ELA, Grexit, and the technocrat turned politician.

The missing link between the Greek solvency problems and its membership of the eurozone is called liquidity. Absent liquidity problems, for example under 100% reserve banking, the two issues would be entirely disconnected, since the banking system would never need emergency liquidity assistance from the ECB.

I believe the doctrine of the ECB underlying ELA, is that ELA deals with a technical (as opposed to political) issue (The way ELA works is nicely described in this piece by The Economist). And this technical issue is what we call multiple equilibria.

According to this view, there exists a bad equilibrium where expectations of exit from the Eurozone and bank runs mutually reinforce each other. Under normal circumstances, banks can get fresh liquidity from the ECB at the going interest rate (which is very low), in exchange for collateral. This collateral has to be “good”. Assuming Greek banks hold Greek debt, the collateral becomes “worse”, the less solvent the Greek government. To the extent that Greek bonds are denominated in euros and owned by non-Greek residents, Grexit would either trigger a redenomination of those bonds in a depreciated drachma, or make it more difficult for Greece to pay them back, since it will presumably experience a substantial real depreciation. Therefore, expectation of Grexit makes Greek sovereign debt worse and Greekn banks less solvent. As depositors fear that their own bank could be liquidated, they run to the bank to get their cash back. Running to the bank delivers not a double dividend, nor a triple dividend, but a quadruple one:

First I am protecting myself against the bank’s bankruptcy. True, my deposit may be insured, but if the bank run is general the insurance system is undercapitalized and I may not get my money back.

Second I am converting the virtual euros of my bank account, that may be converted into drachmas any time, into actual euros that are physically the same as those circulating in Germany, and are much more difficult to convert except by extreme coercion.

Third, I am certain to have cash when I need it, instead of being rationed by bank holidays and controls on withdrawals.

Fourth, I am protecting my savings against a surprise capital levy that could be imposed by the troika on deposits in order to pay back creditors.

When faced with the bank run, the ECB has to do something. If it refuses to provide liquidity, say because the collateral is no longer acceptable, then the banking system in Greece collapses. And in order to provide liquidity to its banks, the Government will have no choice but to exit the Euro, making Grexit a self-fulfilling prophecy. The bank run equilibrium is a Grexit equilibrium, indeed expected Grexit acts as a catalyst for the bank run by reducing the market value of bank assets.

But it makes no sense for the ECB to value the collateral of Greek banks at its price under the Grexit equilibrium, if instead a better equilibrium can be enforced: that is, an equilibrium where the bank run does not occur. ELA is an attempt to enforce the good equilibrium by setting interest rates and haircuts at levels consistent with the good, not bad, equilibrium. If the good equilibrium is indeed an equilibrium, sufficient liquidity should be provided under those terms so as to “tame” the bank run and keep Greece within the Euro area.

The problem with this fairy tale is twofold.

First, technicality is not so easily distinguishable from politics. We see that the ELA tap is being shut by the ECB, because the Greeks are not accepting the conditions set by the troika. The banking crisis in Greece, initiated by the ECB, may bring the government down. There is no way Tsipras can decide, as the democratically elected ruler of Greece, to provide liquidity to banks despite the ECB veto, unless he exits the Eurozone immediately. Voters on Sunday may support the Yes vote because they believe banks will reopen sooner than if No wins. That is, the ECB can bring down a democratically elected government by stopping providing liquidity to its banks. In that respect, the similarity between Alexis Tsipras and Salvador Allende is striking; in both cases we have radical leftists heading a minority government. The difference stops in that instead of having a military coup (Pinochet and the CIA) we have a monetary coup (Draghi and the Troika/Eurogroup), and instead of the trucks blocking the roads, we have the banks blocking the transactions.

While closing the liquidity tap inevitably is a political coup against the Tsipras regime, keeping it open is another forced transfer from European taxpayers to Greek residents. In other words, regardless of the decision, the non-elected ECB cannot avoid doing politics.

Given the fiscal situation in Greece, the terms under which the ECB is accepting Greek bonds as collateral under ELA are probably too generous. Under ELA the ECB lends to Greece at 1.5 % and the haircuts are secret (See here and here on haircuts). Under the assumption that the ECB is successful at killing the bad equilibrium, the terms under which a Greek bank can borrow from the ECB should be the same as those in the market. Since Greece is tapping ELA it means that these terms are better, hence that there is a transfer. The transfer is larger, the larger the gap between the market prices the ECB is trying to achieve and actual market prices. If the ECB were fully credible in extending an infinite credit line to the Greek banking system, this gap would disappear. If the good equilibrium exists, the fiscal transfer to the Greeks is the mirror image of the ECB’s limited credibility and of the market view that the probability of getting to the good equilibrium is lower than 100%. The transfer, and the likelihood of the bad equilibrium, could then be eliminated by making the credit line infinite, killing any doubt by markets about the viability of Greek banks.

But, if the good equilibrium does not exist, Hans-Werner Sinn is right: The Greeks will take advantage of ELA to sell all the Greek debt to the ECB at an inflated price, converting their deposits into fresh and good euros, and leaving the ECB, that is, the taxpayers from solvent countries, with dubious claims on the Greek banks’ balance sheet. An unlimited credit line can no longer kill the bad equilibrium since it is the only one. It would simply raise the amount of money transferred to the Greeks by other euro area residents.

That the bank of Greece, not the ECB, is supposed to bear all the risk of ELA, is a cosmetic provision: ultimately, the bank of Greece accounts are implicitly consolidated with those of the bankrupt Greek government.

And it is hard to believe that the good equilibrium exists. That is, if the Euro were made as big a taboo as incest, the quadruple dividend from getting your money back would just become a triple dividend. Think about it. The benefits of having your money in a bank deposit rather than cash are quite small. The reason we keep it there is because it is the default option for most wage earners (they call it libertarian paternalism). So you only need a small cost of having your money deposited in a bank for it to be rational to withdraw your money. The asset side of the Greek banking system provides ample reasons to justify a bank run.

(The reason why the “good equilibrium” has existed for so long is that banks have been regularly provided with fresh cash by central banks, bailout money by governments, and deposits have been insured. But we may ask whether this form of financial intermediary makes sense. Perhaps the financial crises tell us that it is an evolutionary dead end and that banks should be eliminated. By saving them each time, public authorities are fighting against economic evolution and sowing the seeds of the following crisis.)

Post Scriptum — Here is an interesting piece by Dirk Niepelt. Clearly, the reason why governments would like to eliminate cash has everything to do with exercising discretionary control upon private savings — so as to implement a capital levy when needed, as advocated by Mrs Lagarde — and very little to do with “combating crime”. Virtual cash held at the monetary institute is also vulnerable to capital levy. In the long run, suppression of cash  by heavily indebted government will eventually harm them, as private means of payments (like bitcoin) will arise.


Two things I do not get about Greece

There are two things that baffle me about Greece.

First, the insistence on linking sovereign default with exiting the Euro area. Technically there is no relationship between the two. Greece can default on its debt and continue to use the single currency (in fact its seignoriage share could be confiscated by the creditors), just like many American states defaulted without stopping to use the dollar. Conversely, Greece could decide to exit the euro area and continue to meet its oligations. Indeed, there is talk in Finland of leaving the Euro and this has nothing to do with any looming sovereign default.

The Grexit ghost is a superstition which allows to mutualize the bailout among members of the eurozone in a way which is disconnected from their holding of Greek debt. Conversely, non euro area members contribute little or nothing to supporting Greece.

Second, the Grexit ghost is a way of manipulating public opinion in solvent euro area countries so as to make them accept the bailout. The implicit blackmail is that Greek default would trigger Grexit, then contagion and a collapse of the Eurozone, which would be a catastrophy. In order to avoid catastrophy, we are told, the taxpayer, not the holders of debt, should bear the cost of the Greek default. This blackmail is backfiring against its conceptors as Greece voted for a government which plans on reneging on austerity and live off other people’s money. This blackmail works well as the troika has just offered another 15 bn euros of our money to postpone a decision by five months. Presumably the Spaniards are taking due notice of this hilarious joke and will gladly adopt the Greek mutilated beggar strategy in the next elections.

Second, the lack of recognition that Greece suffers from a debt overhang problem. Despite falling wages the economy is not recovering, because firms expect that the profits they make will be taxed so as to meet the sovereign debt obligations. This is a well understood problem that has been identified decades ago in the context of similar crises and popularized by prominent economists such as Dornbusch, Krugman, or Sachs.

There is no difference between erasing a debt and lending to your debtor the interests he owes you: in both cases you do not get your money back. But in the second case the debt overhang problem destroys the economic incentives of the debtor. Instead of renewing the loans in exchange for fuzzy structural reforms that are unlikely to work because of the debt overhang problem, the troika should erase 75 % of Greek debt once and for all and stop any new institutional lending to the country. Greece will then be able to grow again for ten years. Private lending will resume relatively fast, as suggested by the historical experience.

This has little to do with Euro membership, except that once private lending resumes, another crisis may graduallybuild up. Greece will be too happy to live again with large twin deficits financed by capital inflow, because this will generate an economic boom driven by demand, a welcome substitute for the structural reforms its government is unwilling to do. It will accumulate the competitiveness problems and the debt overhang of the next crisis. For this reason it is not in the interest of Greece to remain in the Euro. Should it have its own currency it could supplement its insufficient fiscal receipts with seignoriage (as recently as 1990, inflation in Greece was 20 %, yielding perhaps 2-3 % of GDP in seignoriage revenues). It could devalue to boost its competitiveness (prices have fallen by 2 % in Greece and only very recently, despite then huge fall in GDP), maintaining external balance despite its tendency to create inflationary surprises so as to boost the economy. All these considerations are important, but they do not imply conditioning exit on default. If anything, it is the future defaults that the exit prevents.

Wealth, materialism and spirituality

I am half-way through the reading of Bobos in Paradise by David Brooks, and he traces the Bourgeois Boheme (aka bobo) lifestyle back to both the French “bohemian” rejection of bourgeois values in the nineteenth century as well as the American transcendentalist movement of Emerson, Alcott, and Thoreau. Presumably the intellectual heirs of that movement are the so-called post-materialistic philosophers, who have some influence on the bobo lifestyle.

So we have to figure out what is so despicable about the bourgeois ideal of competing, thriving, and accumulating wealth, and what makes the bohemian lifestyle desirable and praiseworthy. An immediate, naïve answer is that it is cool to be a rebel, even without a cause, but one has to go beyond such adolescent posturing.

Many would concur with Brooks that the original sin of the bourgeoisie against which the bohemians, the transcendentalists, the dandies, and the modern bobos react is its materialism. This brings forward three questions. In what sense is the bourgeoisie materialistic? Why is such materialism contemptible? And in what sense is the attitude of the bohemian crowd a deviation from materialism?

So what makes the traditional bourgeoisie materialistic? This is supposedly because of their excess taste for wealth and social status. If we consider the meaning of those words, we end up with a paradox. For neither wealth nor social status are material things. They are abstractions. It is true that wealth buys you material things, like a yacht or a plane, but the bourgeoisie against which the bohemians were rebelling was also noted for their relatively austere lifestyle. They might have impressive mansions, but while a mansion is a material object what really matters here is the impression. Therefore, we may want to keep in mind that materialism might not be the right word to qualify those bourgeois values. Another dimension that is discussed by Brooks is the fascination of the nineteenth century bourgeoisie for new technologies (railroads, electricity, and so forth), that the bohemians rejected as vulgar and dehumanizing. Again, what is remarkable about new technologies is that they witness human capacity to get rid of the constraints imposed upon us by our material condition, such as gravity. Therefore, fascination for technology hardly qualifies as materialism.

Nevertheless, it is likely that the bohemians reject such lifestyle because they deem it superficial and soulless. They of course have the right to conduct their life as they wish, but there seems to be a presumption that their lives are somewhat more worthy than those of the bourgeois, according to some reasonably accepted scale of values. So what is above technology, wealth, and social status in such a scale of values? Two common buzzwords are “Art” and “Spirituality”.

Spirituality is as elusive a concept as materialism. The origin of the word is religious; spirituality has to do with some invisible world, maybe the inner world, or the outer world. But, surely, spirituality cannot be defined as the absence of something. Not having wealth, not having a high social status, not being invited to cocktail parties, does not make you more spiritual. It can at best make you nihilistic, which does not qualify as spirituality. The claim by bohemians that they forsake a career in business to focus on their spirituality should therefore be evaluated upon the merits of their actions.

We can observe that most bohemians tend to live pretty secular lives, and in many cases are atheists. They are no Ignatius of Loyola, no Teresa of Avila. The French impressionists, for example, are a cliché of bohemian lifestyle. And their paintings were depicting trivial scenes, quite unlike the despised pompiers who were continuing to produce historical and religious paintings. A cornerstone of the bohemian lifestyle is enjoying daily pleasures without restraint, such as nice wine, dinner parties with friends, dancing in a guinguette, and casual sex. All of this seems pretty materialistic to me. More materialistic, in fact, than the life of an uptight WASP industrialist of the early twentieth century, simply because it resembles more the life of animals. In the 1920s, the American “lost generation” replicated the bohemian lifestyle in Paris and elsewhere, and by all accounts this was quite down to earth and unspiritual. In his novels, Hemingway frequently insists on details such as food, wine, and the like, to the point of having been accused of writing tourist guides. Rejecting the corset of bourgeois conventions may make you more relaxed and more “authentic”, but does not qualify as spirituality. What is going on here, is a false belief that if an individual is subject to less tight social control, he will be freer to express himself, and he will naturally express spirituality, as though humans in wilderness were ontologically more spiritual than civilized beings. Over and over again, we observe instead that this reduced level of self-restraint promotes animal instincts, not spirituality. Indeed, wilderness is a pretty materialistic environment, because survival is the main concern.

How about “art”? Here the implicit view is that the old style uptight bourgeois were incapable of appreciating art, stuck that they were in their vulgar and petty pursuits. In contrast, the bohemians, having freed themselves from material constraints, could fully enjoy the beauty of art, and of course many were artists themselves. It is true that the artists can afford the bohemian lifestyle, because their activity is not sensitive to organized interaction with other people.  It would be a disaster if the train driver, the hospital director, the pizza deliverer, the soldier, became bohemians. But the artist is much less bound by schedules and the need to cooperate. That being said, throughout the ages artists were not typically bohemian: think of Rubens, Bach or Tolstoi. Furthermore, just being a bohemian does not make you an artist. At best you are just mimicking some artists, and this hardly qualifies for a badge of moral or aesthetic superiority. Furthermore, the aesthetics are now self-referential. In the past, an artist was in fact an admirably skillful craftsman. The romantics came and popularized the view that an artist is some genious; art was no longer about beauty or skills, but about innovation. The impressionists are considered as superior to the pompiers, not because they are better painters, nor because their paintings are more beautiful, but because they invested a new way of painting. This avant-gardiste posture culminated of course with the Dada movement and Duchamp’s hanging of toilet bowls on exhibition walls. The end result is that there are no longer accepted criteria to define what art is. If anything, it seems that usefulness (a car design does not qualify as art) and popularity (Sinatra is less highly regarded than Duchamp) are at best irrelevant, as is beauty of course. Yet, as there are many things left that are new, uninteresting and useless, it would be suicidal if they were all considered as art. So only a subset of those artefacts qualify as art: those that are coopted by the self-appointed bohemian elite. An additional irony is that the reason why, historically, art is highly regarded, is because of its spiritual dimension. The Sixtine Chapel elicits emotions that may help connect the individual with some invisible, superior, truth. This can hardly be said of most of the Duchamp inspired contemporary art that is valued by hipsters and bohemians. Nothing is more materialistic than a toilet bowl. While the bohemian lifestyle may be more friendly to art, what passes for art nowadays has no external validity and has been stripped of any spirituality. There is therefore no reason to consider it more highly than any other human activity, such as a football match, a good dinner, or cleaning the (now mythical) toilet bowl.

We conclude that the claim of bohemians to moral and aesthetic superiority is largely bogus. The world they are promoting is in fact more materialistic than that of the despised bourgeois industrialists.

PS – I would speculate that the ideas above bear some relationship to Deirdre McCloskey’s Bourgeois Dignity, which I still have to read.

When did France become a non-employment society?

As of 2015, the general stereotype that the French are somewhat lazy and work little is well established worldwide. Indeed, on this site, I have repeatedly commented on the “non-employment society”, the 35 hour week, etc. For some economists, this is the natural result of regulations and of the very high tax rate on labor which prevails in the country. For others, it is at least in part due to French preferences for working less (although why a preference should be embodied in a regulation remains a mystery to me).

While I do believe that taxes have an important effect, I also always thought that if you deregulate the labor market and reduce taxes down to reasonable levels, the French would still work substantially less than Americans.

So here is a little quiz that may help shed light on this question: what is the average number of hours worked per employed in France in 1950, and in the US?

The answer can be gotten off the shelf from the Penn World Table, and it comes as a big surprise: in 1950, a French employee was working 2158 hours per year, and his american counterpart was working 1900 hours per year on average! Furthermore, the employment/population ratio in the U.S. was 40 %, while it was equal to 46 % in France. The non-employment society, then, if anything, was the US, not France.

In 2011, the French was working 1475 hours a year, and his American counterpart 1700 hours. The French employment/population ratio was down to 41 %, the American one had gone up to 45 %. And this cannot be due to differences in female participation rates, they are virtually identical between the two countries at close to 69 % in 2011.

As a result, French society was providing 1000 hours of work per person in 1950, and it is down to 600. In the US, there were 760 hours of work per person in 1950, and in 2011 it is slightly up to 771.

When did French workers start working less in a given year than American ones? You cannot make this up: In 1982, 1 year after the first socialist/communist coalition came into power.

Therefore, there is no inherent French preference for working less. Rather, skilled politicians managed to put together coalitions of people who increasingly lived off (and therefore supported) a zero sum redistributive game. As a response to that, the population gradually learned to refrain from wealth creation. Perhaps it may become a second nature after a while, but let us not be too pessimistic.

Euro Blackmail

The Greek election results are the perfect answer to the IMF’s, ECB’s and European Commission’s pledge to defend the eurozone at any cost, and their repeated claims that they are willing to exchange any asset against euros in order to reignite the anemic economies of the area and prevent another sovereign debt crisis. So, in effect, the Greeks are saying : you want to buy junk ? Here it is ! Where is the money ? It would be foolish of them to continue their painful austerity policies when they can instead get their deficits financed by using one of the facilities offered by the ECB under the “save the euro” motto. Conditionality is supposed to apply, but the ECB has given every hint that it would yield to blackmail, so why should the Greeks refrain from it ?

The relative lack of reaction of the euro/dollar exchange rate baffles me. Markets do not seem to understand the significance of the Greek election results.

The most favorable scenario would be Greece being kicked out of the Eurozone, defaulting on its debt, and starting over again at a depreciated exchange rate, with a balanced government budget (although Syriza would be unlikely to run a balanced budget) and a depreciated currency that would allow export demand to make up for the fall in domestic spending. Hopefully, after a couple of years of recovery and virtuous fiscal policies, Greece could borrow again on international markets, and even repay its original creditors a little bit. But the episode would set up a precedent, and bring about the possibility of renewed attacks on the sovereign debt of other euro area countries, under the belief that such attacks would lead to their exit from the currency area. This would be 2010-2011 all over again.

At the opposite of the spectrum, the troïka may yield to blackmail as Syriza reverts to primary deficits following a string of demagogical policy measures. The ECB will pose as responsible while running a Ponzi game, purchasing all the debt issued by the Greeks. The Greeks will do just fine, like a teenager, because they will be spending the taxpayer money from other European countries, through the mutualization scheme implicit in the ECB debt purchases. Things will eventually turn nasty as the electorate in other countries – Portugal, Spain, Italy, France – will conclude that blackmail works better than austerity and vote for their own populist parties. The ECB will find itself compelled to issue more money, and it will have lost any credibility regarding its ability to control the price level. Inflation will pick up and the euro will continue to fall. German consumers and pensioners will then increasingly favor a German exit, as it would occur at an appreciated exchange rate, thus improving solvency and purchasing power.

Finally, an intermediate scenario is that the troïka refuses to continue to purchase Greek debt unless the government goes ahead with austerity. This will be a casus belli, likely to trigger immediate default as the Greek government will revert to primary deficits. Since it will then be unable to borrow, it will want to exit the euro area so as to be able to monetize its own deficits.

I suppose the euro establishment believes that Syriza will turn out as  Lula or Menem style leftists, that is, they will renege on their most demagogical campaign promises and continue to pursue austerity.  They forget that Lula and Menem did not have a foreign entity with a wide open cheque book for them.

There is no such thing as bad publicity

One of the big frustrations of my life was not to be cited in those books that regularly come out in France and complain about economists being stupid, ignorant, or evil lackeys of capitalism. This always gave me a sense of failure. For this reason, I am happy to learn that I am one of the “architects of the ongoing disaster”. It gives me a sense of power, at least for fifteen minutes. You can read it here and have fun.