sábado, 7 de febrero de 2015

On Pettis and Greece: we’re not all equal at the Mediterranean

Pettis's central thesis is that the formation of mountains of debt is caused both by those who borrow and those who lend the money. In this fantastic post, Pettis tells the story of war reparations paid by France to Germany after the Franco-Prussian War. The size of the payments was immense (though less than the inflow of money into Spain in the years of the bubble) and France came out ahead because it made two bond issues that were oversubscribed, it used the money to pay Germany and Germany squandered all that money by investing in bad projects and entered into default some years later, ("huge inflows of money are almost never matched by commensurate Increases in the number of profitable investment projects").

France came out ahead because the world was in those years in a phase of expansion of trade and liquidity and could generate wealth without difficulty. Moreover, and above all, France became an exporter and Germany one importer, i.e., the fabulous amounts of money going to Germany put it into a brutal trade deficit because the Germans spent the money to buy foreign products, so England and France took advantage and turned over the trade balance. It all sounds very familiar right? German banks exported german’s trade surplus in the form of loans to Spanish banks that squandered all that cheap money investing it in amazing projects surrounded by corruption. Among others, giving mortgages to whom could not return the money; generating an asset bubble; an increase of wages without increasing productivity and increased government revenues that could not last.

The implication is clear: those debts can not be paid (except if the debt is denominated in a currency other than the debtor one in which case, the State can devalue the currency and therefore devalue the debts) unless they are accompanied by a very expansive economic cycle in which indebted countries can generate lots of wealth. That is what France did by transforming the country (France did structural reforms as we would say today). Yet, if the cycle is contractive you need a Ceacescu that make its own people to starve in order to extract the necessary resources to meet the payment of the debt.

What Pettis adds in his new post is a warning of the costs implied by the delay in resolving the indebtedness of a country. Collateral damages in the form of poisoning relationships; suffering of the population and destruction of the productive fabric are enormous. Therefore, when assesing the German position assessment in terms of cost / benefit (the problem of moral hazard, ie Greece or Italy or Spain ending up as very poor countries in the medium term and, therefore, the idea that it can not be left to Greek or Italian or Spanish politicians the implementation of reforms while staying in the euro), we should be aware that the costs may be higher than it has been thought and therefore that benefits must be also be greater if we want to support the German position.

I think Pettis is wrong. First, the Spanish indebtedness was partially the result of an individual decision maker, not of millions of individual decisions. Saving banks were controlled by politicians which borrowed hundreds of billions of euros in European markets and Spain had a watch dog – the Bank of Spain - that could have prohibited saving banks to go into this fabulous credit expansion. True, it was inevitable that "some Spanish Entities (would) ... answer foolishly to extremely aggressive offers of cheap credit, cheap credit especially once this cheap credit had set off a real estate boom" but the fact is that corporate governance of these institutions was the one that it was. If the Bank of Spain would have controlled the saving banks and, better, if saving banks would have been privatized in the nineties, the excess savings of the Germans ("German workers Have Suffered from stagnant wages and decaying infrastructure") would have finished in the US market  or – still - invested in public debt from Italy and Greece but not in Spain.

The Spanish case is very different from the Italian or the Greek ones. In Spain, we got private overindebtness. Families and firms borrowed and by defaulting, partially transferred their debts to banks first and eventually the State. In the case of Italy (and Greece) it was the state rather than individuals who were absorbing those Germans savings galore by issuing public debt that was not directed to investment but to pay the running costs of a State that could not extract more from its citizens via taxes. Spain had no deficit until revenues plummeted highlighting the shortcomings of our tax system. The Spanish government was not distributing those loans coming from Germany among Spaniards . The Italian and Greek governments, were. The evolution of Italian and Spanish public and private debt can not be more significant.

But, secondly and more importantly, I think Pettis distorts the position of Germany, the European Central Bank and Rajoy. There is no doubt that there will be debt forgiveness - Jubilee - in the coming years in Europe, not necessarily in the form of a formal debt restructuring procedure. All indications point in that direction and the introduction of quantitative easing by the ECB is a strong signal that it will happen. But it has been already a very important signal in the interim: Spain is virtually paying no interest on the public debt and Italy and France, neither, and the situation is this since 2013. Therefore, the overhang should not impede economic growth because economic agents know that debt restructuring, is on the way. And such conviction can reduce the restrictive effects of indebtedness. Germany, the ECB and Rajoy know this and that explains why Rajoy is right to tying itself as closely as he can to creditors.

But creditors can not make any sign of weakness (blink) in the negotiation process before Greece and Italy - and to a lesser extent, Spain and France – make credible commitments that they will implement the reforms every debtor put in place in order to grow economically and to enter into a path of sustainability of public finances (what France did in the Third Republic). The Spanish government has probably done enough for germans to allow a partial forgiveness of the debt by the issue of money and purchases by the ECB. The euro is not exactly a gold standard since Europe and the ECB can manipulate the value of the euro, but not the value of the gold. That’s the (secret) commitment that Rajoy has extracted from Germany and the ECB. But Spain is the only PIGS country in the position to do so because Italy, despite Renzi, has not taken any single significant step in the right direction.

Then, the position of Greece – and of Italy - is qualitatively different. Syriza has sent two contradictory signals: they say that a debt restructuring is necessary - a significant reduction of the nominal amount of the debt and to link interest payments to the growth of the Greek economy – but, at the same time they insist in not reforming the country to make it a modern State in institutional terms; Syriza insists that its "sovereignty" is important and can not be put in question.

Germany is not Ceacescu and has enough empathy and aligned interests to accept this jubilee without difficulty. But the problem is that Syriza does not want to give up their sovereignty. As Rajoy also refused to do. And when a country lacks the institutional system that allows it to prevent clientelism, theft and waste by politicians in such a great scale as in Greece and Italy, to proceed with a debt restructuring is shortsighted or as we say in spanish, “pan para hoy y hambre para mañana”. Therefore, Greece has to choose: it waives its sovereignty or it leaves the euro. It is not, as Pettis caricatures that discussion, a question, of "allegations of moral virtues or immorality" by Greeks or Spaniards. It is a political-institutional problem. The one of building a strong State in Fukuyama’s terms: a meritocratic and impartial bureaucracy; a system for minimally efficient tax collection; a regulatory regime that does not crush individual initiative; a high level of "social capital" in terms of trust between countrymen. If Germany agrees to abide Greek sovereignty and, in turn, it reestructures the debt along the Syriza proposal, forget about Italy ever being reformed.

Europe's problem is that, as Pettis explains, over-indebtedness has coincided with the economic crisis, so that to get out of the debt overhang is much more difficult. But another is that Europe shares a currency between states that remain sovereign. And frankly, Greek, Italian or Spanish sovereignty is not worth a penny. If you have to sacrifice it for the welfare of Greeks, Italians and Spaniards go ahead with it.

Pettis is also wrong in his prediction of the resurgence of extremist parties, as far as Spain is concerned. Podemos has not yet reached the government and my prediction is that it will not. The Spaniards have always been sensible when choosing who rules (with the exception of 2008, probably and then, for a narrow margin). The Greeks and Italians have never been good at it what, again, explains a lot in terms of institutional differences (the Spanish constitutional arrangements are probably more efficient than the ones of Greece and Italy). Germany can rely on the use of Spanish sovereignty by spaniards but cannot trust Italians or Greeks electing governments.

Pettis’ solution is a general one, valid for all and each overindebted country. But, inside Europe, a catch-all solution will not be the best one. Greece overindebtness needs a different solution from the one Italy needs and Italy a different one from Spain. Spain does not need of a formal reestructuration of its debt. That’s why I still trust Schäuble although he cannot be left alone. 

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