21 Lessons from the Greek Crisis



The refinancing deal struck on 13th July between Greece and its Eurozone partners left everyone bruised and unhappy. While it staved off the immediate threat of yet greater chaos from Greece being forced to abandon the euro, doubts remain as to whether the deal will succeed. So what are the lessons to be learnt?

  1. The creditors remain in charge. The radical left-wing Syriza-led government in Greece gambled that its international creditors would be so worried about the potential damage from a “Grexit” from the Eurozone that they would grant it softer terms on another bailout. It was wrong. Despite securing a strong ‘no’ vote in a last minute referendum on a package requiring it to deliver on reforms and further austerity measures, Syriza ended up having to capitulate to an even tougher deal.
  2. Politics trump economics, at least in the short run. At times the numbers in the fiscal plans that the Greeks were proposing were very close to those suggested by its creditors, but the confrontational tone of the debate made it hard for politicians on either side to sell the deal to their voters.
  3. Trust matters. The negotiations became acrimonious, and violent swings in bargaining positions (particularly from the Greeks) got in the way of striking a deal. In the end, trust is essential in any financial transaction. Sadly, given the Greek Prime Minister Alexis Tsipras criticised the deal as ‘blackmail’, mutual mistrust will persist.
  4. Don’t rely on economic forecasters. Forecasts on the outlook for Greece, not least from its creditors, have repeatedly been woefully optimistic, drastically underestimating the damage to growth from budget cutbacks. Only a little over a year ago, the International Monetary Fund was forecasting that the Greek economy would grow by 4% in 2015, now it looks like shrinking by the same amount.
  5. Severe austerity has a political price. Syriza’s support sprang from the depression in the Greek economy, which sent unemployment soaring to over 25% of the work force. This has bred resistance to further fiscal restraint.
  6. The more essential reforms become, the harder they may be to implement. The wrangling over the last few months has inflicted more damage on an already weak Greek economy and fuelled a toxic political climate. Intrusive surveillance of reform implementation by foreign creditors may be required, but is likely to meet with hostility.
  7. Just because an economic strategy has failed, it doesn’t mean it won’t continue. The combination of severe fiscal austerity and lack of reform has seen Greek government debt rise rather than fall. More austerity, in the shape of spending cuts and tax rises, has already been agreed, but it is not clear how far the pace of reforms will pick up.
  8. Make sure that you have an explicit and credible ‘Plan B’. Former Finance Minister Yanis Varoufakis claims that Greece, if it failed to get external finance, had a secret ‘plan B’ to introduce a temporary currency linked to the euro. But with the banks closed and the economy struggling, the creditors believed that Greece had either to accept its terms or face an economic meltdown. Other populists elsewhere in the Eurozone will have to reflect on this before eyeing the Euro exit door.
  9. Game theory is tough to apply in practice. Varoufakis, an expert in game theory, lost out on this one. Not only is the Eurozone a multi-player game, with each player having distinct motivations, it is also a multi-period game, rather than a one-off game: you have to recognise that other players will remember how you behaved before, and act accordingly.
  10. There are deep-seated differences in thinking within the Eurozone not just on politics, but also economics. The debate over Greece laid bare old divisions. On one side there is a German-led hard core emphasising rules, discipline and austerity and on the other the softer camp led by France and Italy advocating solidarity and growth.
  11. Fiscal union is a distant prospect. There is little appetite to share economic burdens across the Eurozone. As a result, the original vision that European monetary union would be bolstered by a system of fiscal transfers from the richer to the poorer members looks further away than ever.
  12. The Eurozone will continue to have a deflationary bias in the event of future debt problems. Debtors will be expected to deliver on budget cuts, with no matching expectation that creditors will offset this with fiscal stimulus measures.
  13. Generous welfare systems will continue to be under threat. Drastic cuts to public spending in Greece, with pensions being a particular target, will send a message across Europe. The young will have less secure financial futures than their parents.
  14. The Euro is no longer irreversible. German Finance Minister Schäuble’s public advocacy of a temporary Eurozone ‘time out’ for Greece – for which there is no provision in its founding Treaty – has opened the door to future speculation that members could leave. This creates a precedent that may come back to haunt the Eurozone.
  15. Without growth, Greece will struggle to repay its debt. There are plans to help with EU-backed investment programmes, but these are relatively small and are unlikely to be delivered until Greece delivers on austerity and reform measures.
  16. “Kicking the can down the road” makes it bigger. Eurozone creditors remain reluctant to write-off Greek government debt, as advocated by the IMF. While politicians attribute this to Eurozone rules, it stems more from fears of a voter backlash if they acknowledge losses on loans to Greece. The strategy of lowering interest rates and lengthening the payback period on the debt – ‘extend and pretend’ or ‘reprofiling’ – is less embarrassing than partly writing off the debt, but is likely to prolong the agony.
  17. Interest rates will remain low. Monetary policy will continue to carrying the burden of supporting economic growth. The European Central Bank will have to persevere with its programme of bond purchases (‘quantitative easing’) to hold down long term interest rates.
  18. The euro will remain a weak currency. While the ECB is set to be locked in to keeping interest rates low, the US and the UK are set to raise them in the next few months, driving the euro lower still.
  19. The rest of the world will have to live with weak demand from the Eurozone. Although the recent hiatus in Greece may prove only a temporary blow to the recovery across Europe, economic growth is likely to remain lacklustre. Moreover, the weak euro will continue to make it hard for exporters to the Eurozone.
  20. Exports will continue to be the bright spot for Eurozone companies. Producers in the Eurozone have benefited from the falling euro, which is making prices more competitive on world markets. The relative buoyancy of the US and the UK is also helping.
  21. Don’t make important financial decisions at night. The sight of bleary-eyed politicians announcing a deal at 7am after sixteen hours of negotiations should serve as a warning…

This post also appears in the latest edition of ING World

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Globalization Disrupted : Will world trade continue to disappoint?

Since the onset of the financial crisis, world trade is no longer growing twice as fast as output. I examine the reasons behind this in this presentation, an updated version of one produced to support a panel debate at a trade finance conference in Chicago last month. Although many commentators expect the headwinds confronting trade to continue, there are important offsetting factors in the longer term. The key points are as follows:

  • Growth in the developed markets is slower, reflecting sluggish domestic demand…
  • …especially in big deficit nations, which are trying to emulate Germany’s export success…
  • …with varying degrees of success – US and Spain have done well
  • Offshoring and re-imports have waned
  • Disruptive technologies may also reduce trade in the long term
  • But there could be positives from…
  • 1. Further Trade liberalisation.
  • 2. Offshoring : the spreading of Western FDI away from China to other low cost countries
  • 3. Offshoring by Chinese companies that want to produce close to their Western customers
  • 4. New energy flows, especially from the US
  • 5. A policy shift to boost infrastructure
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The New Abnormal

It’s remarkable how pervasive ‘New Normal’ thinking still is, despite innumerable economic and financial market shocks. Forecasters continue to assume that the global economy will gravitate towards low but stable growth, regulators still aim to deliver a more stable financial system, and central banks keep aspiring to ‘normalise’ policy after years of radical improvisation. Yet, as I argue in a report entitled ‘The New Abnormal’ such thinking is in for a few surprises. The world is still far from any sensible definition of ‘normal’.

The idea of a New Normal glosses over several sources of instability. The New Abnormal is characterised by on-going structural changes that extend beyond the decade-long challenge of reforming the financial system. Economic policy is unbalanced, with monetary policy forced into the role of supporting economic growth in the face of headwinds from fiscal consolidation and tightening financial regulation.

Sadly, unconventional monetary policy interventions, such as quantitative easing, have enjoyed more success in boosting asset prices than economic growth. As a result moves to ‘normalise’ interest rates could turn out to be much bumpier than the markets expect. As a result, there is a serious risk that financial market volatility will spill over into the real economy. Indeed, market volatility and weak growth could easily become mutually-reinforcing. To the extent that central banks recognise this, this will make the road to higher rates as much ‘market dependent’ as ‘data dependent’.

Meanwhile, the reluctance of policy-makers to embrace growth-enhancing fiscal and structural reforms is deterring the investment that could stimulate a surprisingly robust upswing in the longer term. The upside of the volatility of the New Abnormal, in contrast to the fashionable miserablism of the New Normal crowd, is that there is potential for positive surprises in the longer term. As I’ve argued before, a host of new technologies offer the potential for positive network effects and answers for the demographic challenges to global growth. But it remains to be seen whether the shock of another recession will be required to trigger the shifts in economic policy that might give business the confidence to embrace that potential.

Posted in Bond Markets, Economic Growth, EMU, Innovation, Macro, Macroeconomics, Productivity, Technology, Uncategorized, US Treasury Bonds | Tagged , , , , , , , , , , , , | 1 Comment

US triumphs in the World Economic Cup

Economic Cup 02 (2)

The legendary manager of Liverpool, Bill Shankly, once said, “Some people believe football is a matter of life and death… I can assure you it is much, much more important than that.” I’m tempted to agree, but sadly I get paid to analyse economics, not football. As countries start to compete on the football fields of Brazil, I thought it would be fun to see how they are competing against one another economically. So who will win the World Economic Cup in 2014? Based on analysis by the ING Economics team, I would say the USA.

To get to this momentous result, we took a range of indicators to assess how twenty of the leading nations competing in this year’s World Cup have performed since the last competition in 2010. How fast did they grow? Did they reduce unemployment? Did they improve their competitiveness and exports? Did they reduce their unit labour costs? .

Economic Cup 03

Ranking their performance on the basis of these five economic criteria ( based on data from the IMF, EIU and World Economic Forum), and then combining them into a single index, we came up with a league table. The USA came out on top, alongside Mexico. Interestingly, two more countries from the Americas, Chile and Brazil, feature in the top five. For football aficionados, this is a pleasing result, because in each of the seven occasions that the real World Cup has been held in the Americas, a team from the Americas has won (for the record, the winners were Uruguay, Brazil and Argentina).

In fact, the only European team to feature in the top eight is, you’ve guessed it, Germany, at number three. The Netherlands and Spain, two great footballing nations, barely scrape into the top ten, alongside Russia. England, represented in the World Economic Cup by the UK, comes in at number 13. This puts it just ahead of the remaining European competitors, who dominate the bottom of the table, which is propped up by Nigeria. Clearly the Eurozone crisis has weighed on the economic performance of Europe in the past four years.

Economic Cup 01

To see how these economic rankings would look when translated into the knock-out format of the real World Cup, we put each country into the Groups drawn for this year’s competition. Sadly, on this basis, The neither the Netherlands nor Spain make it out of Group B, because they have the misfortunate of being in the same Group as the more highly economically ranked Chile and Australia.

In the table below, each game is won by the team with the higher economic ranking. As a result, hosts Brazil lose out narrowly to Chile in the second round. Chile then beat England in the quarter final, but then go on to defeat against Germany in the semi-final. The other semi final is between the USA and Mexico. Since they have identical rankings, we decided to have a ‘penalty shootout’ based on the performance of their stock markets since 2010. The USA emerges as the winner, and then goes on to beat Germany in the final to win the World Economic Cup.

Economic Cup 02 (2)

Now you may be wondering, where would China fit into this story? Well, China is not in our World Economic Cup because it failed to qualify for the real thing. But, despite its rapid growth, China would not have won the Cup, even if it had qualified: its economic ranking is let down by its scores on competitiveness and unit labour costs. Indeed, it would have lost to Mexico in the quarter final.

With all due respect to Bill Shankly, like football itself, our exercise is hardly a matter of life and death. But there are still some important lessons. The performance of countries in Asia and the Americas show how rapidly the list of winners and losers can change. Meanwhile, it is clear that Europe’s economies are paying the price of the Eurozone crisis. Yet despite this, Germany’s economy, like its footballers, can never be counted out. This is something to emulate. But, thankfully for the rest of us, whether in business or in football, Germany can still be beaten.

(With thanks to Anke Martens)

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By Accident or Design – Optimism from a Dismal Scientist

> I recently spoke at a conference in Santa Monica California organised by the Design Management Institute entitled Designing the New Economy. Tired of being miserable, I decided to take on the fashionably gloomy view of the long term outlook. My presentation was entitled By Accident or Design – Optimism from a Dismal Scientist

> While the devil may have the best tunes, the more I thought about it, the more the optimistic view began to appeal. After all, economic forecasters have hardly covered themselves in glory in the past. Indeed, few saw the financial crisis coming, so why should we take as read the new consensus that the West faces a Japan-style lost decade or two? The current pessimistic funk could prove just as misplaced as the self-congratulatory optimism that preceded the crisis. This is not to deny the current headwinds from debt deleveraging in the developed world. But they won’t last forever, and a growing list of exciting new technologies could spark a surprising surge of growth in the longer term. Economic reform and trade liberalisation are on the agenda, This is especially remarkable in the face of high unemployment, which makes destructively nationalistic options tempting. Emerging markets still have a lot of technological catching up to do, and despite occasional reverses, their economic governance is still on an improving trend.
> The attached presentation (click here for the long version) summarises the case for optimism with the following twelve points:

> 1. Dismal economists are too pessimistic

2. Policy-makers are learning, by trial and error, and austerity won’t last forever

3. Crisis is shifting resources to more productive uses

4. New ways of financing are developing

5. The list of potentially disruptive technologies is impressive

6. Connectivity is still in its infancy

7. Network effects promise accelerated learning

8. Technology will create jobs as well as destroy them

9. Emerging markets still have a lot of catching up to do…

10. …and will fuel demand

11. Developed world still has leadership in design and technology…

12.  …which can drive growth and trade

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Draghi’s confidence trick is working a treat

Over the last few months there’s been a dramatic turnaround in capital flows to the Eurozone’s periphery, illustrating the success of ECB President Draghi’s rhetorical flourish last summer to do “whatever it takes” to support EMU. Today’s Financial Times carries two articles featuring ING’s number crunching on this topic, including elements of one of my current favourite charts (click here: Eurozone Balance of Payments).

The chart underlines the point that volatile private capital flows are the driving force behind the performance of the euro and the Eurozone financial markets. The other side of the balance of payments, namely the current account, has been improving since 2010, at least in the sense that the deficits of the periphery (Italy, Spain, Portugal, Greece and Ireland) have been declining. The problem is that while this has partly been due to growth in their exports,  it has also been due to falling imports as their domestic demand has plunged. That plunge in turn continues to threaten the periphery’s solvency by undermining their capacity to cut their budget deficits.  

Indeed, that’s precisely why there was an emerging market style capital flight of out of the likes of Italy and Spain in the first few months of last year, as fears of EMU breaking up mounted. This is vividly illustrated in the chart, which shows an exodus of private capital, equivalent to almost 20% of the periphery’s GDP,  in the first eight months of 2012.  Draghi’s verbal intervention in late July, followed up by September’s offer of “outright monetary transactions” to support the periphery’s government bond markets, came just in time to avert disaster. Since his comments, private capital has been flowing back into the periphery, albeit initially at a slower pace than it left: on our estimates the influx of €92.7bn in the final four months of 2012 was the equivalent of just under 9% of GDP.

The markets’ strong start to this year suggests that Draghi’s confidence trick may be gaining momentum. The trick seems to be working a treat. But unless the markets’ optimism starts to translate into stronger economic activity over the coming months, and politicians use the current breathing space to make progress on banking union and other moves towards integration, the treat may turn sour.

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The Four Minute Solution to the Euro Crisis…

…complete with Dutch subtitles, here’s a video, posted originally on the website http://www.mejudice.nl. It summarises the key conclusions arising from the ‘Roads to Survival’ report about how EMU break-up may be avoided (see my June 5th post). But for now, the Eurozone still seems to be on the unsustainable path of Austeria. Sadly, policy-makers are slow in learning the required ‘3 Rs’ – reform, reflation and redistribution…

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