City Week 2015: The role of international financial services in driving the global economic recovery

CITY WEEK 2015: THE ROLE OF INTERNATIONAL FINANCIAL SERVICES IN DRIVING THE GLOBAL ECONOMIC RECOVERY

GREECE, THE PERIPHERY AND THE EURO ZONE CRISIS: THE LESSONS OF THE PAST OUR GUIDE FOR THE FUTURE

A. In February 2009 the Commissioner for Economic and Financial Affairs of the European Union said, with regard to the performance of the economy of a country member of the euro zone:  The economy of this country is in better condition compared with the average condition in the euro zone, which is currently in recession.

You might have guessed that the country to which the then commissioner was referring was Greece.

And I start my presentation with this statement, because I believe it to be indicative of an approach to reality, to say the least, very faulty.

The fallacy is of course obvious. There was a focus on the value of the GDP growth of a country, without analyzing, whether this growth was due to a debt inflated economy or whether it was sustainable growth.

Based on a similarly faulty way of thinking, at the micro and the macro level, at the onset of the euro zone crisis European financial institutions were over- exposed: To the US sub primes, to the euro zone periphery and to Eastern Europe.

With regard to the institutions of major European economies, this exposure amounted, according to figures by the Bank of international Settlements at something more than 3 trillion $, out of which more than one trillion to the euro zone periphery.

Here one has to ask, why did important financial institutions behaved with such exuberance, over-optimism and unsound economic analysis?

According to a Briton,  prof. at Brown University, USA, Martin Blyth in his book  Austerity  The History of a Dangerous Idea,  “if you swapped out your low yield debt and replaced it with as much PIIGS debt that you could find and then turbocharged that by running operating leverage ratios as high as 40 to 1 , higher than your USA counterparts , you would have a guaranteed money machine”. According to an article in Bloomberg , March 27 2012, by Nicholas Comfort Elena Logutenkova from data compiled by Bloomberg,  total assets by the two biggest European banks exceeded Tier 1 capital by 44 to 1.

From a different perspective the recognition by the European and the euro zone institutions that these were the causes of this major financial disaster that we call the euro zone crisis can be seen in the project of the Banking Union. An  ambitious and necessary exercise in progress that aims at creating  rules and safeguards, so that the European banking system does not repeat its mistakes of the past and that the link between the sovereign and the citizen be cut .

And the above exposure was evident in the case of Greece: There could be no surprise about the outcome,  taking into consideration the macroeconomic figures of Athens, current account deficit for example, that was there for everyone to see, at a sharp downward trend, and within the framework of a monetary union with a currency area that was, and is, not an optimal currency union and where there exists no lender of last resort.

But still when the trouble became apparent and something had to be done with regard to the Greek debt it is clear in retrospect that the remedy applied was not an effective one, and that is indeed an understatement..

According to the strictly confidential minutes of the 9th of May 2010 of the IMF board meeting, leaked in the Wall Street Journal “many members objected that it placed all the burden of a painful adjustment on the Greeks while asking nothing of its European creditors”.

A member of the board said “the program may not be seen as a rescue of Greece but as a bailout of Greece’s private debt holders, mainly European financial institutions”.

Martin Wolf in the Financial Times of 28.1.2015, Greek Debt and the Euro zone Default of Leadership states that “the creditors have a moral responsibility to lend wisely; otherwise they deserve what is going to happen. In the case of Greece the scale of the external deficits was obvious. The position that the rest of the euro zone has been extraordinary generous to Greece is false. The loans went overwhelmingly not to benefiting Greeks but to avoiding the write down of bad loans to the Greek government. Just 11% directly financed government activities, 16%  financed interest payments and the rest went to capital operations of various kinds, came in and flowed out again”.

The above were roughly the story and the motives.  And there is no doubt as to the result of the program that was compiled for Greece. The country lost 25% of its GDP, unemployment grew to 27% with youth unemployment at around 60% and 1/3 of the population facing poverty. The country lost as much of its GDP as Germany between 1914 and 1920.

And the dire consequences for the social tissue and the population are not hard to imagine.

With comparison, the other countries of the periphery within a program faced far lower contractions; Spain and Portugal lost 7% of their GDP, Ireland 4%. That answers the question why the situation is today so severe only in Greece.

B. At this point one might ask, what the road ahead is, not only for Greece but also for the euro zone as a whole, how can the countries hit by the crisis escape austerity and the debt trap.

I think that there is almost general consensus   that boosting demand in the periphery, structural reforms and fixing structural imbalances between surplus and deficit countries are conditions sine qua non.

A lot of economists like Paul Krugman and Larry Summers, who furthermore proposes off balance sheet debt for infrastructure and investment, belong to that school of thought.

Martin Wolf in his article of 21/10/2014, Reform Alone is no Solution for the Euro Zone in the Financial Times, states that “the big challenge of Euro zone  is to promote adjustment and restore growth” […]. “The people of Europe cannot be expected to be patient forever” […]. “What the euro zone needs is unconventional monetary policy or expansionary fiscal policy”. […]  “ If the euro zone would seek to generate a current account surplus as big relevant to its GDP as Germanys, this would mean not a surplus of 300bn$  as in 2013 but of 9oobn$. The rest of the world would not be  able to absorb it”.

The Financial Times, in their leading article of the 27th of January stated that “to serve its debt burden would require Greece to operate as a quasi slave economy running a primary surplus of 5% of GDP purely for the benefit of its foreign creditors”.  And believe me a slave economy cannot be now days, and, if it were to, in another universe, that  would not be in the interest of anybody.

Richard Koo, Chief Economist of Nomura Research Institute  with his balance sheet recession, an evolution of  Irving Fishers debt deflation theory of the 30’s, argues that, after the implosion of a debt fueled asset bubble, when prices collapse but liabilities remain,  people and companies,  being highly indebted, abandon the quest for maximizing  profit. Instead they tend to minimize debt, to deleverage, and, however low the interest rates, they have an aversion to borrowing.

In such a case, and the euro zone crisis is considered like 1929 and Japan by Koo such a case, quantitative easing is not enough and massive fiscal support is needed. On Japan he argues, that a fiscal support of half a trillion yen provided four times that amount in GDP thus helping the country to avoid a recession.

The Governor of the Bank of England in a recent speech at the Ministry of Foreign Affairs of Ireland in Dublin, entitled characteristically Fortune Favors the Bold, opines that on current projections it will take the euro area eight years to achieve  recovery and to escape the debt trap. He further argues that in the euro zone many savings are trapped and much of finance remains fragmented, as fiscal space is separated from fiscal needs. He also highlights the danger that high unemployment might  become entrenched and destroy future economic capacity. Importantly he notes that “internal devaluations” “reallocate demand within a currency union without boosting aggregate demand in the currency area as a whole”. For him the only answer is to build risk sharing institutions present in any successful currency union. He further remarks that with the percentage gross general debt roughly equal between the euro zone and the UK, the  euro area has an unemployment of 11 ½  where as  the UK of almost half.

Keynes had seen in 1945 dangers of that kind when, in a different context but within a framework with broader similarities, he proposed automatic stabilizers be put in the Breton Woods System for cases of such discrepancies.

C. Dear friends,

It would be a mistake to argue that for all the issues that we face only the others are to blame and not the Greeks. There have definitely been also endogenous problems, like an inefficient public sector and tax evasion. And the target is not to tear apart the positive things that have happened in the previous years but to fix problem such as the above.

That means far reaching structural reforms that will cope effectively with these  issues  so that the process of fiscal adjustment be completed while at the same time social justice becomes entrenched.

Greece is at this point negotiating with the Institutions on the basis of the agreement of the euro group of the 20th of February..

It is a serious negotiation and one that I believe will come to a positive European agreement that will guarantee the road of my country towards recovery and that will further  have a positive impact on the citizens of Greece as well as on all the citizens of the Euro zone and of the European Union.

Here I wanted to state that according to the latest polls 80 % of my countrymen  want Greece to stay within the euro zone.

What we are working for is an agreement that will unleash the potential of the Greek economy, that has a large pool of skilled persons,  and that will help to implement expansionary economic activities in the sectors of energy, tourism,  shipping, agricultural production, industry, processing, communications, Green Growth, new networked systems and clusters.

Particularly concerning private initiatives and investments I would like to stress that our government wishes for and will support private investments that can play a key role in the effort of the production reconstruction.

We seek to attract investments in key sectors and utilize the state’s assets more efficiently on a case by case basis and respecting the public interest.

D. Dear friends,

As we all know finance deals with the allocation of assets and liabilities under conditions of certainty and uncertainty.. Finance is the blood machine of our economies and at the same time it is a very powerful tool that carries all the advantages and dangers that any forms of energy do.

If this is so, I believe we can agree that our homework is to approach finance as if it were a science, if indeed it is not one: With an open mind that tests its models, discards malfunctioning theories and tries to  adapt to reality as much as possible.

Thank you