Sunday, March 28, 2010

Marshall Auerback on Greece


by Marshall Auerback

As before, this is in fact another statement that indicates no checks are to be written.

The purpose is probably the hope that it be read as a statement of support which will facilitate continued funding of Greek debt.

It is a clear statement that no funding is available until Greece fails to find funding elsewhere. However, understood but unstated, is that the process of finding funding is necessarily that of price discovery. Greece, like all borrowers, simply offers securities at ever higher rates until it finds the needed buyers. Failure, in theory, is defined as the rate reaching infinity with no buyers. At that time, the euro members would step in with a loan offer at a non concessional rate which would then presumably be infinity.

This makes no sense at all, of course. The statement is in fact a statement that Greece must first drive rates to infinity before euro zone member loans are available. In other words, it's a statement that says Greece is on its own, and that they will stand by without taking action as observers of the standard market default process of Greek funding rates going into double and then triple digits as happens to all failed borrowers of externally managed currencies, including nations with fixed exchange rates.

"In this context, Euro area member states reaffirm their

willingness to take determined and coordinated action, if needed, to safeguard financial stability in the euro area as a whole, as decided the 11th of February.

As part of a package involving substantial International Monetary Fund financing and a majority of European financing, Euro area member states, are ready to contribute to coordinated bilateral loans.

This mechanism, complementing International Monetary Fund financing, has to be considered ultima ratio, meaning in particular that market financing is insufficient. Any disbursement on the bilateral loans would be decided by the euro area member states by unanimity subject to strong conditionality and based on an assessment by the European Commission and the European Central Bank. We expect Euro-Member states to participate on the basis of their respective ECB capital key.

The objective of this mechanism will not be to provide financing at average euroVarea interest rates, but to set incentives to return to market financing as soon as possible by risk adequate pricing. Interest rates will be non-concessional, i.e. not contain any subsidy element. Decisions under this mechanism will be taken in full consistency with the Treaty framework and national laws."
The problematic institutional structures for the euro zone have been present since inception. But it's always been unclear as to what triggered the crisis at this particular time. ECB President Trichet gives a clue:
ECB President Jean-Claude Trichet took some pressure off Greece today by extending emergency lending rules, saying its bonds won’t be cut off from ECB refinancing operations next year in case Moody’s Investors Service lowers its rating to a level comparable with other companies.
Trichet’s remarks marked a reversal for the ECB, which said in January that it wouldn’t soften its collateral policy for the sake of a single country. The bank was scheduled to reintroduce pre-crisis rules at the end of 2010.

This basically confirmed my earlier suspicions that this whole crisis was triggered by the ECB. They closed the window, which placed attention on the perverse institutional structures at the heart of the EMU. The markets began to query the solvency of Greece as a consequence.

The problems of the EMU have been in existence since inception (Jan, you've written about this for over a decade). But it's always been curious to me that the crisis came when it did. I always thought that the ECB was responsible. But at whose behest did they unilaterally change the rules of the game on Greece? I suspect Germany was responsible here.

Early Feb ECB decided to unwind QE. Remember, Greek banks were doing backdoor monetization: buying Greek government debt, reporting it to ECB, and then taking the reserves from that and buying more government debt. Germans surely took offense to that, since it is Weimar 2.0 from their paranoid perspective. Irish have also been using this loophole. In Randy's book, turn to the page with the vertical and horizontal money diagram: this was the only way to get vertical money into Greece, once ECB stopped expanding its balance sheet as the crisis died down. So they start mentioning in front of microphones that ECB rule waiver will be up at year end, the one that lets ECB hold and repo low quality rated eurozone government debt, and away we go."


  1. You should write a book.

  2. Historically, inflation expectations largely determined market yields.  Now its "crowding out".  But by what calculation can we measure the increased demand for loan-funds associated with our & their bloated bureaucracy?

    It's my discovery.  Contrary to economic theory, & Nobel laureate Dr. Milton Friedman, monetary lags are not "long & variable".  The lags for monetary flows (MVt), i.e., the proxies for (1) real-growth, and for (2) inflation indices, are historically, always, fixed in length.  However the lag for nominal gdp (the FED's target??), varies widely.
    Assuming no quick countervailing stimulus:

    jan..... 0.54.... 0.25 top
    feb..... 0.50.... 0.10
    mar.... 0.54.... 0.08
    apr..... 0.46.... 0.09 top
    may.... 0.41.... 0.01 stocks fall

    Should see shortly.  Stock market makes a double top in Jan & Apr. Then the real-output of final goods & services falls/inverts from (9) to (1) from Apr to May.  Recent history indicates that this will be a marked, short, one month drop, in rate-of-change for real-output (-8). So stocks follow the economy down (with yields moving sympathetically?)

    The rate-of-change in inflation should top in Mar. (e.g., CRB index).   Later on this year, the inflation rate drops sharply/inverts after Sept month-end.