Press reports have suggested that the International Monetary Fund has become unhappy with the Greek government’s austerity measures, since it felt not enough was being done to maintain fiscal solvency. Anyhow the latest tranche of money has been credited to the Greek government and life goes on, although Greece’s international creditors are watching the budget numbers month by month. The following note recognises that the Greek government is not far from achieving a ‘primary budget balance’ (i.e., non-interest public expenditure is only slightly above tax revenues). In that sense, much has been done to restore the creditworthiness of the Greek state. However, the cost has been calamitous, with falls of about a quarter in real terms in both national output and government expenditure. Even worse, it is not clear that the big austerity drive so far will be sufficient. Two points have to be emphasized. First, output has fallen so heavily from the peak (i.e., in 2007), and is still falling at such a rate, that a budget surplus would be needed to stop the debt/to/GDP ratio from rising further. There is no sign of that. Despite the defaults to private sector creditors, IMF data show the debt-to-GDP ratio now at about 175%. Second, the drop in output has of course a large cyclical element and, sooner or later, a cyclical recovery must surely happen. However, a deeper problem is now emerging, that international investors are shunning Greece and the trend level of output may be going down. To halt the rise in the debt-to-GDP ratio, Greece therefore needs an overall budget surplus over a series of years and not just a primary surplus in an emergency period Again, there is no prospect of that in any relevant planning horizon.
The Eurozone resembles a vast dyke which is full of holes and liable to disintegrate at any moment. This note concentrates on Portugal, where the recent resignation of the very able finance minister, Vitor Gaspar, was a huge disappointment. (It must be said that the Eurozone’s holes in Greece, Spain, Italy and France also remain large and conspicuous, despite international officialdom’s attempts to patch them.) Portugal’s problems arise partly because the economy’s trend rate of growth is now very low, perhaps even zero or negative. Gross domestic product per head is lower than ten years ago. With inflation almost zero, nominal GDP is at best flat. As a result, any deficit leads to an increase in the ratio of public debt to GDP. A May 2011 bailout negotiation with the ‘troika’ extended €78b. of loan and other financing, to help the Portuguese government and banking system. It must be acknowledged that Portugal has tried hard, with Gaspar at the finance ministry, to meet the conditions attached to the bailout plan. The cyclically-adjusted budget deficit fell from 9.0% in 2010 to 4.0% in 2012. Nevertheless, the debt-to-GDP ratio has kept on rising and is now over 120%, the kind of figure that was associated with the Greek dégringolade in 2012. (A fair verdict is that a debt-to-GDP ratio of 120% is sustainable when the nominal interest rate on the debt is 5% or less, but – once the interest rate goes into double digits – the debt interest burden runs amok like a Frankenstein monster.) The Portuguese people are apparently weary with austerity, and it has to be said that – without a resumption of growth and particularly of asset price appreciation, which would help banking solvency – the danger has to be that further deficit-reduction measures would not restore fiscal sustainability or national solvency. Holders of Portuguese banks’ bond liabilities and depositors with Portugal’s banks, you have been warned! PEXIT (Portuguese exit from the Eurozone) is – almost certainly – a better option than staying in.
The Greek government recorded a surplus on its finances in January, an apparently heartening development in the continuing Eurozone melodrama. The surplus was the result of huge cuts in expenditure combined with the seasonal pattern of tax payments, which has the effect of making January a month of unusually high tax receipts in every financial year. (Greece had a budget surplus in January 2010, also.) Key decisions on Greek public finances are now being taken by the troika, the group of international bodies (the International Monetary Fund, the European Commission and the European Central Bank) acting more or less in unison to ensure that financially distressed Eurozone countries can honour (some of) their international debts. Can these organizations at last start celebrating? Is austerity having the desired effects? In fact, the wider macroeconomic background in Greece remains appalling. The January outturn is unsustainable, and reflects both desperation and severe fiscal trauma. Needs must when the troika drives. Tax revenues were lower, by over 9%, in January 2013 than a year earlier. The surplus was ‘achieved’ only by a fall of over 20% in expenditure, from €5,362m. in January 2012 to €4,239m. last month. It should also be emphasized that in January 2011 expenditure was €8,408m. In other words, Greek government expenditure at the start of 2013 was half (yes!) the level of two years ago. The Greek state is having difficulty controlling its borders, with immigrants widely reported to be responsible for a crime wave. There is still a high risk that Greece and/or Cyprus will leave the Eurozone.
David Cameron has promised, or at any rate indicated, that a newly-elected Conservative government would in 2017 hold an In/Out referendum on EU membership. As the Conservatives are generally regarded as unlikely to win the general election in 2015, Cameron’s promise may not amount to much. Nevertheless, the debate on the UK’s relationship with the EU will be intense at least until the general election and probably for some years thereafter. The purpose of this week’s e-mail note is to describe key features of the international scene, particularly those relating to Europe’s role in the world, as background to the debate. The main point is simple, that the EU’s share in world output and population is falling sharply, and the importance of the EU to the UK’s international trade and finance will decline. The focus is on two dates, 2017 for obvious reasons and 2059. 2059 is chosen because it is 42 years from 2017, while 2017 is 42 years from 1975, the last time that the British public was consulted in a referendum on EU membership. By 2017 British politicians would have taken 42 years to refresh the original mandate for UK involvement in ‘the European construction’. The most neutral assumption is therefore that – if that mandate were renewed in 2017 – they would take another 42 years to seek to refresh it again. (This note expands the argument on an article in the February 2013 issue of Standpoint.)
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.
Fears are being expressed that in 2013 the American economy will plunge over a so-called fiscal cliff. On unchanged policies the budget deficit (cyclically- adjusted) is due to fall sharply. Keynesian textbook orthodoxy says that a large decline of that sort represents a marked tightening of fiscal policy which will ‘withdraw spending power from the economy’, and so reduce demand, output and employment. But will it? The thinking behind modern fiscal policy were first developed in Keynes’ 1936 General Theory, particularly in its chapter 10, and his 1939 essay How to Pay for the War. The ideas were attractive in theory, not least because they accorded the government a large role in ‘managing the economy’. That appealed, and continues to appeal, to ‘the socialists in all parties’. (The phrase ‘socialists in all parties’ comes from Friedrich Hayek, The Road to Serfdom.) But does Keynesian thinking on fiscal policy work in practice? In the last few years the International Monetary Fund has published a database which includes numbers for both the output gap and the cyclically-adjusted (or ‘structural’) budget balance for all its important member nations. Analysts can therefore check the evidence on the relationship between changes in the structural budget balance and growth relative to trend. The Keynesian worldview would be confirmed if above-trend growth were associated with (or ‘caused by’) increases in the structural budget deficit. In my 2011 book Money in a Free Society I looked at the US evidence and established, at least to my own satisfaction, that the data up to 2008 flatly contradicted Keynesianism. In today’s note I extend the analysis to 2012 and also allow for some changes to old data. My conclusion in Money in a Free Society is not only confirmed, but reinforced. Naïve fiscalist Keynesianism does not work in the USA. The further implication is that the fiscal cliff does not mean that the American economy will suffer from another recession, or even demand weakness, in 2013.
Portugal (the P in ‘PIIGS’ for Portugal, Ireland, Italy, Greece and Spain) has been out of the media in the last few months, not least because its government has made a serious effort to comply with the conditions that accompanied its 78b. euro bail-out package in May 2011. The budget deficit in 2011 was indeed sharply lower than in 2010, although that owed much to the one-off effect of the re-classification of pension liabilities. As the following note by Mr. John Petley shows, so far this year the deficit is running above the 2011 level. However, the deficit is not radically higher than in 2011. It is still early days, but the deficit may end up in the 6% - 8% of GDP area, down from the 2010 figure of almost 10% of GDP, but not as good as 2011’s outturn of under 4 ½% of GDP. Portugal’s public debt is over 100% of GDP and, all being well, the debt/GDP ratio is expected by the International Monetary Fund to peak at under 120% of GDP in 2013. Also relevant to debt sustainability are the external borrowings of Portugal’s banks. Portugal’s banks have borrowings from the ECB of over 60b. euros, about a quarter of GDP. As no doubt much of this debt takes the form of the ECB’s ‘long-term refinancing operations’, the banks ought to be comfortable with their funding arrangements for a year or two yet. The right verdict for Portugal seems to be ‘much better than Greece, but its return to fiscal probity has been slower than Ireland’s’.
Very early in its development the Great Recession was described by Daniel Yergin as ‘a crisis in search of a narrative’. In an article in the Financial Times of 20th October 2009 he complained that, despite a mass of commentary, few accounts had put together a convincing analysis of cause and effect. The Yergin article had some great insights, but I didn’t agree with it then and I don’t agree with it now. In my view the Great Recession, and the associated Great Financial Crisis, can be readily interpreted with the aid of the monetary theory of the determination of national income and wealth. Indeed, the events of the last few years have much the same features as many earlier cyclical upheavals, except that they have been on a larger and more dramatic scale. (I also believe that the supply-side performance ‘of the leading economies’ has been surprisingly bad by the standards of the previous 20 or 30 years, and this is more puzzling.) My purpose in establishing International Monetary Research Ltd. in early 2009 was to provide a platform for the monetary – or, if you wish, the monetarist – analysis of the Great Recession/the Great Financial Crisis. It came as a profound shock to me to realize – in late 2008 and early 2009 – that key policy-makers (in the UK, the USA and elsewhere) had no understanding whatsoever (I mean that) of the implications of the regulatory bank-bashing then under way for the rate of growth of the quantity of money. Even in mid-2012 many top officials continue to applaud rapid bank recapitalization and deleveraging as the answers to the crisis, without seeing that the result will be a contraction in the quantity of money. So the current e-mail sets out a quick and rather brief ‘Monetarist explanation of the Great Recession’, as background to an article by Professor Steve Hanke in Globe Asia. The article seems to me of the first importance, because it shows that this type of analysis is beginning to gain traction and influence. I don’t agree with every one of Steve’s words, but I warmly commend his analysis to the clients of International Monetary Research Ltd.
Greece’s financial plight is intensifying, despite the promises made to international creditors and, more specifically, to the Troika of the International Monetary Fund, the European Commission and the European Central Bank. Fiscal austerity had become essential after the budget deficit reached 15% of GDP in 2009, but – because Greece is a member of the Eurozone and does not have its own currency – fiscal austerity could not be offset by monetary expansionism. Because of the wider Eurozone malaise, the attempt to reduce the budget deficit has had to be made while demand in Greece’s main trade partners has been weak. The data show that the attempt has failed. According to the IMF’s latest database (prepared in April), Greece’s gross domestic product was 230b. euros in 2010, but will fall to about 205b. euros in 2012 and 2013. The IMF also gives the ‘net borrowing’ of Greek general government as 15.6% of GDP in 2009, falling to 10.6% in 2010, 9.2% in 2011 and 7.2% in 2012. Well, that isn’t the message from the Greek government itself, which helpfully publishes a website with the data. The data show that the government deficit was 23.3b. euros in 2010 and 27.3b. euros in 2011, and is running at a somewhat higher level (although not dramatically higher) in 2012. The detail of the figures shows that serious efforts at fiscal restraint have been imposed, but the slump, and the resulting fall in tax revenues and increase in welfare spending, have overwhelmed the Roughly speaking, the Greek budget deficit is stuck at about 15% of GDP despite all the efforts of international and local officialdom.
Recent reports in the newspapers suggest that the Greek budget deficit might be 8½% - 9% of GDP in 2011, above the target of 7½% or so agreed with the IMF and the EU, but within striking distance of it. In fact, the data available so far indicate that the deficit is heading for about 15% of GDP, although this might be an over-estimate if the closing months of 2011 see immense receipts from privatisations. Assuming that privatisation receipts are negligible (which is reasonably in the current traumatic environment), Greece’s budget deficit is like to be about double the target agreed in last year’s bail-out package. Greece cannot be allowed any more wiggle room. But, because cutbacks in government spending (i.e., a tighter fiscal policy) cannot be offset by an easier monetary policy, attempts to slash the budget deficit are counter-productive. The debt is rising remorselessly towards 175% - 200% of GDP, while the market interest rate on new and maturing public debt is far into the double digits. Greece is completely bust and beyond rescue.