink with a senior surgeon that earns 4,000Eur a month, his son is also in the bar is a GP intern at 1,200Eur a month. School teacher 1,000Eur a month. Apartment in NE Barcelona costs 800Eur a month.

    See any trouble?