Monday 9 February 2015

Greece - Cognitive Restructuring

"Economic depression cannot be cured by legislative action or executive pronouncement. Economic wounds must be healed by the action of the cells of the economic body - the producers and consumers themselves." - Herbert Hoover

Like any good cognitive behavioral therapist, we tend to watch the process rather than focus solely on the content. We have been therefore watching with interest the Greek saga and it's "Schedule Chicken" redux:
"The practice of schedule chicken often results in contagious schedules slips due to the inner team dependencies and is difficult to identify and resolve, as it is in the best interest of each team not to be the first bearer of bad news. The psychological drivers underlining the "Schedule Chicken" behavior are related to the Hawk-Dove or Snowdrift model of conflict used by players in game theory." - source Wikipedia.
It is therefore not a surprise that, given our fondness for behavioral analogies, we decided this week to use as our title analogy "Cognitive Restructuring" with the on-going Greek debt odyssey taken by its new hero, Greek Finance Minister Yanis Varoufakis to alleviate Greece's €315bn Damocles sword. 
When it comes to our title, as a tongue in cheek to debt restructuring, it refers firstly to a psychotherapeutic process of learning to identify and dispute irrational or maladaptive thoughts known as cognitive distortions, such as "all-or-nothing" thinking (splitting), magical thinking, filtering, over-generalization, magnification, and emotional reasoning, which are commonly associated with many mental health disorders according to Wikipedia. Our title is even more appropriate when one realizes that  "Cognitive Restructuring" is used to help individuals experiencing a variety of psychiatric conditions, including "depression", substance abuse disorders (debt), anxiety disorders collectively, bulimia (more debt), social phobia, borderline personality disorder, attention deficit hyperactivity disorder (ADHD), and gambling, just to name a few.

In this week's conversation, we will visit Greece issues from an historical perspective and look at solutions as well for the long term.

  • Greece: a story of "unfinished business"
  • Redistribution without efficient taxation cannot work on the long run
  • How do you deal with a Mezzogiorno country like Greece?
  • Will a GREXIT solve Greeks' woes?
  • Keynesian solution to counter the fall in aggregate demand even with QE will fail

  • Greece: a story of "unfinished business"

The on-going Greek Tragedy and its "Cognitive Restructuring is from an historical point of view a question of "unfinished business", in the creation of a modern state. On that subject we recommend reading "The Greek State: Its Past and Future" - An interview with Anastassios Anastassiadis from March 2012:
"Greece’s budget deficit and debt started growing rapidly in the eighties. At first, devaluations of the drachma and inflation softened the blow, but they were also bad for that Greek “frugality” that I mentioned a moment ago. In the second half of the 1990s, control of public finances was only ephemeral, and was quickly set aside by the euphoria elicited by the pharaoh-like projects that were planned for the 2004 Olympics. Furthermore, upon entering the euro, the Greek economy benefited from broad access to cheap credit. Within barely twenty years, frugality had given way to consumption, leading to a heavy dependence on credit. The Greeks borrowed from their banks, which borrowed from French and German banks. Why? To buy French and German goods." - Anastassios Anastassiadis.
On the subject of Greece, we read with interest the following comment from a reader of the Economist article "What emergency liquidity assistance means":
"Syriza seems determined to generate a payments crisis in Greece.
They have pledged (this weekend) extra spending:
- rehiring over 10,000 redundant civil servants
- increased pensions for lower income pensioners
- various schemes for providing free utilities & food to low income households
They have pledged (this weekend) to cut taxes:
- tax-free threshold for income increased to €12,000 (above median wage)
They have proposed no areas for spending cuts or raising tax revenue (beyond vague notions of tackling tax avoidance; some hopes that a higher minimum wage might boost tax revenue; alongside wishful consideration of fiscal multipliers and Laffer effects).
Against that background (a Greek payments crisis seems pretty certain, irrespective of whatever credit conditions Europe offers Greece), we should also recognize that a Greek begging bowl is offensive to the many poorer countries in the eurozone (Portugal, Slovakia, Slovenia, Estonia, Latvia, Lithuania).
- Greece has a basic state pension of €400/ month (which will be €5,200/ year when Syriza reintroduce the "13th month payment"), but most Greeks receive much more than this (state pension increases based on earnings). That is far more generous than, say, Lithuania's €236/ month (flat) state pension (only 12 months - they can count). Why should Lithuania pay for Greek profligacy? Compare public sector wage levels, government transparency, court performance, corruption, etc and there are many good reasons for most eurozone countries to grudge lending Greece a cent more than they already have.
If Syriza wants to rescue this, then they are going to have to come forward:
1) with sensible cashflow (revenue, expenditure) projections, and with proposed policy adjustments (moving forward) for accommodating any surprises. There must be a high degree of confidence that Greece can function without additional borrowing, without triggering a payments crisis in the near future.
2) with a credible programme of structural reforms, e.g. disempowering the oligarchs, taxing the church, forming a land registry and progressively taxing land, reforming courts, slashing military budgets, investing in education and R&D, making it *easy & quick* to register a business online and to begin doing business (without obtrusive or protracted licensing requirements), etc.
3) with a credible pledge to (by 2016) run a small primary fiscal surplus (perhaps a 1-2% of GDP target) and some domestic mechanism (auditing, legal review, etc) for generally pursuing this target (with some flex, but without bias towards deficit)
These three points are the absolute minimum - without these three points, there can be no further credit provisions for the Greek state. Syriza must somehow be brought to recognize this - based on their remarks over the past couple of days, they seem determined to default on pensions & wages, bankrupt the banks, wipe out business and broadly destroy the Greek economy entirely."

  • Redistribution without efficient taxation cannot work on the long run:

We agree with the above analysis from a reader from The Economist and we reminded ourselves what we wrote back in August 2011 in our conversation "Liquidity? The IV Greek Credit Therapy":
"One thing Greece must address is tax cheats who represents 30 billion euros, or 12 per cent of GDP, every year. Another American solution to European woes would be, for Greece, to tax its citizens on their worldwide income, similar to the US. It would be a very efficient way to stabilise its ailing banking system and deposit outflows given one third of its funds withdrawn have gone abroad for fear of a crackdown on tax evasion. By imposing Greek citizens on their worldwide income like US citizens, and with the help of Luxembourg authorities, Cyprus, Switzerland and the United Kingdom, the outflow could be stemmed and vital tax receipts could rapidly help close the gap on the very acute budget deficit, but that's another story..."
There is nothing new about the Greek situation and the errors that have been made by its creditors, French and German banks initially (before being bailed out by European taxpayers) as written by French great writer Edmond About in 1858 as reported in Vox Europe in their article of February 2012 "Greece 1858 – plus ├ža change":
"Loans are only granted to governments that are well established. Loans are only granted to governments that are believed to honest enough to honour their commitments, and loans are only granted to governments that lenders want to maintain in office. Nowhere in the world does the opposition lend to the government. Finally, lenders can only grant loans when they have the necessary funds themselves." - Edmond About
But the issue with Greece, when it comes to "Cognitive Restructuring" and focusing on the process rather than the content (as any good behavioral psychologist would do), is the "unfinished creation" of a proper Greek state we would argue. It was further debilitated by the introduction of the Euro .It led the government access cheap credit and mis-allocation of European subsidies, mixed with corruption of the government, who used European funds to boost public spending on a grand scale. This "mis-allocation" of "capital" (funded by European banks) led to prices rising to inappropriate levels due to the inappropriate level of salaries in the increasing cohorts of public servants hired:
"The Greek system nonetheless suffered from three serious shortcomings: finances that were generated primarily by indirect consumption taxes; haphazard enforcement, which gave some professional groups better salaries simply because of their superior negotiating powers; and, finally, the use of public-sector employment and of advantages granted on the basis of “social criteria” as a cheap way of providing social insurance." - Anastassios Anastassiadis
Of course a fiscal policy based mostly on consumption taxes and the lack of a proper land registry (even after Europe poured €100 million euros for this specific purpose) meant that as soon as "austerity" measures were put in place by the Troika, revenues collapsed and misery increased on a grand scale. 

  • How do you deal with a Mezzogiorno country like Greece?
As clearly highlighted by Dr Dambisa Moyo, in her book "Dead Aid" relating to the $1 trillion in development-related aid transferred to Africa, we believe Greek Finance Minister Yanis Varoufakis is right in the need for a sort of New-Deal for Greece.

Without the mis-allocation of a large part of European subsidies, sunk into Greece, and the completion of a Greek state there would not be such a difficult debt problem in the first place. Direct investments in infrastructures which human capital benefits from as well as productive capital, is the strategy currently followed by China, for instance in Africa. This is as well a subject tackled by Dr Dambisa Moyo in her most recent book "Winner take all".

  • Will a GREXIT solve Greeks' woes?
Without "Cognitive Restructuring" and dealing with the "unfinished business" of creating a proper state with efficient records and taxation, Greece's exit from the Euro with a devaluation and a return to the Drachma, will not bring an end to its misery. This is clearly shown by Dr Constantin Gurdgiev's post from the 30th of January 2012 entitled "Fake Doctors Treating Fake Disease in Greece":
"There are many 'expert' voices in the media saying Greece should exit the Euro zone in order to return to growth. This, as I commented earlier today, is a gross oversimplification of the reality.
There is simply no evidence whatsoever that Greece can grow on its own any faster or more sustainably than it did within the Euro. In fact, the evidence presented below shows that the only period during the last 30 years in which Greece was able to somewhat marginally close the gap in growth between itself and the Advanced Economies group is the period immediately following its accession to the Euro.
It is a fallacy of 'alternative expectations' to believe Greece will be enabled to grow its economy under post-euro devaluation beyond achieving a 1-2 years-long 'bounce'. Analysts who expect Greece to recover on the back of exiting the euro & devaluing are deluding themselves for two major reasons:
1.Greece has no fundamentals for growth & its debt overhang will remain, unless it defaults hard. Even with a default, removing debt overhang is not going to deliver growth to Greece beyond simple mechanical post-depression bounce, as Greece lacks all fundamentals for growth - institutional, cultural and historical.
2.However, with a hard default option, post-Euro, Greece will not be able to borrow & absent Government spending Greece has no capacity to grow. This is clearly shown in the charts below which highlight that in 23 out of the last 29 years, Greece has managed to achieve growth only with accompanying fiscal imbalances.
In summary, Greece never once had any fundamentals to grow on its own without massive subsidies either via loose monetary policy or overinflated expectations relating to the country accession to the European common structures. Greece is not about to get real growth-driving fundamentals within or outside the euro area.
 In short, all those talking about 'Greece must exit euro zone to achieve growth' are nothing more than fake doctors treating a patient who himself is faking a disease. Greece's problem is not the Euro. It's problem is Greece itself." - Dr Constantin Gurdgiev - True Economics blog
There is no good decision for Greece between Grexit or No Grexit. Regardless of the path it chooses, the lack of completion of its state is the only way to put an end to the misery of its people.

  • Keynesian solution to counter the fall in aggregate demand even with QE will fail
We already touched on debt deflation in our August 2011 conversation "AAA ratings - 10 little indians...and debt deflation (why Irving Fisher is right)":
"For Keynesians, the fall in aggregate demand caused by falling private debt can be compensated by growth in public debt, a government credit bubble. It isn't working."
When it comes to Greece in particular and Europe in general we reminded ourselves of the wise words as well of our good credit friend in 2012:
"When somebody has too much debt and cannot reimburse it, how do you bail him out? Obviously by restructuring his debts, which imply losses for his creditors.
But when one lends him more money in order for him to pay back what he owes, he is not bailing him out but rather pushing him in a bigger hole! The game until now has been to "print" more money and to add more debt on the shoulders on the indebted ones, to gain some time in the hope that growth will resume and reduce de facto the weight of the existing debt burden and the additional new debt issued to support the initial debt troubles.
This is a big misunderstanding of debt dynamics and its effects on the economy. When debt becomes too big, which it is now the case in many parts of Europe, the servicing drains all the available cash flows and reduces the growth potential."
We keep reminding ourselves that credit dynamic is based on Growth. No growth or weak growth can lead to defaults and deflation. We hate sounding like a broken record but: no credit, no loan growth, no loan growth, no economic growth and no reduction of aforementioned budget deficits and debt levels.

The only way to make the marginal-utility-of-debt go positive, is to decrease the debt load back to a level where the private sector can produce more than its interest payments.

In Europe without debt mutualisation and fiscal transfers on a grand scale, deflation will not be avoided, QE or not.

From our August 2011, we indicated at the time that Irving Fisher's Forward Year Tax Receipts was indeed an interesting solution for the debt deflation situation plaguing the world (with the US in mind given the efficiency of the IRS and the fact that US citizens are taxed on their worldwide income):
"Recognizing that the federal government issues liabilities (debt) in its own currency and thus can never go bankrupt, another solution is for the federal government to become more like the corporate capital markets with debt issuance at high real interest rates and equity like issuance at even higher real rates of appreciation. The likely candidate for equity like issuance by the federal government is forward year tax receipts. A forward year tax receipt is a receipt for taxes paid in advance that are due some time in the future. Like government debt issuance, forward year tax receipts have a rate of appreciation and a duration. Unlike, government debt, the rate of return is not guaranteed. The realized rate of return is totally dependent on the owner's future income and subsequent tax liability. And so savers are rewarded with a positive real rate of return and debtors can realize an after tax cost of credit that is significantly less. For instance if the federal government sells 30 year debt with a 3% real rate of return and sells forward year tax receipts with a potential 7% real rate of return, then a debtor can realize a -4% cost of credit. At that point inflation is not required nor should it be desired." - source Debt deflation
Unfortunately, with most of the world implementing ZIRP, there will be no happy ending this time around rest assured:
"If you want to raise real GDP, you raise the real interest rate on government debt (which the federal reserve controls) and / or you lower the tax rate. This works well enough until you run a huge trade imbalance (like with China) that suppresses real interest rates or if you have a great depression type scenario where the inflation rate is severely negative (massive deflation). In the massive deflation scenario real GDP may show growth while nominal GDP would show contraction.
The way to get around both scenarios is to sell forward year tax receipts. A forward year tax receipt lowers the after tax cost of credit in the private sector while not depriving the bondholder of income (Friedman's permanent income hypothesis). This is the problem with monetary policy as it stands now. In a true great depression massive deflation type scenario even tax cuts don't have any traction because if nominal interest rates are 0, lowering the tax rate would have no effect on either money velocity or GDP." - source Debt deflation
On a final note we give you a revised Schedule Chicken" redux:
  • "Wednesday February 11th – Likely t-bill auction to cover EUR 1.4bn maturity on 13th 
  • Wednesday February 11th - potential emergency Eurogroup 
  • Thursday February 12th – European Council of EU Leaders, Tsipras likely to meet Merkel on sidelines 
  • Friday February 13th – Voting for new Greek President begins, EC Commissioner Avramopoulos most likely candidate, originating from New Democracy. Likely completed by second round on the following day requiring 151 MP majority
  • Monday February 16th – Eurogroup where Greece likely to be top of agenda, conditions for extension of program to be made explicit by now 
  • Wednesday February 18th-19th- - Bi-weekly ELA review Saturday February 28th – Current EFSF program expires" - source Deutsche Bank
As well as Greece debt profile as displayed in a recent CITI report:

- source CITI

"When people are taken out of their depths they lose their heads, no matter how charming a bluff they may put up." - F. Scott Fitzgerald

Stay tuned! 

No comments:

Post a Comment

View My Stats