Saving Denmark from Greece

11 May 2010

Henrik R Clausen

For anyone who has followed the financial crises over the last few years, it is not surprising that the negotiations once again take place behind closed doors. Like in any good crisis, major decisions are to be taken quickly and secretly to prevent critical press and independent experts from ripping apart the content of the agreements and get parliaments to vote against their leaders' decisions.

Who are we actually saving? Originally it was reported that we had to save Greece, and that the price would be 45 billion euros (about 57 billion dollars). That could all be just fine, for if Greece disappeared, we would have to find less attractive destination for our holidays. Greece is a nice place with a warm climate, for those away for a couple of weeks and have money. As a permanent habitat, Greece is not a very pleasant country, poor and corrupt, and with large immigration problems.

The phrase "We must save Greece" is misleading, though. First, the country would obviously not simply vanish from the world map if we refuse to send € 45 billion their way. Something different would take place: They would have to admit that they cannot pay all the money back, get an accord with their creditors, and find a repayment scheme that the poor investors need to be content with. They would obviously only accept an accord that eliminates the Greek fiscal deficit and gives them a realistic opportunity to get perhaps 70 or 80 percent of their original money back.

A lesser, yet still noteworthy problem is that Greek banks (Jyllands-Posten, May 5th 2010), has a portion (10%, approx. € 45 billion) of their reserves in Greek government debt, not cash. When the debt loses value, the bank reserves shrink, which can destabilize them. It is surprising that it is legal to use debt as reserves rather than cash, but there is probably a good explanation for this, that it does not constitute fraud. But it does seem strange.

If the euro countries bail out 'Greece', is it really the investors lending money to Greece that are being helped. Not Greece, not the Greeks. With fresh money from the ECB, investors can sit back and let their Greek bonds run to maturity, and then move their money to other safer places. They were indeed quite unequivocally told in 2008 that they should not assume unnecessary risk, and Greece is today the ultimate unnecessary risk. If the bailout package goes through, Greece's current creditors should write a nice letter to thank the eurozone citizens for the generous contribution.

Greece, however, would only see one kind of debt replaced with another. Obviously the ECB and Brussels would force the Greeks to spend less money, which would be unpopular in the already poor country, and probably lead to a career change for several top politicians. ECB and Brussels would in any case have much more to say in Greece, which they certainly would not mind. The temptation of cheap loans has undermined the country's sovereignty. It was not exactly what the Greek government had told its citizens to expect when it cooked the books to join the euro.

What does this cost? The original price tag for saving the creditors of Greece from their bad investments was 45 billion euros (about 57 billion dollars). For ordinary citizens, this is an unimaginable amount, and even for business people, who are accustomed to juggle millions over lunch, the figure is out of this world. For politicians and central bankers who do not have to earn money, it is somewhat easier to write numbers with this many zeros. Especially the money-issuing authority in the eurozone, the European Central Bank (ECB) will have no problems issuing the necessary euros, for they have the independent authority to do this. The huge gap between daily amounts and those billions probably is the reason that we are not seeing demonstrations in the streets, protesting the cost.

Now the 45 billion euros is not much in context, so the amount was quickly increased to 110 billion euros (about 140 billion dollars). It was approved on Sunday May 2nd, with the technical reservation that national parliaments, who are funding agency for governments, also have to approve spending that much public money. Parliamentarians are accustomed to vote as their leaders ask them, so it'll be likely to pass. For this is a major crisis, and financial stability can not be bought too dearly.

Now, 110 billion euros is not much in context, so it was quickly raised to 750 billion euros (about 952 billion dollars). It was approved on Sunday May 9th. The rush was due to markets reacting negatively to the previous rescue package, investors moving their money away from euro positions. There were fears that it could develop into an actual panic, and thus the EU leaders decided to get more money, that also Spain, Portugal and other countries can be saved. Surprisingly, the U.S. President Obama interfered (according to EUobserver) in the process, applying pressure on German Chancellor Angela Merkel to have the new and somewhat larger rescue package implemented.

Of course there is the technical subject that national parliaments, who are funding agencies for their governments, also had to approve spending this much public money. Parliamentarians are accustomed to vote as their leaders ask them, so presumably it'll go through. After all, this is a major crisis, and financial stability cannot be bought too dearly. This time the bill be so high that its members can not immediately find money in their treasuries, so the United Kingdom, Switzerland, Japan and Denmark will also participate in this large-scale purchase of 'stability'.

There is just a caveat, that it is only 1œ year since we last passed giant rescue packages to ensure financial stability. Back then states rescued banks, without major public debate on the wisdom of moving the excess risk from banks to the states, who at the same time increased their annual deficits sharply to stimulate the economy. One would think that stability with such short shelf life is bought too dearly. It it is surprising that the press has not been more critical of the the meagre results from last year's rescues.

The latest development is that Britain refuses to participate in the bailout. Although the country is outside the euro, Britain is expected to show 'solidarity' with the euro countries, presumably also to ensure that the bailout will not weaken the euro too dramatically against the pound and other currencies. This has led France to threaten that Britain would not be helped by the other countries, if (when) that becomes necessary.

What is the source of the bailout money? This is a difficult question, for ordinary citizens are rarely informed of the central banks' methods and tools. But we get an interesting hint by listening to Jacques Cailloux, chief economist at Royal Bank of Scotland, who on May 4th 2010 is quoted by Bloomberg as saying:

Rather you break the rule book than the euro area […] We're far from being out of the woods. There is now a real opportunity for the ECB to take the lead.
Now the book of rules – and genuine enforcement of these rules – is a basic requirement for us to maintain confidence in the ECB, the euro and the leaders we have chosen to govern Europe's main currency. The rules represent a contract between the responsible leaders and citizens, and are to be respected, not broken. More details on what rules are no longer deemed appropriate (Bloomberg again):

ECB-director Jean-Claude Trichet pledged in January that it would be an option to reduce requirements for government debt as collateral for loans to help a single country. He broke this promise in April as well as in May. Thus the ECB can absorb risk that private investors are no longer interested in, and continue to issue loans with Greek debt as 'collateral' – which in practice is difficult to distinguish from money printing based on debt. There are several possibilities:

The next response to a broadening loss of confidence in euro-area finances would be for the ECB to channel cash through banks, either by lending them more for longer in its regular auctions or by weakening collateral rules further, Deo said. Another option would be to accept bank loans to governments as security, he said.
Forward David Owen, chief economist at Jeffries Group Inc, and Harvinder Sian, Royal Bank of Scotland, both state that there is a real risk that the ECB will make purchases of government bonds to increase liquidity in the market. The Germans, though, are likely to be reluctant about this, as precisely this mechanism caused the hyperinflation of 1923.

Latest: The ECB has started to purchase government bonds.

Would this not create inflation? Whatever the mechanism used by the ECB, it will create new money to cover the bailout of Greece, Spain, and other countries that have assumed too much debt and risk. One would think that printing of new money would lead to inflation, but this has not happened yet. At the time of writing (Tuesday, May 11th) the promise of the extra money has stabilized the market, but sent the price of gold to record level of € 973 an ounce, as the rescue packages in any case will increase the money supply and thus reduce the value of existing money.

That we do not have significant increases in consumer prices would be due to several factors: Nervous citizens saving instead of consuming, the fact that the euro to some extent has replaced the dollar as reserve currency, as well as efficiency increases in the industry all help to keep prices in check. This gives an interesting situation, in that the M3 money supply is stagnant, while the narrower money supply M1 is growing at around 10% annually, lately near 15%. This difference may, in a few years' time trigger uncontrollable inflation, which can break confidence in the euro conclusively.

A slightly encouraging angle on this is the IMF's contribution to the rescue package, at a fairly impressive € 250 billion. Their Special Drawing Rights are an international pseudo-currency, and the IMF's contribution to the bailout moves the burden onto the Japanese, Australians and other irrelevant persons. This eases the burden on Europeans, at least in the short term. Unfortunately, this is also inflationary, but currently it seems that only Germans worry about inflation.

The 'speculators' are not to blame In a search for the cause of this costly mess, French president Sarkozy, German Chancellor Merkel and others have blamed 'speculators', and in turn demanded stricter control of these companies that manage quite a few billions, and whose decisions influence interest rates and money available for the states to borrow. But it is a fault to blame them, for though speculators are usually the first to respond to problems, they are not causing them.

These 'speculators' is a group composed of various types of investment funds, insurance companies and pension funds, managing their depositors' money. The money must be placed so as to provide the highest possible return, taking into account also the risks of various investment types. Sovereign bonds are usually considered a very safe investment, but when a real risk of state defaults appear, investors will not buy its debt, in part because the crisis of 2008 demonstrated the destabilizing effect of excessive risk-taking.

Back then, governments around the world told them not to take too much risk, and advice that seems to be taken. For this reason, their interest in Greek debt is limited, and Greece has difficulty borrowing money on the free markets. This is the main reason for the ECB to step in with other kinds of cheap loans. That private investors are reluctant to lend money to Greece does not constitute an 'attack' on the country, nor in euro as such.

An aspect to this is the rating agencies who wrote down Greek creditworthiness. These agencies are currently a tad too independent for the governments' taste, thus Merkel and Sarkozy have requested EU President Herman von Rumpoy to scrutinize the role of rating agencies in escalating the crisis and are pondering the creation of a new European rating agency, which will issue more politically acceptable assessments of countries' debt. Standard & Poor's, one of the major current agencies, protests and points out that their assessments of public debt solvency has always been more positive than the markets assessment, as established through actual purchases and sales (Reuters). It is worth considering whether a new rating agency that provides yet more positive reviews will really be helpful, or even reliable.

What should Denmark do? First and foremost, we should rejoice in our luck that we have not abandoned the Danish Krone for the euro, and that we therefore have the sovereignty to stand outside the Greek mess.

Rejoicing done, there are some practical issues to take care of:

  • First and foremost, we should refuse to squander good, Danish money in this circus. It is not sensible to throw this many billions at a stability that seems ever more illusory.
  • Next, we should seriously consider cutting the bond to the euro, now. The Danish National Bank already keeps interest rates extremely low in order to keep up the slide of the euro. The purpose of holding a fixed exchange rate is to ensure stability. Without this stability, this policy is meaningless, and can be abandoned.
  • Finally, we should minimize manipulation of our own currency, the Krone. Its value is not created by the National Bank, although it can be regulated by it. The value of the Krone is created by the industrious Danes, who produce goods to be purchased for Kroner. The more production and value creation, the better the Krone will perform internationally. This is the real basis to avoid crises and inflationary 'bailout packages', and should be a top priority for Denmark.