Greece's 'war cabinet' prepares to battle EU creditors as anger mounts

The country's radical-Left leaders have concluded that there is little to be gained from any further concessions to EMU creditors

By Ambrose Evans-Pritchard

11:00PM BST 10 May 2015

supporters shout slogans and wave Greek flags during the main election rally of the extreme right party Golden Dawn in Athens

Syriza will defend their 'red lines' on pensions and collective bargaining and prepare for battle whatever the consequence Photo: AP
Greece's "war cabinet" has resolved to defy the European creditor powers after a nine-hour meeting on Sunday, ensuring a crescendo of brinkmanship as the increasingly bitter fight comes to a head this month.

Premier Alexis Tsipras and the leading figures of his Syriza movement agreed to defend their "red lines" on pensions and collective bargaining and prepare for battle whatever the consequences, deeming the olive-branch policy of recent weeks to have reached a dead end.
"We have agreed on a tougher strategy to stop making compromises. We were unified and we have a spring our step once again," said one participant.
The Syriza government knows that this an extremely high-risk strategy. The Greek treasury is already empty and emergency funds seized from local authorities and state entities will soon run out.
Greece's mayors warned over the weekend that they would not release any more funds to the central government. The Greek finance ministry must pay the International Monetary Fund €750m (£544m) on Tuesday, the first of an escalating set of deadlines running into August.

"We have enough money to pay the IMF this week but not enough to get through to the end of the month. We all know that," said one minister, speaking to The Telegraph immediately after the emotional conclave.

The war council came a day before Greece's three-headed team - deputy premier Giannis Dragasakis, finance minister Yanis Varoufakis and deputy foreign minister Euclid Tsakalotos - are due to go to Brussels for a crucial meeting with Eurogroup ministers.

Time is running out for a deal opening the way for the disbursement of €7.2bn under an interim agreement, due to expire in June. It is even harder to see how the two sides can narrow their enormous differences on a new bail-out programme, which must be intricately negotiated and then approved by the parliaments of the creditor states.

German finance minister Wolfgang Schauble said over the weekend that Greece risked spinning into default unless there was a breakthrough soon. "Such processes also have irrational elements.

Experiences elsewhere in the world have shown that a country can suddenly slide into insolvency," he told the Frankfurter Allgemeine.

Greek officials retort that this is a conceptual misunderstanding by the German and North European authorities. Syriza officials say they may trigger the biggest sovereign default deliberately if pushed too far, concluding that it is a better outcome than national humiliation and the betrayal of their electoral vows to the Greek people.

"If it comes to the crunch, Greece must default and go its way," said Costas Lapavitzas, a Syriza MP and member of the party's standing committee. "There is no point raiding pension funds to buy time. We just exhaust ourselves for no purpose."

"We went up and down Greece in the elections urging the voters to throw out the old government. The question now is whether we mean what we say, and whether we have the courage of our convictions."

Officials say Russian president Vladimir Putin has offered Greece roughly €2bn up-front to smooth the way for the so-called "Turkish Stream" gas pipeline. While this would allow Greece to meet its IMF payments in May and June and then default later to the European Central Bank - deemed the real foe - it would not solve any of Greece's problems.

Gazprom's proposed Turkish Stream project (Image: Russia Today)

The implicit quid pro quo would be a Greek veto on an extension of Western sanctions against Russia. Such a decision would damage the rift with Europe beyond repair and would infuriate the Obama White House, which still has some sympathy for Syriza.

It is understood that US Treasury Secretary Jacob Lew told the Greeks that they would be "dropped like a stone" if they played this game.

Amos Hochstein, Washington's energy envoy, said in Athens on Friday that the pipeline was a foolish distraction. "Turkish Stream doesn't exist. There is no consortium to build it, there is no agreement to build it. So let's put that to the side," he said. Behind closed doors he has imposed an emphatic American veto on the whole plan.

While it is theoretically possible that Greece could go bankrupt and remain in the euro, it would in practice have to nationalize the banking system and introduce a parallel scrip currency. The chain of events would probably force the country back onto the drachma very quickly.

Greece's leaders are bitter that their recent efforts to reach out and seek an "honourable compromise" have achieved nothing.

The only concession so far from the EU creditors is to reduce the target for Greece's primary surplus from 4.5pc to 2pc of GDP next year. "They are like sharks: once they taste blood they come back for more," said one minister.

The Greek newspaper Kathemirini reported that the Eurogroup is drawing up a Plan B that will be presented to Syriza as an "ultimatum", offering nothing from its side to break the impasse.

Greeks want to remain in the euro by a wide margin but they also feel deeply aggrieved that they were sacrificed in 2010, forced to accept what they deem to be an unjust package of loans in order to save the euro and the north European banking system at a time when EMU had no backstop defences in place and was acutely vulnerable to contagion.

Leaked minutes from the IMF confirm that the country was badly treated and needed immediate relief to break out of a vicious circle, but the EMU powers have never acknowledged their shared blame for the debacle.

The political dynamics have become poisonous because what was originally a dispute between the Greek state and private investors has metamorphosed into a dispute between Greece and the rest of eurozone as a result of the bail-out mechanism.  

Any further debt relief would come at the expense of the EMU taxpayers, something that German Chancellor Angela Merkel and other leaders have said would never happen. Yet it is almost certainly going to happen. The IMF has threatened to walk away from the whole process unless a restructuring of Greece public debt - 180pc of GDP - is on the table.

It is clear that if Europe fails to heed the IMF's warnings, the Greek government may soon take matters into its own hands.


A Gifted Economist and the Ultimate Social Scientist

Gary Becker pioneered the use of economics to understand behavior, gaining insights with far-reaching benefits.


May 5, 2014 7:04 p.m. ET

When Gary Becker of the University of Chicago died on Saturday at age 83, the world lost one of the great economists of the past century—and one of its most significant social scientists. Becker believed that economics could be used to explain all social behavior. He proved it by analyzing topics believed at the time to be beyond economic analysis. His work was so revolutionary that it was viewed as heretical when it first appeared in the late 1950s, but it was eventually recognized with the Nobel Prize in economics in 1992.

Thinking of a child as an economic good, as Becker did, or theorizing that discrimination was a conscious choice that traded off a preference for discrimination against profits, seemed to many to be odd and immoral. He changed most of their views, once the skeptics recognized the power of his ideas in explaining the real world. Becker's work had important policy implications that would work to the betterment of humankind.

With his doctoral dissertation in 1955, Becker sought to understand both how discrimination would affect its victims and when discrimination's effects would be most pernicious. Becker treated discrimination as the reflection of a taste for one group over another but recognized that not everyone had the same preferences. As a consequence, markets would ensure that the disfavored employees would work first for those companies that had the least distaste for them.

This implied that when there were large numbers of individuals in the disfavored group, their wages would be much below that of the favored group, because they would be forced to work even for those who disliked their kind. When the disfavored group had few members, the wage difference between the favored and disfavored would be very small or nonexistent because they could find employers who had little distaste for them. Thus, for example, African-Americans suffered more from discrimination than did Jews because blacks constituted a much larger population. The difference in discrimination experienced by the two groups held true even when comparing individuals with the same education and skills.

Becker's economics of demography was among his most important theories. He observed that in the 19th century high-income families were larger than low-income families, but in the latter part of the 20th century the pattern reversed. Rather than resorting to circular taste-based explanations, Becker reasoned that rearing a child combined both goods and time, primarily the mother's. The goods component included food, clothing, shelter and the standard expenditures that one makes raising a child. The time cost varied with the mother's wage rate.

The "cost of a child" was lower for low-wage women because the value of their time in the labor market was lower than that of a high-wage woman. As a result, Becker postulated that families in which the mother has low wages are likely to be larger than families with high-wage mothers. In the 19th century, the pattern was the opposite because high-wage women did not work and the value of their time outside the home was low.

His theory about family size—which has been found to be true almost universally—had dramatic policy implications. The most effective way to reduce population growth is to educate girls so they will have a better opportunity to earn high wages as adults, which induces them to have fewer children. This view now informs development policy throughout the world.

In the 1960s, Becker also developed a theory of human capital that stressed the value of formal schooling and learning on the job. The theory yielded very specific predictions for wage patterns over the life cycle. Because skills are acquired as a career progresses, wages rise with experience but at a decreasing rate. Human capital grows rapidly in the first years on the job and more slowly later because the most important skills are learned first.

Consequently, raises for young workers are larger than those for old workers, and eventually earnings may even decline as human capital deteriorates with age. The theory also implied that turnover rates for young workers, who had fewer skills that made them valuable to a particular firm, would be higher than those of more senior workers. These predictions are borne out in data from many countries and time periods.

Becker also emphasized the wage-enhancing benefit of formal schooling. The educational establishment was at first hostile to this view, resenting a theory that treated education as a mere income-producer. As evidence mounted that education is the single most important factor in raising income, the establishment came around. His insight showed how important education and teachers are to society.

His "Treatise on the Family" (1981) was a comprehensive view of family life that also used economics to reason through behavior. He understood that caring for children was an act of altruism and an investment. He studied gifts, bequests and primogenitor (giving all of an estate to the first born). He examined family formation and dissolution in the context of human capital. His theories of marriage and divorce reasoned that those who had more "family-specific capital" were more likely to stay together, which is why families with children have lower divorce rates than those without, why divorce rates fall with years of marriage, and why couples who are well-matched in education, religion and other characteristics are more likely to stay together.

Becker's family economics was, like his other theories, resisted. Yet its predictions were confirmed in many different real-world settings, winning over most of his critics to the extent that Becker's view is now considered mainstream. He was awarded the Nobel Prize in large part for his work on the family.

Becker also made seminal contributions to understanding the trade-off between punishment and crime detection as deterrents to crime, how the behavior of one individual affects peers, how advertising affects consumer preferences, how to provide organs for transplants in the most efficient way.

Gary Becker was a giant who used his genius to make sense of issues that had formerly resisted analysis. He integrated economics into more general social science and won over his critics. He demonstrated that analytic thinking and economic analysis were the social scientist's most powerful tools. He went beyond scholarship, using his ideas and knowledge to inform policy, which resulted in his being awarded the Presidential Medal of Freedom in 2007. There is no doubt that his ideas will influence scholarly research for generations.

Mr. Lazear, who was chairman of the President's Council of Economic Advisers from 2006-09, is a professor at Stanford University's Graduate School of Business and a Hoover Institution fellow.

The U.S. Government: Adding Illiquidity to Insolvency

By: Christopher Casey
Saturday, May 2, 2015
"Nobody believes that the states will eternally drag the burden of these interest payments. It is obvious that sooner or later all these debts will be liquidated in some way or other, but certainly not by payment of interest and principal according to the terms of the contract." 
- Ludwig von Mises, Human Action (1949)

U.S. bankruptcy code (Sec. 101 (32)) defines insolvency for businesses as the "financial condition such that the sum of such entity's debts is greater than all of such entity's property, at fair valuation."

Although the federal government's $18.2 trillion debt is commonly compared to U.S. GDP of only $17.4 trillion, a far more appropriate debt comparison would be to compare it to assets possessed by the U.S. federal government (since, after all, the "economy" is not obligated to pay the national debt).

The values of such assets, liquid or otherwise, are inherently difficult to ascertain - some are unknown (e.g., real estate, mineral rights, offshore oil deposits) while others are of suspect value (e.g., student loans, U.S. Postal Service).

Most reports estimate such assets at well below $4 trillion, so the net worth of the federal government would be negative $14 trillion. The Federal Reserve is a bit more optimistic: it estimates the U.S. government's net worth at negative $12 trillion. Either way, the federal government is clearly insolvent under its own law, if it were a business.

The U.S. bankruptcy code contains another definition of insolvency; one which is in fact specific to government (municipalities). Here insolvency is defined as "generally not paying its debts as they become due" or "unable to pay its debts as they become due."

Insolvency is not simply a balance sheet issue, but rather one of cash flow: illiquidity is another form of insolvency. Under this definition, except for the occasional (and short-lived) shutdowns, the U.S. federal government is thought liquid and solvent through its taxing power and printing press. But this will quickly change if expenditures skyrocket. With $18.2 trillion in debt, the easiest way this may happen is if interest rates rise.

What are interest rates?

Given the recent history of massive intervention in the bond markets by central banks, few remember that interest rates are ultimately a product of the free market. At a fundamental level, they reflect the time preferences of various actors within the economy. Add in assessments of credit risk as well as expectations of future price levels, and a structure of interest rates over various time frames is revealed. All markets can be suppressed, distorted, or manipulated, but only for a limited time. The bond market is no different; ultimately interest rates will resort to higher levels.

How far must interest rates rise for the U.S. government to be "unable to pay its debts as they become due"? Currently, the federal government effectively pays only 1.3% on its debt obligations - a rate unknown since the depths of World War II. Over the last 75 years, there have been periods of far greater effective rates (the early 1980's experienced 8%) with an average of over 3% - all while the U.S. government possessed vastly better credit worthiness.

Even with record 2014 tax receipts of over $3 trillion, federal debt levels are almost six times current receipts. It is no different than a household earning only $30,000 a year with $180,000 of debt. And this is the official debt level; include Social Security, pension funds, or any of the other myriad promises made, and financial obligations easily balloon to 30 or more times tax receipts. Given this financial condition, one can easily argue that an applicable market-based interest rate for U.S. government debt would be far, far higher - perhaps akin to Greece, perhaps worse.

What happens to interest payments as a percentage of tax receipts with higher interest rates, and thus the ability to pay other obligations? Currently at "only" 8%, they grow to 20% with the historical average interest rate. At interest rate levels experienced in the early 1980's, they expand to almost 50%. All of these projections assume tax receipts are stable, but a recession would compound the calamity as tax receipts fall. The 2008 recession caused tax receipts to fall 18% over a two-year period. Combine 8% interest rates with a recessionary hit to tax receipts, and interest payments alone swell to 60% of total tax receipts. Well before reaching such high levels of interest payments, the federal government would lose the ability to pay other expenses "as they become due" - or otherwise.

For this reason, the U.S. government has suppressed interest rates for years: it simply cannot afford for them to rise. It will continue to do so by remaining reliant (and increasingly so) upon the printing press to purchase bonds and lower rates. But this strategy will only work for so long. Whether through a sober assessment of credit worthiness by investors or via rising price inflation, the market will compel higher interest rates. If the Federal Reserve then continues with proliferate production runs of the printing presses, expect Mises to be prophetic: bondholders will be "repaid", but with a currency which hardly meets the "terms of the contract."

  How To Prepare for US Government Insolvency

As insolvency will be answered with a de facto default - a repayment to bondholders with a substantially depreciated currency - all investors must prepare for price inflation. It may not develop within the next 12 months, it may very well be preceded by an asset deflation, but it will arrive. When it does, it may appear in 1970's fashion: suddenly and substantially.

Reflexively, all investors expecting price inflation seek protection with precious metals.

While precious metal investments are perfectly prudent and will ultimately prove quite profitable, other inflation hedges should be considered - especially those providing income backed by hard assets such as certain types of real estate. Given historically low interest rates, aggressive investors may even wish to partially finance such investments by borrowing at fixed rates.

US government insolvency will involve more than just price inflation, it will include turmoil in every financial market and in every economic sphere. Investors must remain liquid, flexible, and nimble as opportunities will develop as quickly as risks appear.

05/31/2010 10:45 AM

ECB Buying Up Greek Bonds

German Central Bankers Suspect French Intrigue

By Wolfgang Reuter
The European Central Bank has been buying up Greek bonds by the bucketload, even though Athens is already getting money from an EU rescue fund. German central bankers suspect a French plot behind the massive buy-up -- after all, it gives French banks the perfect opportunity to get rid of their Greek assets.

The senior members of the German central bank, the Bundesbank, regarded Axel Weber with a look of anticipation. What would Weber, the Bundesbank president, say about the serious crisis that had them all so worried, they wondered? And what did he intend to do about it?

Weber said nothing and, as some who attended the meeting report, even his facial expression was inscrutable. The Bundesbank president remained stone-faced as he acknowledged the latest figures, which indicated that by the end of last week the European Central Bank (ECB) had already spent close to €40 billion ($50 billion) on buying up government bonds from Spain, Portugal, Ireland and, in particular, Greece.

The ECB already has about €25 billion of Greece's mountain of debt on its books, and it is adding another €2 billion a day, on average. The Bundesbank, which has a 27 percent stake in the ECB, is responsible for €7 billion of the ECB's Greek government bonds.

Many Bundesbank members are wondering why the ECB is buying Greek bonds in the first place, particularly on this scale, now that the euro-zone countries' €110 billion bailout package for Greece has been approved, and the first tranche of the funds has already been disbursed.

The general €750 billion rescue fund for the remaining highly indebted countries has been approved but not yet set up. For this reason, it certainly makes sense to stabilize the prices of Spanish, Portuguese and Irish bonds. Nevertheless, some of the central bankers have a sneaking suspicion that there is a French conspiracy at work.

Bailing Out French Banks

By buying up Greek debt, the ECB keeps the prices of the bonds artificially high. French banks, in particular, benefit from this policy because it enables them to sell their Greek bonds to the ECB, as an inexpensive way of cleaning up their balance sheets. France's banks and insurance companies have a total of about €80 billion in Greek government bonds on their books.

German banks, on the other hand, are not potential sellers, because they have made a voluntary commitment to Finance Minister Wolfgang Schäuble to hold their Greek bonds until May 2013.

Thus, in a roundabout way, the Bundesbank, by spending €7 billion to purchase the Greek securities, has already made a substantial contribution to bailing out banks in neighboring France.

It was ECB President Jean-Claude Trichet, a Frenchman, who, in an alarming and provocative speech, initiated the extensive euro rescue package that was approved on the weekend of May 8-9. And it was Trichet who yielded to massive pressure from French President Nicolas Sarkozy and, soon afterwards, violated a long-standing ECB taboo, namely that the central bank should never buy its member states' debt. This, however, was precisely what Sarkozy had demanded of his fellow European leaders, including German Chancellor Angela Merkel.

Clear Signal

Weber, the Bundesbank president, voted against this measure in the ECB council and criticized it the next day in an interview with the German financial newspaper Börsen-Zeitung. For a central banker, this is a very clear signal of dissatisfaction. But the Bundesbank president faces a dilemma, because he hopes to take over as ECB president when Trichet's term expires next year. The general consensus in the German government is that if he continues to fight against the purchase of the bonds, his prospects for securing the top ECB post will dwindle.

But many German central bankers expect Weber to remain steadfast and not give in. For them, the purchase of government bonds is a betrayal of the principles of the once-proud institution.

By deciding to do so, they say, the ECB has lost its status as an independent central bank -- and, along with it, so has the Bundesbank. And then there is the fear of the consequences of such a purchase, which many central bankers believe could jeopardize the very existence of the ECB.

However, European central bankers do not know how long the ECB will continue to buy government bonds. That depends on how bond prices fluctuate in the euro-zone countries in question.

Managing the Crisis

Every morning, the so-called Market Operations Committee (MOC) of the ECB analyzes the situation. The committee, whose members the ECB does not identify, supports the central bank in its monetary policy affairs, foreign currency transactions and the management of currency reserves. But the MOC has also become the bridge from which the central bankers are managing the euro crisis.

The Bundesbank's representative on the MOC is Joachim Nagel, head of the central bank's markets department. In closed-door sessions, he and his fellow committee members determine when and for what amounts the ECB and the euro-zone central banks, in concerted actions, buy up the government bonds of highly indebted euro countries to support their prices and thus maintain yields at a tolerable level.

The central bankers have informally agreed on what constitutes this tolerable level. The MOC's goal is to manipulate the markets in such a way that bond prices level off at the values that were in place on April 9, before investors, fearing that the governments could default on their bonds, launched into a massive sell-off of the securities.
The Euro Zone's Bad Bank

Bonds worth about €3 billion are now being purchased on every trading day, with €2 billion of the bonds coming from Athens. At the moment, there is no improvement of the situation in sight. "The ECB and the national central banks operating on its behalf are currently the only buyers to speak of," says one market insider.

This policy effectively makes the ECB a so-called "bad bank" (a bank that buys up toxic assets as a means of helping out other institutions), all protestations of its president to the contrary. The pile of junk bonds on the ECB's balance sheet continues to grow. The fact that the ECB is keeping prices artificially high is downright encouraging banks to unload their risky assets onto the central bank.

Thorstein Polleit, the chief economist of Barclays Capital Deutschland, puts it this way: "The ECB is creating excess supply by buying at overinflated prices." In other words, many creditors are more inclined to sell their risky assets to the central bank under these terms. "It's a free lunch," says a top Frankfurt banker. "Anyone who doesn't take advantage of this opportunity to get rid of his securities now only has himself to blame."

But in pursuing the policy, the ECB has backed itself into a corner. What will happen if it stops supporting the market? Will the prices of the bonds of highly indebted countries then hit rock bottom?

Time for a Haircut?

To make matters worse, very few financial experts believe that the governments in question, particularly in the case of Greece, will get a handle on the debt crisis. Deutsche Bank CEO Josef Ackermann recently voiced such doubts, saying that such a failure would result in a so-called "haircut" -- that is, a debt waiver on the part of creditors. If that happened, Ackermann said, the ECB itself could be in jeopardy. The central bank's capital, currently about €70 billion, most of which is invested in the national central banks, would be severely affected or even completely exhausted, depending on how much longer the central bank continues to buy Greek bonds.

The member states would also have to inject new capital into the ECB, a particularly difficult undertaking for highly indebted countries.

Another option for the ECB would be to issue its own bonds to recapitalize itself. But this too creates a problem: At what interest rate would investors lend money to the central bank under these circumstances?

The only remaining solution would be one that has always led to inflation in the past, namely firing up the printing presses.

Good Money for Bad Debt

Although that scenario is unlikely to materialize, those who have always believed that a few days of robust ECB market intervention would be enough to reassure market players and bring yields back to a normal level were mistaken.

At first glance, the ECB's efforts to support the bonds of highly indebted countries would seem to have a neutral effect on its balance sheet, because it reflects a value for the bonds corresponding to their price. But the truth is that good money is being paid for bad debt.

The German finance minister, in particular, will feel the effects of this policy. The Bundesbank normally transfers its profits to the federal government at the end of each year -- in euros, not Greek bonds.

But paying for the bonds ties up available funds, thereby reducing profits, presumably for years to come. This too has a seriously adverse effect on the self-confidence of the central bankers.

Things could get worse. If creditors were in fact forced to forego a portion of their claims, this flow of payments could even be reversed. Under that scenario, the federal government would have to transfer money to the Bundesbank to offset its losses.

Translated from the German by Christopher Sultan