The Greek transfer problem
THE MACROECONOMIC challenge facing Greece in 2010 was side-stepped from the start—driving, in turn, policy missteps.
Figure 3 highlights the truly extraordinary non-resident purchases of Greek government debt—capital inflows—during the decade from 1999. The left chart uses the Bank of Greece’s excellent flow of funds data—recorded at market value of transactions—to track the 4-quarter sum of non-resident and resident purchases of Greek debt. It also shows the fiscal balance throughout.
Between 1999 and 2009 the cumulative fiscal deficit was about €150 billion; meanwhile, total flows of Greek liabilities at market prices was €180 billion (left chart), of which about €160 were purchases by non-residents—meaning, roughly, the entire deficit was funded by non-residents—although this does not imply primary market purchases.
As a result, in terms of the face value of debt outstanding, by 2009 about 80 percent was held by non-residents (right chart)—up from 60 percent in 2003 and, by flow of funds market value data (not shown), from 25 percent in 1998.
Crowded out of their own sovereign’s debt, Greek banks sought, and found, alternative means of generating income—intermediating savings domestically, lowering lending standards, contributing pro-cyclically to demand.
Meanwhile, whereas under a traditional fixed exchange rate arrangement the Bank of Greece might have absorbed part of this immense capital inflow through reserve accumulation, the fledgling currency union made this not only impossible but apparently unnecessary.
In addition, note how as the Crisis hit—with the price of Greek bonded debt in freefall—domestic financial institutions began purchasing from non-residents GGBs at discounted prices. In 2010-11 Greek intermediaries bought about EUR25 billions of government bonds at prevailing market prices—equating to roughly 30 percent of the total face value outstanding!
Thus, temporarily, the non-resident share in the face value of Greek debt fell below 50 percent in December 2011 (right chart). But the debt exchange of March 2012 upset hopes of capital gains; substantial losses were recorded instead, requiring recapitalization via additional program funds—as well as eventually triggering the Cyprus bailout.
In this way, non-resident ebullience and over-exposure to Greece was eased not simply through the flawed 2010 bailout—and ECB purchases under their SMP program—but also through the miscalculation of domestic financial institutions. And the so-called domestic bank-sovereign doom loop is misleading. There would have been no such “doom loop” for Greece had the euro area the institutional frameworks in place along with analytical foresight to trigger restructuring in 2010.
And so, Greek external debt remains about 85 percent of the total outstanding stock—itself about 170 percent of GDP.
And this burden of external government debt has always set Greece apart from other euro area peripheral countries. Figure 4 shows the evolution of the face value of government external debt against the current account in percent of GDP (left chart) and in percent of exports of goods and services (right). The chart shows data for Greece, Ireland, Italy, Portugal and Spain between 2008Q4 and 2017Q1—the earliest point is the left-hand dot in each case.
Greece entered the Crisis with not just with high public debt, but much higher share held externally (90 percent of GDP, 480 percent of exports). Moreover, Greece was running a substantial current account deficit at the time (15 percent of GDP)—again larger than comparators.
This challenge was nearly identical to the Transfer Problem facing Germany in the 1920s. Of German reparations, Keynes noted the “Budgetary Problem” of “extracting the necessary sums of money out of the pockets of the German people”—and the “Transfer Problem”—of “converting the German money so received into foreign currency” in order to repay this external debt are two distinct challenges. And Keynes objected to the “view … widely expressed that the Transfer Problem is of quite secondary importance and that, so long as the Budget Problem is solved, the Transfer Problem will, in the main, solve itself.”
Instead, the problem was in achieving fiscal adjustment while simultaneously transferring resources from non-traded production towards exports. Yet this has been overlooked in Troika analysis throughout the Greek Crisis—the tacit assumption being that austerity could be treated orthogonal to external adjustment. The balance of payments was simply assumed to passively adjust to meet growth assumptions—disconnecting macroeconomic projections from fiscal adjustment. This resulted in a succession of flawed GDP projections (Figure 5, left chart) which now begin to resemble an outstretched hand begging for food.
Thus, absent symmetric expansion in Core Europe—and offsetting export growth—Greece followed the same pattern, though more severe, of contracting domestic demand and imports as revealed across the periphery (Figure 4). In each case, the current account swung from large deficit to small surplus after which the Crisis would abate, domestic demand stabilize, yields moderate. Indeed, in the case of Portugal and Ireland, “clean” program exits were achieved only once their current accounts registered surpluses. For Italy and Spain, yield compression accelerated at this point.
Having recently passed the 5-year anniversary of Draghi’s “Whatever it Takes” speech of July 2012 it is worth reflecting how—important as it was—this speech only really bought time for the completion of peripheral current account compression. Indeed, consider how the same pattern of current account adjustment-cum-stabilization played out identically in the Baltic states in 2008 and 2009 (not shown). They could not benefit from Draghi’s intervention, but their stabilization followed external adjustment. In other words, Draghi didn’t save the euro area in 2012, but Depression did!
Why does this happen? The current account, as a debit item, records interest on all external debt as part of primary income. Once a surplus obtains there is enough foreign exchange generated—roughly a surplus of exports over depressed imports—to service external debt without resort to additional borrowing from abroad.
Alternatively, seen in terms of saving-investment balances, a surplus on current account means the domestic private sector is saving enough to fully finance both private investment and the fiscal deficit—with some foreign exchange to spare. Foreign financing is no longer necessary.
A current account surplus sends a strong signal that the crisis will, at last, abate. With this background, can we now contemplate how the Crisis might be resolved from here? This is in Part III.