Since 2009 Greece has been a barometer of the Eurozone’s continued viability. The rake’s progress of the four years to early 2009 had been remarkable. It had run current account deficits (relative to GDP) of 7.6% in 2005, 11.4% in 2006, 14.6% in 2007 and 14.9% in 2008 or, over the four years combined, of about 50% of GDP. The big external creditors included international banks, particularly European banks, which had acquired large holdings of Greek government debt and made loans to Greek banks. The extra debt could be serviced in the long run only if Greece reduced its current account deficit substantially. A devaluation against the currencies of its main trading partners was therefore sensible, in order to motivate the necessary switch of production towards exports. Unfortunately, as a member of the Eurozone single currency area Greece could not devalue. It could leave the Eurozone, but that would shatter the geopolitical dreams of the Eurozone’s architects in Germany and France. For them the single currency area was a permanent structure which foreshadowed ever-increasing economic and political integration in the European Union. As devaluation within the Eurozone was impossible, the focus of the policy drive to improve Greece’s financial position was on the budget deficit. The Eurozone sovereign debt crisis escalated in early 2010. Since then negotiations have been held between international bodies (usually “the troika” of the European Commission, the European Central Bank and the International Monetary Fund) and the Greek authorities, about targets for the reduction of budget deficits and public debt. The Greeks have repeatedly missed the targets. Fiscal austerity and the implosion of the banking system have been associated with a drop in real GDP of almost a quarter in five years. The GDP decline has further pushed up the debt/GDP ratio. This note examines the latest developments. Although the budget deficit numbers have been better in 2012 than in 2011, the macroeconomic trauma is so severe and unrelenting that Greece must leave the single currency area as soon as possible.
Revelations that the French government is considering an elite Eurozone (i.e., an inner core of Eurozone member states, excluding some of the existing members) have made it essential to analyse the possible results of the Eurozone’s break-up. Drastic contractual revisions would be inevitable, with major effects on the value (in terms of euro) of government bonds and inter- bank deposits. These two assets – usually regarded as being highly nominal- value-certain and hence very safe by banks – would see substantial changes in value. The resulting losses for some banks could destroy all of their capital. If policy-makers were foolish enough in those circumstances to demand that banks “strengthen their balance sheets” (by shedding risk assets and/or assets that had lost much of their value) and “make themselves safer” (by operating with the minimum regulatory capital at all times and raising capital/asset ratios), the Eurozone could suffer an appalling plunge in demand, output and employment. It was these demands – i.e., that banks “strengthen their balance sheets” and add to their capital – that led to the cessation of money growth and the severe downturn of late 2008 and early 2009. The recent rhetoric of some of the key individuals in regulatory officialdom has indeed been depressingly similar to their language three years ago. In this note I argue that instead policy-makers should ensure that the quantity of money continues to grow, and that banks are given time (by means of a long-term, low-cost loan from the state) to rebuild their capital and assets. If a very severe slump threatens, the likelihood has to be that highly expansionary open market operations (similar to the “quantitative easing” adopted in the USA and UK) would be chosen by the European Central Bank and the key Eurozone governments. But it is alarming that until now the emphasis has been on bank recapitalization and the supposed need to make banks “safe”.
The Bank of England’s quantitative easing scheme added at least £150b. (and probably closer to £200b.) to the quantity of money (i.e., the M4 broad money measure, dominated by bank deposits) in the eleven months from early March 2009 to end-January 2010. Although this did not lead to a significantly positive rate of money growth, it did prevent a large contraction in M4 and so averted a recession worse than that actually recorded. The announcement of QE was soon followed by a remarkable surge in asset prices, an unusually positive swing in business optimism and output-raising plans, and an end to the big job losses seen in late 2008. Along with QE, the very low level of interest rates was crucial in this spectacular improvement, not least because it reduced wealth-holders’ desired ratio of interest-bearing money to assets and expenditure. But the Bank has now announced that QE will be put on hold, presumably for at least a couple of months. What will happen to UK money growth without the Bank’s asset purchases? And what is the implicit message for UK asset prices and economic activity? The analysis here suggests that – without QE – UK broad money will be roughly flat in the first half of 2010, i.e., any change will be small and probably within a minus 2% - plus 2% band at an annualised rate. Since very low interest rates will continue to discourage agents from holding interest-bearing money, economic conditions should not be too bad. However, above-trend growth and meaningful falls in unemployment are not to be expected. (Also relevant in constraining the UK economy is a still unhelpful international environment, with the Eurozone’s banking and financial difficulties intensifying.) Fortunately, the Bank’s statement included the sentence, “The Committee will continue to monitor the appropriate scale of the asset purchase programme and further purchases would be made should the outlook warrant them.”
Since summer 2007, and particularly since September 2008, banks have been bashed by governments and regulators. Part of their punishment is that they are being asked to do the impossible and then blamed when they cannot deliver. In particular, they are being required – even instructed – by officialdom to attain two or more supposedly desirable outcomes, even if these outcomes are mutually incompatible. The worst example – related to the paradox of excessive bank regulation discussed here on 14th September – is that banks have been told that they must simultaneously,
- i. raise their capital/asset ratios to make their businesses safer, and
- ii. increase their lending in order to boost spending and the economy.