The great Syrian trek across a disintegrating union

I don’t much like writing about  the economics of human tragedy, but the great import of events in Europe compels me. The European Union has never looked so fragile.

The news is mainly about the conflicts between Germany and its eastern neighbors: Hungary, the Czech and Slovak republics, Poland and the Baltic states. Most of the latter are making themselves look very mean and petty, refusing to offer sanctuary to more than token numbers of Syrian refugees, even though most would probably soon leave for Germany or Sweden anyway.

Germany is threatening to cut off EU funding to any states that don’t carry their share of the refugee burden. The eastern states are questioning whether Germany has any legal standing to make such a threat. If no one backs down, the very heart of the EU, its budget, could fail. The EU is after all an association of independent states, with no real powers of compulsion.

Another key component of the European project, the right to travel freely across Europe, is being rolled back. A number of states, including Germany, have reinstated checks at their borders with other members of the Schengen Zone. Another European treaty called the Dublin agreement, which governs the handling of refugees and asylum-seekers, has all but died.

Meanwhile, a lot of people are acting unbothered. The Greeks have re-elected Alexis Tsipras, making clear they want a government that will do the absolute minimum required of it to stay in the Euro Area after the maximum protest and resistance. The €13b of bailout funds Greece has received so far was only enough to roll over Greece’s debts through the end of this year, not even including the arrears Tsipras ran up during the crisis he manufactured in June and July. He is still being kept on a very short string. A fresh crisis could erupt any time from early next year.

Then there are the Catalans, who are seriously considering leaving Spain, even though that would automatically remove them from the EU. And the UK, where an “out” vote in the promised referendum on EU membership, probably in 2017, is looking ever more likely.

Is the EU about to fall apart? It’s time to step back and take stock.

Some background on the Schengen and Dublin agreements

There hasn’t yet been any real collapse of the Schengen Zone. The right of Schengen Zone residents and legal visitors to freely cross national borders within the zone is not being challenged.

Explicit national border checks within the zone are a new and alarming trend. But there has always been some amount of de facto national border checks within the Schengen Zone. If you’ve traveled much by train in Europe, you’ve probably seen police walking through just after a border crossing checking the documents of passengers who look neither well-off nor European.

The Dublin agreement does appear to be dying, but it has been falling slowly apart for a long time. This is the treaty that requires applicants for asylum to apply in the first EU country they enter, and allows EU countries to deport asylum seekers who entered the EU through another country to that first country of EU entry.

The point of the agreement was to force each EU country to take responsibility for securing its own borders (if any) with non-EU members, and to prevent ineligible people from abusing the benefits given to asylum applicants by applying in one EU country after another.

The agreement failed because it assumed all EU countries would treat asylum applicants with the same humane standards, but did nothing to ensure they all would. And because it offered no guarantees to countries on the front line of a refugee crisis that other EU states would share the burden.

The worst problem was Greece. To be fair, even before the Syrian crisis, Greece would have needed help from the rest of the EU to handle all the refugees and asylum seekers who enter the EU via its territory. People fleeing Iraq, Afghanistan, Libya and East Africa also tend to come that way.

But rather than press that case, Greece simply refused to invest in its capacity to offer asylum. In effect it discouraged asylum-seekers by treating them horribly. For migrants to Europe, Greece became a particularly perilous transit country, where they had to avoid leaving evidence they had been there. If they applied for asylum in another EU country and were found to have transited Greece, they would be deported back to Greece and usually on to Turkey.

Then in 2011, a landmark case was won in the European Court of Human Rights on behalf of one of the unlucky asylum applicants who was found to have crossed Greece and deported back there. The court ruled that it would be abusive to continue deporting asylum-seekers to Greece.

By then Greece was in crisis, so no serious pressure was put on it to improve its asylum capacity. And that’s where things still stood when the Syrian refugee crisis exploded.

This explains why most of the refugees are transiting across Greece and not applying for asylum there, unless they’re detained by Greek police and given no choice.

This also helps explain Macedonia’s anger at the large numbers of refugees crossing its border from Greece. Macedonian authorities’ violence towards transiting refugees was obviously horribly wrong, but it’s also horribly wrong that the refugees are being sent from Greece to tramp by foot over the Balkans.

If the EU system were operating as it should, Syrian refugees would be able to apply for asylum in Greece, without having to cross the former Yugoslavia, as they’ve been doing by the hundreds of thousands, at considerable risk to their own lives and especially those of their children.

And this background also helps explain Hungary’s paranoid reaction to the Syrian refugee crisis. Until recently, Hungary had tried to extend relatively humane conditions to asylum seekers, far better at least than in Greece. Thus, the Dublin agreement still applies to Hungary.

According to it, any asylum seekers who transit from Serbia across Hungary to anywhere else in the EU can and should be deported back to Hungary. Germany recently announced it would stop deportations under the Dublin agreement, and others are likely to follow. But the move was belated, after Hungary had already fenced its border with Serbia.

Too little planning, too late

EU countries are now trying belatedly to agree on burden-sharing. But that’s a lot more difficult when the issue is so direct and tangible.

The crisis has exposed important historical differences between the former Western Europe and Eastern Europe. Much has been made since the 1980s of the deeper common cultures of Mitteleuropa, and for good reasons. But other, unshared histories also matter.

The former communist countries were not colonizers. So their people feel no moral responsibility for the fragility and brutality of the regimes that came after colonialism. Except Hungary, the former communist countries were imperial subjects not imperialists. They are fiercely proud of having come through imperialism with civil society and democratic culture intact, and they credit that to their national cultures.

People in former communist countries are not accustomed, neither in good senses nor bad senses, to large-scale immigration. By bad senses I mean mainly how people in the former Western Europe accept as inevitable the existence of their immigrant slums and put them out of their minds. People from the former Eastern Europe don’t have any such slums in their cities, and they are terrified by them.

Even within the societies of Western Europe, liberals sympathetic to refugees are far from holding secure majorities. Few liberals dare to speak honestly and openly about the scale of the refugee influx, fearing that would only strengthen the hands of xenophobes.

Seriously, how will so many people be integrated into European societies? The apparent unwillingness to discuss that is death to whatever hopes there could be of calming down and communicating with the people of former communist Central and Eastern Europe.

I don’t have any exclusive information, but it’s not hard to work out a few basic realities.

1) There is no end in sight to war in Syria and Sunni Iraq. Anyone who thinks Russia might team up with the United States to end the war is fooling themselves. Russia on the contrary will prolong the war by defending Bashar al-Assad from the pro-Western rebels of northwest Syria. Russia will let the US continue to struggle to contain Islamic State.

2) Around half of Syria’s 22 million people have been displaced from their former homes. Most are still inside Syria, and it’s not clear how many of those intend to leave, or will decide later that they want to leave. Millions more are in neighboring countries, mostly in camps in Turkey and Jordan. All of those are highly likely to want to migrate to Europe.

3) The main factors in these people’s decisions will be: a) the cost of travel to Europe, b) the risk of being turned back, c) the risk to life, and d) the degree of attachment to and hopes for return to Syria. Those appear to me to add up to an undiminishing stream of refugees for the foreseeable future, as stories of success filter back, attachment and hopes are worn down, and earlier immigrants send money home to bring their relatives. Then there’s Iraq, Afghanistan, Libya, East Africa. I would assume Europe will receive at least three million refugees over the next five years, possibly as much as twice that.

4) As long as EU countries offer varying amounts of support to refugees, refugees will go where support is the best, which is currently Sweden and Germany. No system of distributing refugees among countries can work unless benefits and treatment are seen to be equal, or the countries that offer better benefits are willing to harshly and systematically deport refugees back to their assigned countries. It would make no sense for Germany to have a big fight with eastern countries to force them to take refugees, only to allow those refugees to use the eastern countries as a staging ground for immigration to Germany.

5) The past failures of Arab immigration to Europe were both cultural and economic. Especially in France, neither the locals nor the immigrants tried very hard to integrate with each other, and politics favored protecting native jobs while paying immigrants to sit at home in ghettos.

Summing all that up, I’d say there’s no reason why the refugee crisis must destroy the EU. Germany with its relatively liberalized economy is best prepared to employ large numbers of immigrants. But the lack of concrete plans being made even in Germany should be deeply alarming. Unless Europeans start honestly facing up to what’s happening and discussing in all seriousness how they’re going to handle it, there will be more and angrier fighting over it, locally and internationally, and the EU itself could be mortally wounded.

China’s pace of spending reserves is extraordinary

The arm of Chinese government that manages foreign-exchange reserves has just released its count of where they stood at the end of August, which is down by nearly $94b from the end of July. Here’s Bloomberg and here’s the Chinese data.

And the actual pace at which China is spending reserves was even faster than that. The dollar significantly weakened during August: the DXY index fell by 1.6%. That should have increased the dollar value of China’s FX reserves, by nearly $20b if about one-third of them were in non-dollar assets. So it looks like China actually spent at least $110b of reserves in August.

Since China is so big, and has such a big stockpile of FX reserves, $110b in a month might seem like not such a big number. It is. China’s GDP was about $10.6 trillion in the four quarters ending in June, or a bit less than $900b in an average month. That means that in August China spent down its FX reserves at a pace of around 12% of GDP. That’s a very big volume of demand for foreign currency that’s not being met by market sellers.

By comparison, Russia spent $31b of FX reserves in December 2014 at the peak of its selling, a pace of about 17% of its (pre-devaluation) GDP. The ruble ended up losing half its value.

Obviously such comparisons aren’t direct, and Russia is in a much worse situation. But a devaluation of more than 10% in China seems to be the most likely outcome now.

Why Global Trade Is Struggling

A lot of people for a long time have been predicting it, and a lot of people are eager for it to come, or at least think they are. As the data continues to worsen, it’s only a matter of time till the mainstream media picks up on the story.

The day has come!  It’s the end of globalization!

By the most common definition of recession, global merchandise trade is already in one. Volumes of internationally traded goods shrank by 0.5% in the second quarter, after shrinking 1.5% in the first, according to the Dutch government’s World Trade Monitor. Those are equivalent to 2.1% and 5.9% annualized paces.

This hardly compares to the fall and winter of 2008-2009, when global trade in goods shrank by 7.2% and another 10.9% in two consecutive quarters. Volumes of traded goods were still up by 1.1% in the second quarter of 2015 versus the second quarter of 2014.

Also, these numbers don’t include trade in services. International business process outsourcing is still booming, and international tourism is doing fine.

Still, there’s no doubt global trade is struggling. Judging from the recent drops in commodities prices, nobody is expecting trade growth to bounce back anytime soon, not even to the 2.6% pace it averaged in 2012 to 2014. A return to the long-run average of 7% annual global trade growth that prevailed until 2007 seems more far-fetched than ever.

Emerging Markets In Crisis

This is far from the end of globalization. But it is a crisis, and one that could last a while.

The problem is in emerging markets, which had been leading global trade growth since the 2008-2009 crisis. Imports by low and middle-income countries accounted for 71% of the growth of global merchandise trade between 2008 and 2013, though even by the end of that period their imports were only 31% of global merchandise trade. Those figures are by dollar value and are calculated from World Bank data.
 
Trade among emerging markets was especially strong. Imports by low and middle-income countries from other low and middle-income countries accounted for a third of global merchandise trade growth from 2008 to 2013, even though by the end of that period they still accounted for only a tenth of global merchandise trade.

When countries punch so far over their weight, they tend to tire quickly. Put another way, the catch-up process for emerging markets is inevitably cyclical.

Above all, trade growth in 2008-2013 was driven by a frenetic pace of building in China. Housing, retail space, offices, industrial plants and infrastructure were all built as quickly as possible, financed from foreign investment and booming exports. That drove up prices of imported raw materials, especially oil and ores, but China was able to keep up by continually boosting its exports, especially to its raw materials suppliers.

That growth model has been unraveling since 2014. One reason was that Chinese households became reluctant to invest further in housing. I don’t have good data, but based on anecdotal reports, it appears that a large portion of middle- and upper-class Chinese families already hold apartments for investment, and a large portion of those are empty. As apartment prices in most cities have stopped rising, owners of empty apartments are taking losses as their apartments age and depreciate, which is a powerful warning to potential buyers.

Another reason global trade is struggling is the fracking boom in the United States, which by driving down the price of oil hit the incomes of the raw-materials producers that had been most rapidly increasing their imports from China. Steel and iron ore prices crashed as construction industries contracted in Russia, the Middle East and other raw materials exporters, adding to the slow-down of construction growth in China.

Emerging market currencies devalued, even those of materials-importing manufacturers. The dollar value of emerging markets imports didn’t grow at all in 2014, and both values and volumes have been dropping this year.

The next chart is of merchandise trade volumes, again from the World Trade Monitor. It shows how emerging markets, the red line, led global trade growth for many years, and how sharply their demand for imports has recently collapsed.

A Developed-Economy Recovery Isn’t Enough

 

Meanwhile, the United States has reverted to its former status as the biggest driver of global trade demand, at least this year. Import volumes were up 7.4% year-on-year in the first half, according to the Dutch data. A much-touted “re-shoring” trend has been overwhelmed: US manufacturing employment has been flat this year after a modest partial recovery in 2010-2014.

But the US demand growth looks like a one-off that stems directly from the fracking boom. As oil prices and oil import volumes have dropped, the dollar has appreciated, and Americans have reallocated much of their extra wealth to more imports. Latin America has been the biggest beneficiary, with its export volumes up 9.6% year-on-year in the first half of 2015.

But oil prices can’t fall much further. And as you’ve surely noticed, many consumer goods markets in the US are already saturated with imports. By my best estimate, close to half the value of manufactured or processed goods consumed in the US is imported. According to the BEA’s input-output tables, $4.4 trillion worth of manufactured or processed goods were consumed in the US in 2013 by non-manufacturers, not including logistics and trade mark-ups. That year $2.3 trillion worth of goods were imported, of which some obscure but small fraction was re-exported.

Europe has been more or less pulling its weight in global trade since last year. The Euro Area has increased its merchandise imports at an average pace of just over 2.5% a year since the beginning of 2014. But that pace is also unlikely to accelerate. With its numerous highly integrated economies, Europe’s goods markets are already very saturated with imports. International trade within the European Union accounts for about a fifth of global international trade.

Like the name of my blog says, the world economy is already globalized. I believe there’s still much more to come, especially in global trade of services. And of course, any globalized supply chain has at least as much natural potential for growth from improvements in quality and efficiency as any domestic supply chain. But global trade growth will no longer be driven by developed economies substituting imported goods for domestic products.

Trade among emerging markets is now the biggest potential driver of global trade growth. But that growth will be cyclical, and right now we are in a weak stage of that cycle.

Only when emerging markets are growing rapidly can the pace of global trade growth exceed the pace of global GDP growth. When emerging markets are in crisis, global trade will stagnate, even if developed economies are strong.

A Few China Charts To Ponder

Writing about the Chinese economy can be daunting, not only because it’s so big. China is just plain extraordinary. Things in China work differently from elsewhere, sometimes astonishingly so. Predicting how such an unusual place will change is close to impossible.

But change is certainly in the air. The news of the moment is capital flight, which is believed to be accelerating. Not long ago China was a very difficult place from which to export capital. Lately all sorts of formal and informal holes have been opening up in the old system of capital controls. Chinese money brokers boast they can turn your yuan in China into dollars in a foreign bank account in about an hour.

Nomura’s chief China economist, Yang Zhao, estimates that $100b was sent or pulled out of China in the first three weeks of August, on top of $90b in July. That’s according to the Daily Telegraph’s summary of his private research. Much if not most of the departing money represents Chinese investors paying off dollar financing and liquidating long positions in the yuan or commodities.

The trigger for this exodus was a mere 3% drop in the value of the yuan, a scale of devaluation that anywhere else would have been taken in stride. But the Chinese currency market is so carefully managed that a 3% move wasn’t just shocking. It was understood to represent the tip of an iceberg of market pressure.

And indeed the yuan has been under growing pressure for about a year. The central bank’s decision to hold the yuan stable against the strengthening dollar resulted in a costly appreciation against most of China’s trade partners. With export growth slowing, that has been difficult to defend. As of the end of June, the central bank’s foreign exchange reserves had shrunk by about $340b over the past 12 months. Probably about half of that was devaluation of non-dollar assets, and the rest was spent intervening in currency markets to prop up the yuan.

Now the central bank is believed to be spending FX reserves much more rapidly, as it struggles to prevent further depreciation. The pace and scale of its intervention is likely more than $10b a week.

That’s the background in which I present the next three charts. I don’t mean them to provoke alarm or to spread a sense of doom. Remember, China is different.

One way China is especially different is its very large volume of bank deposits. As of the end of June, China’s M2 money supply, which includes circulating currency and bank deposits, came to $21.5 trillion. M2 is defined somewhat differently in different places, so international comparisons aren’t exact. But if taken at face value, China has about 75% more M2 than the United States, although the US economy is still about two-thirds bigger than China’s.

What this chart shows is a sizable portion of the world’s wealth moving into Chinese bank deposits. That has happened partly thanks to the considerable wealth-generating power of China’s export-oriented industry, and partly because in China other kinds of financial assets are less developed. Bank deposits in China substitute for any kinds of public and private savings, insurance and safety nets one finds in advanced economies.

Those $21.5 trillion worth of Chinese deposits and currency also represent the opposite side to commercial bank and central bank assets. The largest and most important part of those are commercial bank loans, which in China are largely state controlled and often used as a kind of quasi-fiscal stimulus. China had $15.2 trillion worth of bank loans outstanding at the end of June, compared to $12.9 trillion at Euro Area banks and just $8.3 trillion of bank loans in the US, where bonds are favored over loans in corporate finance.

In other words, the value of deposits in Chinese banks is backed mainly by the loans those banks made to finance China’s urbanization and industrialization.

The next chart puts the difference between China and major advanced economies in starker terms. Instead of comparing the outstanding stocks of M2 across economies, this chart compares the flows of new M2 being created, relative to GDP.

And here you can clearly see how different China is.

Remember all the talk about the vast sizes of advanced-economy quantitative easing programs? You might be able to see those here, barely. Major advanced economies have been adding M2 at paces that usually hover around 5% or less of GDP, broken mainly by a surge of M2 creation in the Euro Area before the 2008-2009 crisis. But even that didn’t come close to the pace of 15%-40% of GDP at which China has been adding M2. Remember, most of that M2 creation in China is through commercial bank lending.

The good news is: the loans tied to this M2 growth have by and large worked, despite some that haven’t. Chinese exports grew from about $320 billion in 1999 to $2.2 trillion in 2014. That’s according to the import data of China’s trade partners, so there’s no question of fudging. Even after accounting for dollar inflation, that still represents an almost quintupling of exports over 15 years, or an average growth pace of about 11% a year. That couldn’t have happened if loans were rampantly misspent.

The other good news is that Chinese people and companies seem to mostly trust that their deposits will be made good. One of the main distinguishing features of an undeveloped country is lack of popular trust in bank deposits. The least developed countries of the world typically have M2 to GDP ratios of less than 25%, and if they attempt to grow M2 too rapidly, most of it turns quickly into circulating banknotes and drives inflation.

The Chinese people’s willingness to hold bank deposits is evident in the fact that M2 reached 204% of GDP at the end of June. That compares to 184% in Japan, 98% in the Euro Area, and 68% in the United States. When people are willing to hold increasing volumes of bank deposits as savings, that sterilizes liquidity and allows banks to boost lending without driving a lot of inflation.

The bad news is: the supply of bank deposits in China is nonetheless probably too high. There appears to be a large pent-up demand in China for alternative financial assets in which to save. The high-flying, short-lived equity bubble of last November to June can be seen as one symptom of that pent-up demand. The same can be said of the over-investment in residential apartments that prevailed until last year, leaving a glut of unoccupied flats held for investment.

The current wave of capital flight could be another symptom of pent-up dissatisfaction with deposits. After all, even one-year time deposits earn only about 1%-1.5% in real terms. A 3% devaluation and a perceived threat of more are serious reasons to reconsider trying to save that way. However unusual China is, it can’t get around that it’s still a developing country without the rule of law and other liberal traditions that underlie popular trust in bank deposits in advanced economies.

The other bad news is: China’s bullish lend-and-grow strategy might not be working anymore. Many people have tried to call its expiry date before and been proved wrong, so I wouldn’t be too certain. But it does appear that large sectors of China’s industry are hitting a wall of overcapacity.

That’s most clearly reflected in the fact that nominal GDP growth, especially in US dollar terms, has slowed much more rapidly than real GDP growth. Nominal GDP growth in the first half of 2015 was just 6.5%, less than real GDP growth. That means output volume gains are driving down prices.

One of the biggest problems for China is that most of its fastest-growing export markets were its suppliers of raw materials. They have been hard hit by big drops in prices for those materials, and many are devaluing their currencies and sharply reducing imports.

Greece Is Still Trapped, Act Three

And so Greece’s parliament has endorsed the first stage of the deal struck last weekend when its prime minister, Alexis Tsipras, completely caved in to an exasperated Angela Merkel.

He is now on a shorter leash than ever, forced to take the lead role in carrying out a stricter Troika reform program than the one initially proposed to him back in February.

As I’ve been explaining since late January when Tsipras first came to power, Greece is trapped by simple economic reality. The Greek government had zero primary surplus in 2014, which means that even if it defaulted on all its debts, including to Greek banks, it would still have no room to fund fiscal stimulus.

The only way Greece could get such room would be to quit the euro and accept a large devaluation of all Greek financial assets, including deposits in Greek banks. That’s a political non-starter in Greece: only a minority of Tsipras’ Syriza coalition and a couple small far-right parties are willing to go there.

It will be interesting to see how long Tsipras can last in this situation. He appears to be under no near-term threat in parliament. An accommodation appears to have been reached for now in which the centrist opposition will support the reform program while the farthest-left and far-right corners of Tsipras’ ruling coalition will cast symbolic protest votes against reforms but not do anything to bring down Tsipras or his government. The farthest-left factions lost minister and deputy minister positions. The far right kept the defense ministry.

Tsipras’ resounding victory in the July 5 referendum has proven that he is skilled at channeling the public mood into support for himself. The fact that he won the referendum completely dishonestly, by urging Greeks to vote for an anti-austerity option that he knew didn’t exist, doesn’t seem to have cost him much in Greek domestic politics, at least not yet.

Meanwhile European political leaders are hurriedly working on rolling over Greece’s €2b of overdue debts to the IMF and another €3.8b of principal and interest due mainly to Euro Area central banks on Monday. The European Central Bank’s governing council has reportedly added €900m to Greece’s “emergency liquidity assistance” allowance, the lifeline that was keeping Greek banks liquid until the council stopped approving increases in late June. Greek banks are expected to open on Monday, though I don’t think €900m is nearly enough to enable the Greek government to lift all of the protections it has granted to Greek banks from their depositors.

Understanding the meaning of “debt relief” in IMFese

As I wrote back on July 2 when the IMF first published its report saying Greece needs “debt relief,” the meaning of those words is being widely misunderstood. Gradually more and more journalists have been figuring it out, but there’s still a lot of confusion around, so it’s worth clarifying this point a little further.

The IMF was not saying that Greece needed a write-down. What the IMF said was that Greece needed extensions of the maturities of its official debts that fall due after 2018, plus another €52b of official loans. That breaks down to: €30b to roll over the debts that fall due by the end of 2018; €20b to clear arrears, rebuild run-down cash balances, and replace bank bailout reserves that the EU seized in February after Greece threatened to default; and €2b to roll a portion of interest due before 2019 into more long-term official debt. The crucial point to understand here is that the IMF considers new official lending to be a kind of debt relief, because it’s long-term and low-interest.

With all that, the IMF opined, Greece could probably sustain its debts without any more official lending after 2018. That was a very optimistic projection. Few people really believe Greece won’t need another EU-IMF lending program in 2018, to continue rolling over its various other kinds of debts as they come due into long-term, low-interest official debts.

But the IMF’s rules say that before it lends it must ensure that the recipient country will be able to sustain its debts after the lending stops. And there is no political will right now to commit to lending to Greece past 2018. So the IMF needed to meet a high standard of sustainability that assumes Greece won’t have any more access to official lending after 2018.

The need for €52b of new lending and maturity extensions of official debt due after 2018 was the IMF’s opinion three weeks ago (the report was written a week before it was published). On July 14 the IMF published an update dramatically increasing its estimate of Greece’s financing needs from €52b to €85b, and saying Greece needed either maturity extension with “a very dramatic extension with grace periods [of deferred interest] of, say, 30 years on the entire stock of European debt, including new assistance” or “explicit annual transfers to the Greek budget or deep upfront haircuts.”

The latter two options are obviously politically unpalatable. So the IMF is really calling for the first of those options: extensions of maturities and grace periods of deferred interest on Greece’s debts to the EU.

How could Greece’s financing needs have grown by €33b in three weeks, you ask? The IMF says, “the events of the past two weeks — the closure of banks and imposition of capital controls — are extracting a heavy toll on the banking system and the economy, leading to a further significant deterioration in debt sustainability.”

The IMF probably also took an opportunity to climb down from over-optimistic nominal growth forecasts built in to the three-week-old report. The experience of not being paid on time tends to push creditors to revisit such things. The IMF is undoubtedly maintaining the high hurdle that Greece’s debts must be plausibly sustainable without any further official lending after 2018.

The IMF is also apparently not taking into account the new reform program’s section on privatization, which calls for Greece to raise €50b and put half of it towards repaying debt. That would imply €25b less financing needs, though the program document doesn’t say how soon Greece would raise so much money. Anyway €50b is a wistful fantasy, which could only come true if things go so well in Greece that it won’t need the money.

A clarification of Greece’s fiscal position

Most media covering Greece have reported that the new reform program represents a deepening of fiscal austerity.  Dan Davies has written a popular blog post arguing the opposite, that actually Greece is being given room for fiscal stimulus. So who’s right?

The mainstream view here is much closer to being correct. The deal is fiscally austere. Greece had zero primary surplus last year, and the new program calls for that to tighten to 1% of GDP this year and to 3.5% of GDP from 2018 on. Unless you believe there are growth forces at work in Greece that will greatly improve the fiscal position without any change in tax or spending policy, that is a big fiscal tightening.

On the other hand the deal is not any more fiscally austere than the one offered to Greece in June. When I say the new program is much stricter, I mean its regimen of supply-side reforms. The fiscal numbers are exactly the same. And they’re much easier than the fiscal path Greece committed to under its 2012-2015 bailout program. The latter called for Greece to tighten to a 4.5% of GDP primary surplus from 2016 on.

What the media have missed is that Greece has actually already severely tightened its fiscal position in the first half of 2015. Remember that Greece kept current on its debts until the last day of June, and its repayment schedule is not light. Greece hasn’t been able to raise any new private financing since last year, and has only been able to roll over debts owed to Greek banks and other captive local creditors.

The only way Greece could make its debt payments was by sharply tightening its fiscal position. And it did so in a completely ad hoc manner, by running up arrears or just not making budgeted expenditures. As the table below shows, Greece’s state budget (the core central government) ran a primary surplus of 3.1% of GDP in the first half of 2015. That’s probably about equal to an overall primary surplus of 2.6% of GDP, judging from the fact that Greece’s core central government ran an 0.5% of GDP primary surplus in 2014 while the IMF calculated a zero overall primary surplus.

Note that my calculations rely on Greek government data, but I don’t use the Greek government’s own count of its state budget primary surplus, which wrongly counts privatization receipts and refunds of previously paid interest as primary income. The IMF consolidates all central and local government entities and makes other adjustments.

So this is the valid point that Davies could have made: relative to the severe austerity that has prevailed so far this year, a 1% of GDP primary surplus target for this year does represent something like a fiscal stimulus. It means Greece is allowed to run a primary deficit of around 0.6% of GDP in the second half. Actually Greece is likely to endure another couple months of severe austerity and then enjoy a rush of public spending in the fourth quarter.

But Davies’ actual argument is all wrong. He thinks Greece will enjoy fiscal stimulus because the primary surplus of 1% of GDP minus interest costs he estimates at 3% to 4% of GDP leaves an overall deficit of at least 2% of GDP. But fiscal stimulus is a negative change in the fiscal position, not a negative level. For fiscal stimulus Greece would need to be able to spend more and/or collect less revenue than it did last year. And no one is offering to lend Greece enough money to do that.

Besides, Greece’s actual interest costs are around 2.5% of GDP, net of expected refunds but including deferred interest, and about 1.6% of GDP in terms of cash paid net of refunds. And payment of interest to foreigners, in cash or not, is never a fiscal stimulus.

Tsipras Caves, Again

Alexis Tsipras, the Greek prime minister, has pulled another duplicitous about-face. He has, with what appear to be only very minor proposed changes, accepted the Troika’s June 26 offer.

Last Sunday’s referendum, it turns out, was entirely without substance. It was nothing more than political theater. So too was the past two weeks of hardship in Greece, of closed banks and limits on ATM withdrawals. All of that served no other purpose than for Tsipras to pretend to the Greek public that he was standing up to the EU. Less than a week after the referendum, he turned around and proposed to the Troika almost the same program they proposed to him on June 26. The main difference is that he is asking for €53.5bn of new loans, and they were offering only €50bn. If Tsipras had countered with this proposal two weeks ago, I think it would have been accepted, and Greek banks never would have closed.

Come to think of it, Tsipras’ offer is not really all that different from the Troika’s first offer to him back in February.

I guess one should never be surprised by the brazen duplicity of politicians. But this is so extreme, European leaders are probably having trouble believing their eyes. I imagine politicians across Europe today forwarded Tsipras’ offer to their staffs with virtually the same questions: “What am I missing? Where’s the catch?” Perhaps somebody will find one. I didn’t.

Tsipras has just put European leaders through a hell of a wringer. He insulted and denounced them vehemently in front of the Greek nation. He swore he could never accept their humiliating demands. He urged Greeks to back him in his defiant stance, and received their backing.

And then he turned around and asked European leaders to let him take their old offer, with what appear to me to be minor changes that could easily have been accepted if he had made them two weeks ago. European politicians would normally care more about the fundamentals of any Greek offer than how they are dressed up for the benefit of Greek domestic politics.

But Tsipras may have simply gone too far with this stunt. Europeans may be too insulted and annoyed to let him get away with it. It will be interesting to see.

(UPDATE: Bloomberg is reporting that Tsipras is asking for “debt restructuring and reprofiling of Greece’s long-term debt due after 2022,” which if true could be the catch I missed. I see no such language in the version of Tsipras’ proposal that I linked to above, which was published by Le Monde. A demand for a write-down would be rejected. A demand for some maturity extension might be considered. Le Monde, by the way is reporting that the French government had a big hand in crafting Tsipras’ proposal.)

Greeks Back Tsipras’ All-In Bet

Tsipras has won his referendum, with 62.5% turnout and 61.3% of votes for “no.”

In other words, the Greek nation has thrown itself  behind Tsipras’ all-in bet that European leaders will fold and bow to his demand to roll over Greece’s debts on looser terms. Even though Greeks are holding the weakest of all possible hands.

Greeks simply don’t have much in the way of credible threats to hold over the rest of Europe, especially since markets are reacting fairly calmly. The only potent card they have, if Tsipras is willing to try to force them to play it, is their willingness to endure what could be widespread suffering, if he carries out his threat to let Greek banks run out of euros and not introduce any new currency.

The bet is to the ECB Council

Play now goes to the European Central Bank’s governing council, which will hold a conference call on Monday to decide how to react. Just before that, the ECB chairman, Mario Draghi, will hold a conference call with top EU political leaders.

Hanging over the council’s decision is one powerful fact and another powerful inevitability. The fact is that Greece defaulted on June 30 to the IMF. Due to cross-default clauses, Greece has since also been declared in default on most of its debts to the EU by the EU’s bail-out fund, the European Financial Stability Facility.

The inevitability is that Greece will default on €2.2b of principal and interest due to the ECB and another €1.4b of principal and interest due to Euro Area national central banks. The €3.6b of payments are due July 20.

The council has three options, but realistically, only two. In theory, the ECB council has the power to inject new liquidity into Greek banks and allow them to open and start paying out on deposits normally. The council would have to vote to increase the cap on Greece’s use of Emergency Liquidity Assistance, a way that EA NCBs are allowed in crisis situations to create and lend euros to their banks against substandard collateral.

Such ELA loans are backed by the NCB’s own guarantee to the ECB. Which could be a little difficult for the ECB council to justify accepting just now, given that an NCB’s guarantee is only as good as that of the government behind it, and the Greek government is in default to another EU institution.

The second option, and the nicest the ECB council could realistically be to Greece in this situation, would be to maintain the cap on Greece’s use of ELA at its present level of €89b. That would allow Greek banks to continue to disburse €50 or €60 a day to depositors for a little while longer. Nobody outside the Greek government and banks knows exactly how much cash and unused ELA allowance Greece has left at the current pace of withdrawals, but I think not more than a few weeks worth. See here.

The third option, which ECB councilors will likely feel legally compelled to take despite how harsh it is, would cancel most of Greece’s ELA allowance except the €2b that all NCBs are normally permitted. According to an ECB summary of the secret rules governing ELA, any NCB with an ELA allowance above €2b automatically loses it unless re-confirmed by a council majority “within a pre-specified short period of time.”

The council has lately been holding ELA re-confirmation votes for Greece about once a week, most recently on June 28, after Tsipras called the referendum but before he missed the IMF payment. My guess is that without a positive vote, the €89b ELA allowance would expire sometime this week.

Losing the ELA allowance would mean Greek banks would run out of cash faster. They would probably stop reloading ATMs the next day. It would amount to an order from the ECB to the Bank of Greece (the national central bank) to immediately recall about €87b of loans to Greek banks. The BoG would probably be obliged to seize Greek banks’ deposits at the BoG, without which they would have no way of paying each other electronically. The BoG might even be obliged to come for the banknotes in their vaults and cash drawers.

The argument for taking the nice option will be to leave a door open to Tsipras to make his new offer, and that Monday is simply too soon. But I don’t sense that European leaders are really expect much serious from him, or that they’re really all that eager to see what he comes up with. The argument for taking the harsh option will be that with the Greek government in default to the EU, the ECB can’t accept the guarantees of the Greek national central bank.

The council is very different from other EU bodies, as it decides by simple majority, and small countries carry much more weight. The ECB council is made up mainly of the 19 EA NCB chairmen, plus six EU-appointed ECB governors, including Draghi.

That means Germany lacks the veto power at the ECB that it has over most EU bodies, which is good for Tsipras. But it also means the former communist European countries carry a lot of weight at the ECB, which is very bad for Tsipras. The council tends to follow Draghi, and if EU political leaders weigh in strongly one way or another, that would likely carry their vote.

The Greek nation volunteers to be taken hostage

Tsipras knew what he was getting into. I’m pretty sure his voters did not know, and it will not be a pleasant awakening.

The Greek nation has essentially volunteered to be Tsipras’ hostage as he heads into his final show-down with European leaders. Tsipras says he is determined not to issue any new currency. But his government and banking system are very near to running completely out of euros. If he continues to resist issuing a new currency, and Europe gives him no fresh supply of euros, the economy will collapse into deep crisis.

The first big problem for Tsipras is that he has made European leaders hate him. They want very much to do him personally no favors.

His second big problem is that the EU strictly adheres to the rule of law, and he is in the wrong side of it. His government is in default to the EU and will be soon to the ECB and EA NCBs. That greatly limits European leaders’ options.

And the third big problem for Tsipras is, when the money runs out and the cupboards run bare, Greeks will not stay behind him. Despite the convincing vote, there will soon be mass protests against him. If we take Tsipras at his word that he will not issue any new currency, then when euros run out, Greeks will literally starve.

Tsipras will probably back down long before it gets that far, probably by introducing IOUs or some other kind of pseudo-euro and denying its a new currency. I don’t rule out that he could ultimately cave in and accept Europe’s conditions for a roll-over of Greek debts.

But the Greek people have committed themselves to a very dangerous bet. Tsipras and his game-theory professor finance minister, Yanis Varoufakis, could be planning to deliberately make the Greek people suffer in order to pressure the EU to back down. But the pain would really be all Tsipras’ doing, and it wouldn’t take his hostages long to figure that out.

[UPDATE: The ECB council chose the nicer of its two realistic options, and kept Greece’s ELA cap at the same level it had been for about two weeks, which Bloomberg reported a bit more precisely at €88.6b. Haircuts on collateral were increased, but not by so much that Greek banks can’t make up the gap with other collateral. All in all a very mild reaction to Greece having defaulted to the EU and IMF. There will be lots of meetings ahead, but probably the most important upcoming events are 1) the inevitable default of Greece on €3.6b owed to the ECB and EA NCBs on July 20, 2) the ECB council’s reaction, which could be immediate or after a likely grace period expires, 3) the inevitable exhaustion of Greek banks’ euro supply, anytime within a few weeks and 4) probably about the same time as that, the introduction of new money, probably some kind of pseudo-euro, backed only by Greece.]

Why Greeks Will Be Voting Their Birthdates

The Greek polling agency Public Issue has published the results of a poll that breaks down Greeks’ voting intentions by age group, and the results are sobering.

Whichever side of the debate you’re on, you’d probably like to believe that this is a vote about policy and ideology. A “no” majority would throw off the strictures of euro membership and give a mandate to the leftist prime minister, Alexis Tsipras, to steer economic policy independently. A “yes” vote would sack Tsipras, submit to European policy oversight and probably move policy back towards centrism.

In a country and continent where leftism is conservative and reforms are driven by free market ideology, one might expect to see young Greeks leaning right and older Greeks clinging to leftist tradition. After all, the “red-line” issue over which Tsipras walked out of talks with the Troika last week was their demand to cut pension spending.

But it’s the other way round. The younger you are, the more likely you want to defy Europe and support Tsipras. The older you are, the more likely you want to sack Tsipras and cling to Europe.

Obviously, ideology is not the crux of this vote. This is between hanging on to what you have, and risking it all in hopes of finding a better way.

Taking the Argentina comparison too far into the future

Lars Christensen has a post that has received a lot of attention predicting a robust recovery if Greece votes  “no” and introduces a new floating currency. In it, he compares Greece today to Argentina in 2001, as I have done, and shows that Argentina bounced back strongly in the following years.

The biggest problem with that argument, as Lorcan Roche Kelly points out to Christensen here, is that Argentina’s economy is driven by commodities exports. Argentina’s crash in 2001 and boom over the next several years were obviously driven by the commodities cycle.

What then could we expect in Greece after a “no” vote? Initially, a big mess. Tsipras would have a strong mandate, but on the basis of the false claims he is making that he will still be able to secure the support from Europe he needs to preserve the euro value of Greek bank deposits. After a “no” vote, that support would not come, and those deposits would be devalued.

Tsipras’ policy-making is also likely to turn very bad. I think he would most likely introduce some kind of pseudo-euro with a dual exchange rate, with one-to-one convertibility for the government and select importers and a value far less than that for everybody else. I think his distribution of pseudo-euros would be very politicized, aimed mainly at defending himself from the mass protests that would inevitably come against him.

On the positive side, I don’t think Tsipras would last long. But I suspect that after him would follow a long period of political and economic turmoil, and policy could turn even worse before it turned better.

So the scenario that Christensen is touting, of Greece with a new floating currency and, by implication, no sharp deterioration of other economic policies, isn’t likely to happen anytime soon. It’s one of many possible places Greece might eventually get to after the turmoil that would follow a “no” vote.

Devaluation’s Winners and Losers

Even after all the decline in incomes and asset prices of the past several years, Greek assets and labor are still somewhat overvalued relative to where they would need to be to spur enough investment to re-employ all of Greece’s recently unemployed.

No doubt a currency devaluation would be the easiest way to solve that problem. A floating currency would indeed be better for Greece’s GDP, over the long run, than euro membership.

But a devaluation is what it says it is. Your income shrinks and you lose wealth, at least in terms of foreign goods and assets. The hope is that national income and wealth will grow back, over time. But that rebuilding of incomes and wealth is not symmetrical.

Real GDP tends to bounce back quickly after a devaluation, since real GDP counts only domestic products. Real wealth takes longer to recover, especially for countries like Greece that import a large portion of what they consume.

And there are all kinds of other asymmetries. There are winners and losers.

I personally don’t see anything to gain from endorsing Tsipras, even for young people. I think the result would be not at all what his supporters are imagining. But I can understand a young patriot wanting to throw off European strictures, believing that in the long run Greece will find a better way. For young people there’s a good enough chance that policy will turn out okay and their long-term income-earning prospects will be better outside the euro than they would have been inside it.

For older people that possibility isn’t there. They have far more savings to devalue, and usually the kind of savings that don’t rebuild, such as pensions. And they will be far more dependent on those savings for their livelihood.

IMF Greece Update: Zero 2014 primary surplus, €5b of new arrears

Back in February, I published a very wonky blog post, which to my surprise has proven to be my most popular post by far: Greece’s Primary Surplus Was Smaller Than Reported. In it I explained why Greek data purporting to show the government ran a primary surplus of 1% of GDP in 2014 was phony. The data wrongly counted privatization revenues and refunds of interest previously paid as primary income. Those were worth a combined 0.5% of GDP.

I also explained that the Greek data referred only to the state budget (the core central government) and can’t be directly compared to the primary surplus benchmark used by Greece’s creditors, which refers to the general government (the whole public sector, except state-owned businesses).

And I explained that although Greece publishes general government budget results that can be used to estimate its primary surplus (I came up with 0.7% of GDP for 2014), the EU and IMF apply very different accounting rules from Greece when they calculate the primary surplus of a country. So we wouldn’t know what Greece’s 2014 primary surplus really was by EU or IMF standards until one of them counted and published it.

Today that happened (see page 19), and here’s the answer: Zero. Greece had no primary surplus at all in 2014, by the IMF’s calculation.

That came after a 1% of GDP primary surplus in 2013, by the IMF’s count. So the Greek primary surplus actually deteriorated in 2014, when according to Greece’s adjustment program, it was supposed to improve, to 1.5% of GDP.

Another €5b of arrears

I’m not really surprised, nor am I by this: according to the report, the Greek government has run up an additional “about €5b” of arrears since the IMF’s previous review, published in May 2014. That underscores the severity of what I have been calling “ad hoc austerity”: the ostensibly temporary withholding of budgeted expenditures, in order conserve scarce cash.

The IMF doesn’t give any details of exactly how or when “about €5b” of arrears piled up since May 2014, but probably most of it built up since February. The report includes this interesting comment: “Cross-country experience suggests that unreported arrears may be significant under tight financing conditions because agencies may not report all invoices received in such a constrained budgetary situation. This would impart an upside risk to the estimate.”

Here’s an update of Greece’s state budget expenditures. It shows how the core central government spent €2.6b less than it was budgeted to spend in February through May. That’s almost 16% of budgeted expenditures other than interest that weren’t paid, and more than 4% of the period’s GDP. It doesn’t include local governments and some central government bodies.

Withholding 4% of GDP worth of budgeted expenditures is a whole lot harsher than anything the Troika of Greece’s official creditors asked for, even at the beginning of talks in February. If all of the roughly €5b of new arrears were run up in February-June, that would be more than 6.5% of that period’s GDP.

And now, with access to euro banknotes restricted and many businesses accepting nothing else, austerity just got a great deal harsher still. I have trouble understanding how limiting bank deposit withdrawals to €60 per day can be sold to the public as throwing off austerity. I guess we’ll see soon enough in Sunday’s poll.

But Tsipras wasn’t bad at collecting taxes

What puzzles me most about Tsipras’ move is that he put such effort into avoiding default all the way through the end of June. As the next table shows, his government’s tax-collection performance in February through April was actually right on target and significantly better than the Samaras administration’s average last year.



Even after poor performance in May – possibly related to taxpayers being on the wrong side of those arrears – the four-month average was still not too shabby, by Greece standards.

That €50b is proposed new lending, not debt relief  

This, by the way, is the same IMF report that’s being widely misreported in the news as calling for €50b of debt relief for Greece. Actually the report says Greece would borrow €50.2b more from the EU and IMF over the next three years under the Troika’s new bailout offer.

Of that, €29.8b would merely roll over maturing debts. The other €20.4b plus the government’s projected €11.4b of primary surpluses and privatization proceeds would pay for €13b of interest payments (net of refunds), clear €7b of arrears, rebuild €7.7b of run-down public sector cash balances, and put €5.9b into the government’s bank bailout fund (see page 7, table 1).

Tsipras Shoves All In

And so, months after I abandoned my prediction that Alexis Tsipras would lead Greece into an international default, he has gone and done just that.

Far from humbly accepting that Greeks want to keep the euro more than they want to reverse austerity, as it appeared to me in March that he had, Tsipras is making the most wildly high-risk bet he could possibly make. In poker terms, Tsipras has just pushed all his chips into the pot and dared his opponent to call – while holding the worst of all possible poker hands. Unless he’s extremely lucky, he’s going to crash out, and probably never play a major tourney again.

The play now goes to the people of Greece, who in this game can either confirm or reject his bet. He’s campaigning hard for a “no” vote against accepting the terms that have been offered to roll over Greece’s debts, and doing his best to persuade Greeks that if they support him, European leaders will fold and improve their terms.

If the vote goes against him, then Tsipras is out, and some new, more pro-European government will probably replace him, probably after another general election. But he will very likely win, mainly because he has given Greeks so little time to live and think through the real implications of a “no” vote.

Greeks are getting a taste of it this week, and it’s not at all pleasant. Sending money abroad is banned. Withdrawals of banknotes from bank accounts are limited to €60 a day, and practically available only to those who line up early at ATMs. Pensioners who wanted their pensions in banknotes were offered one partial payment of €120 this week after waiting in long, angry lines.

Some importers can still make payments abroad, if they receive approval from a newly established government committee. And Greeks can still make bank-to-bank payments among themselves, with payment cards or online. But Greek bank deposit balances are obviously already worth less than face value.

I haven’t yet seen anyone report a market exchange rate of cash euro banknotes for bank deposit balances, but I’m sure it would be hard to get more than 50 cents on the euro. Big businesses are facing a very tough decision whether to continue accepting payment cards and bank transfers, and most small businesses have already stopped.

And even this situation is too good to last. Greece can’t afford to keep up those €60 and €120 payments. Soon the euro supply in Greece will dry up, and the government will only be able to offer some kind of new notes, which will probably be nominally valued in euros but worth less than half their face value.

In other words, Greeks’ real spending power just fell off a cliff, and it’s going to roll further downhill from here.

Grexit: officially impossible, de facto all too likely

But many people will gladly suffer a week of hardship for what they see as a patriotic stand-off, and many will be willing to risk suffering more and longer.

If Greeks support him, Tsipras will continue to steadfastly deny that he’s quitting the euro, and technically, he won’t be. Despite what you might have read, there is in fact no way whatsoever to formally expel Greece from either the Euro Area or the EU.

To kick Greece out of the EU or euro, the EU would first have to amend EU treaties to allow it. That would be an agonizingly slow and difficult process, similar to amending a federal state’s constitution. It would unsettle other periphery countries, and invite anybody and everybody with a complaint about the EU to try to inject it into the treaty process. Nobody wants to open that can of worms right now, or for that matter even suggest the possibility.

So even if Greece de facto introduces another currency, which is very likely, the rest of Europe will still consider Greece to be formally a euro member. And legally that’s what Greece will still be.

If the “yes” vote wins on Sunday, and there’s a prompt election of a new, pro-European government, I think Europe will make a serious effort to rescue the Greek economy and restore it to its June status quo ante. There would be no new Greek currency.

But if Tsipras wins, the odds that European leaders will fold and cave into his demands are practically zero. To return to the situation that prevailed in June, Tsipras would need to convince the EU to welcome him back to renewed negotiations and the European Central Bank to renew its support to Greece while those negotiations proceed.

Call me pessimistic, but I for one just can’t see that happening, no way no how. The negotiating table that Tsipras wants to go back to no longer exists. If he wins the vote, he will be left to manage the Greek economy without European support, and Greeks will be left to learn the hard way how much they like that. Europe will wait for Tsipras’ government to fall, which probably won’t take all that long.

Greece is almost out of euros

It’s hard to say exactly how many euros remain in the Greek banking system, but it can’t be many. As of the end of May, there was somewhere between €4.2b and €4.9b in the banking system under the control of the Greek government and Greek banks, down from somewhere between €8.4b and €10.4b at the end of December.

The Bank of Greece (the national central bank) also had €2.6b of unused “emergency liquidity assistance” allowance as of the end May. ELA is a way that the ECB permits Euro member NCBs in crisis situations to create euros and loan them to local banks in return for substandard collateral, which the NCB must guarantee to the ECB. The point is that Greece being a junk-rated sovereign has very little quality collateral, and what little there is has already been pledged. The BoG’s total allowance has been raised by €8.8b since then, to €89b as of June 26.

But increases in the BoG’s ELA allowance are generally signs that the Greek banking system has bled even larger amounts of cash. The ECB raised the BoG’s ELA allowance by a total of €11.9b in March through May, while a net total of €14.4b was wired abroad or withdrawn as banknotes from Greek banks during the same period. Even when the ECB was supporting Greece with repeated ELA allowance increases, the supply of euros in the Greek banking system was gradually dwindling.

The BoG also had €5.3b of gold and €19b of debt securities not including those held for ECB monetary policy. I don’t know if the BoG could or would consider selling those. The government must also have some banknotes in safes and cash drawers.

Meanwhile, even after all the austerity, Greece has still been running a current account deficit of around €800m a month for most of the year. Last year that swung to a large surplus during the summer tourist season, with more than 40% of the year’s international tourism revenues coming in July and August. I’m afraid this summer’s tourism revenues will be far lower.

In any case, the current account must right now be undergoing a hard, sudden adjustment in the positive direction. Most payments abroad are blocked, and people’s limited ability to spend from their bank accounts must be cutting deeply into sales of fuels and other imports. In any event, without ECB support, Greece must balance its inflows from exports and tourism with outflows for imports.

The government can’t for long on top of that pay to distribute euro banknotes through ATMs and to pensioners, even in seemingly limited amounts. Withdrawals of €60 a day per person can add up quickly. There are at least 6,000 ATMs in Greece and more than 8 million adults. If the ATMs are well stocked, outflows could easily exceed €100m a day.

Think Argentina, not Cyprus 

If the “yes” vote wins on Sunday, the following section will probably be scratch. But given the strong chance Tsipras will get the “no” vote he’s looking for, it’s worth looking at what would come next.

There would be, I’m sure, no return to serious talks anytime soon and no further increases to the ELA allowance. Within no more than a couple weeks, Tsipras would be forced to admit that even limited disbursals of euro banknotes are no longer possible.

This situation is a close parallel to what Argentina went through in 2001. Whatever funds aren’t withdrawn while the €60 a day allowance lasts will be permanently devalued.

Greece’s experience with “capital controls” won’t be anything like that of Cyprus, which enjoyed continued ECB support and had some relatively easy ways available to improve its current and financial accounts. Greece will have much more capital flight, and is likely to undergo a long period of political uncertainty when inward investment will be very limited. “Capital controls” is a shabby euphemism for what’s happening in Greece, which is a sudden collapse of the real value of bank deposits.

The only way Greece could afford to keep the euro as its actual everyday currency without ECB support would be to apply sharp haircuts to bank deposits. That of course would be political suicide. It’s not in Tsipras’ nature to be so brutally honest.

Instead, look for Tsipras to introduce a new de facto currency, with a nominal value in euros, but backed only by the Greek government. These could be called “IOUs” as many are suggesting, or whatever, it’s not important. Banks would open and offer pseudo-euros, not euros, to anyone wishing to withdraw from their accounts.

All the while Tsipras will insist these are temporary measures and that Greece remains officially a euro member. And the latter at least will be true. I expect a Greek pseudo-euro to be worth less than half a euro.

The big question is how the Greek government will deal with imports and foreign payments. The intelligent way to do it would be to dispense with all pretenses and force all holders of pseudo-euros to buy hard currency at market exchange rates. Banks could then make foreign payments from anyone’s bank account or card by simply applying the market exchange rate.

In other words, one possibility is that the new Greek currency could be a de facto separate floating currency, linked to the euro only in name. In such a scenario Greece would suffer a short steep recession but could recover relatively quickly from there.

But there’s also a stupid way to do it, which I fear is likely to happen. The government could maintain the pretense that its pseudo-euro is actually worth a euro. The government and other privileged organizations would be able to convert pseudo-euros to euros one-for-one, while most people and companies would have to
go to black-market money-changers to buy real euros.

In other words, another possibility is that Greece could become a dual exchange-rate country, like Venezuela or the communist parts of Europe back in the 1980s. And that of course would be an economic disaster.

But let’s face it, when left truly to his own devices, this is the kind of thing that Tsipras will very likely do. Indeed there’s already an element of dual exchange rates in place: a new Committee For The Approval of Bank Transactions is deciding which importers have the privilege of being able to convert their Greek bank deposit balances to euros.

(The chart data is all from the BoG: BOP data, aggregate bank balance sheets and BoG balance sheets version 1 and version 2. ELA appears in version 1 under “other claims on euro area credit institutions.” I did some addition and subtraction.)

Greece Is Still Trapped, Act Two

The Greek government has released budget performance numbers for February that show a remarkable improvement in revenue collection. Although it’s always wise to wait for more than a single month of data before changing one’s mind, I’m withdrawing my prediction that the government’s deal with the rest of Europe won’t stick.

For all the sound and fury, it turns out the new government has pretty quickly settled down to accepting that keeping the euro means keeping austerity.

I wrote earlier that revenues were an alarming 20% below target in January after an 11% shortfall in December. If the new government didn’t fix those revenue shortfalls immediately, the tentative deal it struck last month with other Euro Area governments was bound to fall apart. A collapse of the deal would lead quickly to a banking crisis in which Greeks would lose their bank deposits.

Well, it’s only one month of data, but the difference is dramatic. Overall budget revenues were a mere €28m or 0.7% short of target in February. That’s actually better than the average performance in January to November of last year.

Even more telling, state budget expenditures in February were €828m short of budget. That’s an ad hoc sequester of 15% of the month’s budgeted spending, or 19% of non-interest spending. Obviously the government was straining to meet its debt payments after revenues had fallen short by €1.8b during the sort-of interregnum of December and January. The big expenditure shortfall in February shows in the most direct way possible that the new government is willing to impose austerity to avoid default.

Here’s the data, from the finance ministry:

 

The Bank of Greece also released some data for February that shows that Greek banks remained under severe stress in February, but not as much as in January, when Greek banks lost €31b of funding, including €17b of foreign interbank credit and €13b of deposits. Greek banks appear to have lost somewhere between €16b and €18b of funding in February, which is still very bad, but not as extremely bad as in January.

The data released so far for February is only indirect and relies on two things that typically happen when people pull money out of the Greek banking system. First, the Bank of Greece lends funds to Greek banks to allow them to redeem the private funding. Second, the Bank of Greece incurs a liability to the Eurosystem. These are so-called “Target” liabilities for money wired out to elsewhere in the Euro Area, and for deposits paid out in banknotes, liabilities for over-quota issuance of banknotes into circulation. Here’s the data and some more from the Bank of Greece:

Bank of Greece lending to Greek banks grew by €31.4b euros in January, while Bank of Greece liabilities to the Eurosystem grew by €32.1b – both fairly closely mirroring the €31b of private funding that Greek banks lost that month. In February Bank of Greece lending to Greek banks grew by about €16.8b, while Bank of Greece liabilities to the Eurozone grew by €17.8b. [UPDATE: Greek commercial banks’ loss of private funding in February turned out to be €18.8b, including €9.4b of deposits and €9.4b of international interbank credit.]

Note that the line I label “emergency liquidity assistance and sundry” is called in Bank of Greece data “other claims on euro area credit institutions denominated in euro.” That’s because emergency liquidity assistance is technically secret, so it’s hidden, albeit not very well, in a sundry category. Typically there are between €0.5b and €2b of items in that category that aren’t ELA. The increase in BoG lending to Greeek banks in February is thus an estimate. The exact increase in January is known from another source.

The data also shows how powerful the move was by the European Central Bank’s governing council on Feb. 5 to make Greek government debt and government-guaranteed debt ineligible for collateral for ECB-backed refinancing. The decision effectively withdrew €43.6b of funding from Greek banks. In compensation the ECB council reportedly raised its cap on the total amount of ELA the Bank of Greece is allowed to issue, but only by €9.5b.

It appears from this data that the stress was already lessening by the end of February. On Feb. 18, the ECB reportedly increased the ELA cap from €65b to €68.3b. The ECB wouldn’t have done that unless the BoG was close to breaching the €65b cap. But as of the end of February, ELA appears to have been still right around €65b. Apparently, Greek banks didn’t lose much funding between Feb. 18 and the end of the month.

Greek banks have continued to lose funding in March but at a decelerating pace, judging from the ECB’s latest increases to the ELA cap, to €68.8b on March 5 and €69.4b on March 12, according to Bloomberg.

I’ll be keeping an eye on the story, but for it’s looking like the Greece story is settling down. As I wrote back on Jan. 28: “The harsh truth is, Greece is boxed in. Trapped as trapped can be. So Greeks elected the only people who claimed to know a way out, however radical. But what can the Tsipras government actually do? I suppose it could make a show of throwing itself against the walls that surround it on every side. That might be what Greek voters are expecting.”

But there wasn’t even much show. The bottom line is that Greeks want to stay in the euro more than they want to reverse austerity, and Tsipras has proved to be adept enough of a politician to understand that. If you need confirmation that Tsipras has abandoned the leftist cause, here’s the Socialist Worker.

Here’s How Nemtsov’s Killers Could Be Caught

Some grainy, partly obstructed footage of Boris Nemtsov’s assassination has been leaked to the Russian television channel TV Center which bravely broadcast it. It doesn’t show a lot, but it does show enough to establish some of the basics of what happened. Enough is visible that it prevents Putin from getting away with a completely concocted version of events. For example police publicized that they were looking for a white car, but the car seen in the video picking up the assassin and driving off is dark.

The murder happened while Nemtsov and his girlfriend Anna Duritska were walking south from Red Square towards Balchug Island, which lies in the middle of the Moskva River. The footage appears to be taken from a camera mounted on the outside of an upper floor of the Balchug Kempinski Hotel.

Two blurry figures that must be Nemtsov and Duritska can be seen walking on the west sidewalk of the Bolshoy Moskvoretsky Bridge. Some kind of municipal utility vehicle slowly catches up to them as they cross behind a large light pole, and the murder apparently happens right at the moment it pulls alongside them. Two seconds later a figure emerges from behind the truck and walks out into the middle of the road, gets in the passenger door of a car that was driving up from the same direction, and they drive away.

The utility truck stops as Duritska kneels over Nemtsov. Then she walks over to the truck driver apparently to ask for help. Other people arrive, the truck driver leaves, Duritska and two others walk around the area together, and finally a police car arrives.

There’s a lot of speculation going around about the role of the truck and how the assassin arrived on the scene without being visible. Some have assumed everything was carefully coordinated to hide the killing from the camera, but this was a very far-off camera. My guess is the assassin was standing near the light pole where Nemtsov was shot down, invisible to the camera, and the truck was not involved.

But there’s a way we could find out for certain, if anybody has the guts to do it. There were several cameras located much nearer to the scene where Nemtsov was gunned down, on at least two nearby lamp posts. Everything possible needs to be done to make the footage they captured public.

One, pictured at the top of this article, has a large traffic camera (click for Google street view) pointing north towards the scene of the crime from about 120 meters to the south. Its view of the killing was likely blocked by the truck, but it probably recorded the assassin arriving at the scene of the crime. Unless it was broken or turned off it should have better images of the assassin stepping into the getaway car, and it should have excellent footage of the getaway car driving directly towards and under it.

The other post is about 60 meters north of the crime scene and has this set of cameras on it (click for Google street view):

Which tells you something about the nature of the killers. It seems very unlikely that they carefully planned to hide from a distant camera but didn’t mind being caught from shorter range on a big traffic camera and probably at least one of these cameras. Duritska is reportedly being held against her will in an undisclosed location, and Ukrainian officials pressing for her release probably won't get anywhere without US backing.

It surely won’t be easy to find that traffic camera footage. I understand of course that most Russians are either understandably too scared of Putin to act against him or stupidly glad that Putin is killing Ukrainians and Russian opposition leaders. Anyone who really cares about Russia’s future should be doing their utmost to make that footage public and get Duritska out of Russia.