Economics and similar, for the sleep-deprived

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Update: seemingly not

Update: Oh yeah!

Wednesday, June 12, 2013

Mistakes we knew we were making ...

"When you ask them about the bloodshed, they tell you that you can't make an omelet without breaking eggs. When you ask where's the omelet, they tell you Rome wasn't built in a day" - George Orwell, possibly apocryphally.

I am not sure that I would have chosen the job of "Professional Apologist For Extremely Problematic People And Organisations" on the graduate milk-round, but I also suspect that if it was a choice between that and losing my benefits, I'd have the sense to realize that I'm more temperamentally suited to that than many other things. And it does strike me that in the specific case of Greece, the IMF deserves a fairer shake than it got, and that its "lessons learned" exercise is in danger of learning a load of wrong lessons. In particular, even if I spot the IMF's many detractors most of the political and bureaucratic constraints summarized in that tweet Pawel quoted, there are still a number of issues on which I think that the general market and media consensus is oversimplifying and (literally) taking things at face value. Mind you, I need two subheadings and a conclusion to make my case, which is usually a sign that it's wrong, and I still basically end up criticizing the IMF staff ...

1. This Isn't Your Parents' 180% Debt Ratio

Consider Tarquin, who has rich parents. He has monthly income of $x, and monthly expenditure of $x + y. Historically, the gap has been financed by, every few months, calling up his dad and asking for a "loan" of $3y. Tarquin's dad keeps track of these "loans", and the balance has built up to somewhere around $36y. Tarquin has no other liabilities at present, so his equivalent "debt/GDP ratio" is 300%.

I think the sharp cookies who read this blog can see where this example might be going. Tarquin's debt profile is completely sustainable and more importantly the 300% figure is utterly irrelevant to assessment of that sustainability. In Tarquin's case, if he is asking you to lend him a score until Tuesday, the only piece of information you need to know is whether he's in his dad's good books at the moment.

Debt that is very likely to be written off isn't debt; it shouldn't go into the calculation at face value and it might be less misleading to exclude it entirely. And debt which, with high degree of certainty, is going to be rolled over again and again, always on concessional terms, into the far future, is quite like debt that's going to be written off, for a lot of financial purposes. When one considers that there is a road map to fiscal union for the Eurozone (which is obviously as controversial as all hell and shot with political difficulties, but see the section below), I would say that on the relevant continuum, Greece's intra-EU official sector debt looks much more like borrowings from the Bank Of Mum And Dad than Argentina or Indonesia's external debts ever did.

Which, to me, says that the exercise of doing a bunch of forecasts, dividing the "debt" number by the "GDP" number and seeing if the line on the chart is going north-east or south-east is not going to give you a useful answer, particularly if your question is "has this program been good or bad for Greece?". The program needs to be assessed on the basis of the cash flows, not the debt stocks, precisely because this is not a case where double-entry bookkeeping is appropriate; the true debt burden of Greece isn't necessarily equal to the sum of past borrowings.

In cash flow terms (and presuming that at some future date there is going to be major official sector writedowns, because there will), the program was a massive positive for Greece. One can certainly argue about the speed of consolidation and whether it made any sense to try to get Greece back to primary balance so fast[1]. But that's the sort of argument that needs to be had, not anything based on the debt burden number being "too big" or "unsustainable". Anything's sustainable if there's a clear and obvious interest on the part of one of the world's biggest economies in sustaining it.

But ... my argument here is that the Greek debt burden doesn't matter, because the dogs in the street know it's going to be restructured [2]. So why not just write it down and make the accounting a little cleaner and more transparent? That goes on to ...

2. Rome Wasn't Built In A Day, Minister

I admit it, I was the only viewer of "Yes Minister" who used to cheer for Sir Humphrey, but really - RWBIADM. Some delays are the result of bureaucracy, foot-dragging and politicized attempts to run out the clock. But some delays are the result of either a) something taking a while to do because it is difficult, or b) something being more sensible to delay, because it depends on something else, and that something else will be in better shape if you leave it a while. Greece was very much a case of b), where the "something else" was the Euroland banking system.

It's sometimes very frustrating to watch people in the markets demand that everything must be sorted out! now! and with certainty! now! while you can see that a civil service is operating to its own timescale, and is keeping control of developments by, literally, controlling the agenda - the order in which things are decided. If you're going to have a PSI debt writedown, you do it after you're sure that it's not going to cause any domino effects anywhere else. If you're going to put a bank into insolvency, you do it after you've created a set of legal and administrative structures that allow you to default on the bonds while keeping money in the ATMs.

And in so far as is possible, you don't set hares running by talking about massive apocalyptic scenarios more than you absolutely have to. Which is a principle that the EU doesn't really observe, and the IMF rightly criticizes them for. Lots of reserves of energy, goodwill and risk tolerance were burnt up by Trichet's steadfast refusal to rule out Grexit in any kind of clear or unambiguous language. But that wasn't the IMF's fault.

Related to this issue is that it doesn't make much sense to talk about any program as having been one in which the interests of Greece were sacrificed in the name of broader stability in the Euro area. The number one interest of Greece was in preserving its external financing, the number one provider of financing to Greece was the Eurogroup, and it's pretty obvious that the ability (let alone the political feasibility, and remember that in context "politically possible" just means "possible") of the Eurogroup to provide financing to Greece is highly dependent on whether or not they are having a massive crisis triggered by trying to do things too quickly in Greece. The Eurogroup were totally correct in doing this - it's the equivalent of making sure that your own oxygen mask is securely fastened before helping others.

Rome really wasn't built in a day, minister. And it's surprisingly difficult to say what would have been gained by writing down the debt early. All the IMF can come up with is that it "allowed private sector participants to exit without losses and increased the cost to the official sector". To which, a) this is only true for the bonds which matured between 2010 and 2011, everyone else took their lumps, b) conversely, the way things were done preserved the T-Bill roll and therefore kept a bunch of private sector participants in the game, who would otherwise have had to be replaced, and c) since the IMF is a preferred creditor, where do they get off anyway, telling the Eurogroup how to spend their own money.

There are a lot of other RWBIADMs which in my view explain all sorts of things about the Eurocrisis, but they're not directly relevant to Greece.

3. Conclusion

In the end, I think people just hate the IMF debt sustainability analysis because it was so far off, and it was a political compromise. Fair enough, if a private sector bank or quoted company printed anything into the markets that was so clearly in bad faith I would be jumping up and down and calling the regulators. But really - in context, honesty is over-rated. Given the constraints on the IMF's ability to act (and the requirement for the ESM to only lend in the context of an IMF program), to fail to find the debt to be sustainable would have meant no package, no loan and probable Grexit. If I was a Greek diabetic in a hospital running out of insulin, I think I'd like to be sure that if I was having my health sacrificed for something, it would be a bit more significant than the sacred purity of IMF debt sustainability analyses. Sure, it's wrong to sign off on a dishonest document, but there are always get-outs when the consequences are disastrous. By convention, it's even acceptable to lie to the House of Commons about an impending devaluation of the currency.

And in any case, how very very awful was this analysis anyway? It failed because of pretty predictable incompetence and bad faith on the part of the political partners. But really, is it incumbent on the IMF to predict that everyone else involved in the deal is going to screw it up? You or I might want to operate on that basis as a principle of sensible risk management, when investing our own or other people's money. But is it really actually dishonest for the IMF to plan on the basis of the assumption that the people it deals with will keep their promises? Remember as well that this was 2010, at which point it was not at all yet known that Germany wasn't prepared to pick up the whole tab or allow some form of mutualisation, eventually.

I'm not Dr Pangloss here. This wasn't the best of all possible programs in the best of all possible worlds. But it was a decent stab at a compromise, given the actual world that we have. It bought time, and (with the Banking Union, a new ECB governor and a roughly 50% increase in the capital base of the banking system) I do not agree that this time was entirely wasted, just because some of it was spent chasing up a blind alley of Eurobonds. As I keep saying, the IMF, ECB and Eurogroup aren't supervillains and they aren't bumbling incompetents. They are reasonably intelligent public servants, trying to deal with an almost unimaginably difficult problem (which was not created by them), under circumstances of absurdly difficult constraint (most of which, to be fair, were created by them in the first place). I am going to keep on writing lousy adventure games until people get this point.

" The major difference between a thing that might go wrong and a thing that cannot possibly go wrong is that when a thing that cannot possibly go wrong goes wrong it usually turns out to be impossible to get at or repair." - Douglas Adams

[1] The IMF document explicitly rejects "speed of adjustment too fast" as a possible ground for criticism, despite the fact that it's one of the main ways in which any such problem could have been really "bad for Greece" (the IMF actually says the program was "bad for Greece" because the debt/GDP ratio was a big number, and this might have depressed ye confidence and investment. Which, yeah maybe, but surely probably a second-order effect at most?).

[2] It is even possible to construct a "Springtime for Hitler" scenario in which Greece ends up getting, ex post, debt relief which is larger, as a EURbn sum, than its entire outstanding debt burden before the crisis struck. "But ... Mr Bialystock ... it seems that in some circumstances a peripheral state could get more fiscal transfers by not running a functional political and economic system!"

2 comments this item posted by the management 6/12/2013 04:19:00 AM

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