Archive for January, 2015

The Shifts and Shocks – The Eurozone is an incomplete and imperfect union

Saturday, January 31st, 2015

Martin Wolf has already, after only a few chapters, given his opinion of our research question – “No”. Many people, including myself, think that the Euro crisis was offset by the US financial crisis, but that does not seem to be the case. Europe was obviously affected by it since the global financial system is all interconnected but it was not the cause of the crisis. What caused the Euro crisis, according to Wolf, was the current account imbalances that were caused by “stupid” lending and borrowing.

Prior to the crisis, investors viewed all Eurozone government bonds as equally risky. Countries with excess saving and no credit demand then felt safe to invest in and lend billions of dollars to Ireland and southern Europe where there were higher credit demands and higher rate of returns. This caused huge current account imbalances where countries like Greece (-$44.7bn) and Spain (-$144.3bn) had big deficits while Germany ($248bn) and the Netherlands ($52.7bn) had major CA surpluses. Countries with current account deficits have excess spending over income and they were unfortunately not able to use all the credit properly. In the beginning of 2009, spreads started to emerge between troubled countries´government bonds and Germany´s bonds. At this point, investors understood that their investments in Ireland and southern Europe were not as safe as they thought. They started pulling their money out of these countries and there was a sudden stop in funding. The spending of the CA deficit countries collapsed.

The CA deficit countries were suddenly running larger fiscal deficits. They were forced to cut spending and raise taxes without external credit, which dug the deficits deeper. If Spain, for example, had its own currency, previous investors would try to sell that currency and that money would probably be re-invested in Spanish assets and the Spanish government would be ensured that the liquidity is around to fund the debt. Deficit countries cannot get the unlimited support they would have with their own currencies. Hence, Eurozone countries with fiscal debts depend on external credit to fund that debt. The European Central Bank can provide limited funding and then it is up to the other individual member countries to decide if they want to lend money to deficit countries. Many countries think the risk is too high to lend deficit countries the money they need. Wolf argues that the major problem is that the Eurozone is a currency union, not a banking union. It does not have the central authority that could fund all these public debts.

Martin Wolf concludes this chapter by saying that the Euro crisis was not initially a fiscal deficit problem, but the “stupid” lending and borrowing made fiscal deficits a major post-crisis problem.

Upcoming Deadlines

Saturday, January 31st, 2015

FYI, I put two upcoming deadlines on the Tasks page:

  • Preliminary group Report on What are the Financial/Economic/Political Aspects of the Euro Problem – Due: Feb 13
  • Prelim Commentary on Your Engagement & Insights – Due: Feb 27


WSJ Documentary on Debt Crisis

Friday, January 30th, 2015

I watched a short documentary on Greece and the European Debt Crisis by the Wall Street Journal.  There were two major points that stood out to me as it pertains to the research question:

1. Countries belonging to the Eurozone must be fiscally responsible

This does not mean that member countries never borrow or spend on credit. It means that they are both willing and able to pay back money that they borrow.

2. Some central authority, like the ECB, must ensure the members of the Euro area maintain fiscal responsibility if they refuse to do so on their own.

It is doubtful that the Euro will be sustainable in the long run if member countries will continually require bailouts or default on their debt.

Will Greece Be Allowed to Remain in the Eurozone?

Thursday, January 29th, 2015

There is an ongoing debate over Greece’s new reform program, which threatens the already sensitive Eurozone system. The new Prime Minister of Greece, Alexis Tsipras, has proposed a set of reforms to Greeks debt situation that are similar to the London Debt Agreement of 1953. Essentially, Greece is refusing to implement the austerity measures and Greeks official lenders, such as Germany, are agianst any reform. Prime Minister Tsipras is attempting to isolate Berlin through a unified political assault of like-minded leftist governments within the EU. Should Tsipras succeed, leftist political parties stand to gain more influence in their host country’s government and would likely push for more socialist policies and the rejection of austerity implementation. This is especially problematic for countries like Spain, which has adopted the austerity measures and has begun to see benefits from those measures.

Recently, Spain has experienced a turnaround in its economy. With Spain’s real Gross Domestic Product (GDP) expected to grow by 3 percent next year and unemployment having fallen by 400,000 since 2014, there is proof that the pro market reform policies are actually working. The Spanish government believes that if Greece is allowed to reform its debt return policy, Spain’s leftist political party, Podemos, will take control of the government. If Podemos is able to take control of Spain’s government, the party will likely reverse the austerity measures put in place, just as Greece is trying to do now. While Prime Minister Tsipras has gained support in both France and Italy, conservative European politicians believe that this “support” will not actually aid Tsipras. Many Europeans feel that Greece, which already has the longest debt maturities and the lowest interests costs in proportion to the GDP of any Eurozone country, should not be allowed to reform their debt policy. Government’s are not willing to act generously towards Greek taxpayers, as their tax payers would bare the cost if they have not already.

With the risk of Spain and other indebted Eurozone countries calling for a reverse in austerity implementation, the chance that Greece will be able to reforme their debt policy is unlikely. The Eurozone would suffer as a whole if countries threaten not to pay back their loans and Greece would certainly suffer if the country were to exit the Eurozone. Greece, with its already slowed economy, would lose out on the advantages the country currently receives in the EU and would need to look to other lenders to borrow the money the country will likely need in the future.


Article: The Wall Street Journal. Why the Eurozone May Need to Sacrifice Greece to Save Spain, Author: Simon Nixon.


Scott McPeek

Boomerang- “And they invented Math”

Wednesday, January 28th, 2015

I thought the chapter title was exceptionally clever as this section of the book focuses on Greece’s role in the global financial crisis and their many financial miscalculations.

In the 1980’s-1990’s, prior to adopting the euro, Greek interest rates were a full 10% higher than German interest rates. As people felt the Greeks were far less likely to repay, many Greeks were never really able to use credit cards or have mortgages. In a modern world that basically revolves around credit, this system seems archaic, because it was. The Greeks felt they got their “big break” to the modern world when they had the opportunity to adopt the euro.

However, before this could happen they needed to show their deficits were under 3% of GDP and inflation rates that were comparable to German rates (Germany acting as the benchmark of a good Euro economy). As this was definitely not the case, the Greeks got creative and moved a wide range of expenses such as pensions and defense expenditures off their books. To lower inflation they froze prices for electricity and water and cut taxes on gas, alcohol and tobacco. After a bit of rearranging they were able to adopt the euro and could now borrow at a rate around 5%, in comparison to a previous 18%. And borrow and spend they did.

After this is when things get slightly out of hand, and Greece runs up massive amounts of debt. Here are several ways in which they did this:
1. The average government job paid 3 times the private sector
2. Their national railroad had revenues of EUR100 million, while their annual wage bill was EUR400 million, plus EUR300 million in other expenses
3. Their education system employed 4 times as many teacher per pupil as #1 ranked Finland
4. Between 3 government-owned defense companies, they had an aggregate debt of EUR1 billion
5. Retirement age for men was as early as 55, and 50 for women
6. Rarely anyone in Greece pays taxes. (There are laws in place against cheating on taxes however they have a horribly inefficient court system, so in the interest of time, cases are rarely brought against people who evade their tax obligations.) This is not limited to individual taxes, the corporate tax system is even more corrupt. The example Lewis uses is an Athenian construction company that has an actual tax bill of EUR15 million, yet somehow they pay nothing. How? The company fails to declare itself a corporation, and hires an outside party to create fraudulent receipts for expenses the company never incurred and if a problem arises they simply bribe the tax collectors. This is the norm, and nothing was done in response to it.

In October 2009, the Greek government estimated its deficit was 3.7%; two weeks later it was revealed the number was more like 12.5%, and eventually revised estimates turned out to be nearly 14%. They were able to reach the outrageously inaccurate 3.7% by doing things such as leaving a yearly pension debt of $1 billion off the books (they pretended the cost didn’t exist, even though they paid it). They had no Congressional Budget Office and no independent statistics agency, so all the finances were unquestionably what the government said they were.

After a realistic measure of Greece’s debt is calculated, Greece has $400 billion in outstanding government debt and they owe $800 billion in pensions, which equals a total debt of $1.2 trillion. THe main concern is what happens when/if Greece walks away from it’s $400 billion outstanding debt obligation. What happens to the banks that lent the money? And will this set a precedent for other countries in Europe on the brink of default?

To simplify, the crisis of Greek debt occurred because spending grew in excess of what they were able to pay. This went unnoticed because of phony calculations, manipulations and lying. As this information was made public, credit rating agencies started downgrading the credit rating. This caused pension funds, global bond funds, and other institutions who buy Greek bonds to panic. Where Greece differs from Iceland is they have Europe to bail them out. Here’s a brief timeline of Greece after the bailouts start.

April/May 2010- Eurozone countries approve $145 billion rescue package for the country; this was done under the assumption that Greece would adopt austerity measures to repay the debt. Prime Minister at the time, George Papandreou called for the austerity measures, however this resulted in immense rioting from the public

July 2011- EU leaders agree to channel EUR109 billion through the European financial stability facility

October 2011- Eurozone leaders agree to a 50% debt write-off in return for further austerity measures. Rioting ensues.

November 2011- Papandreou resigns

February 2012- Greek parliament approves EUR130 billion bailout

March 2012- Greece reaches a debt swap with private-sector creditors, enabling it to reduce its massive debt load

October 2012- parliament passes EUR13.5 billion plan aimed at securing the next roux of EU and IMF bailouts

Early 2013- Unemployment is 26.8%; young unemployment is almost 60%

Early 2014- Unemployment reaches a high of 28%

April 2014- Eurozone finance ministers says they’ll release more than EUR8 billion to further the Greek bailout
The full timeline is here:

Boomerang– Iceland’s role

Wednesday, January 28th, 2015

Boomerang by Michael Lewis is divided into several different chapters that examines the role a specific country played in the global financial crisis.

The first country examined was Iceland:

Some background info on Iceland, circa 2003 the three biggest banks in Iceland had assets of only a few billion dollars, which was about 100% of their GDP. Just 3.5 years later assets had grown to 140 billion, which was too high to even calculate a sensible percentage of GDP. The increase occurred because banks typically lent money for stocks and real estate purchases, as a result prices of these investments increased dramatically from 2003-2007. During this period the stock market increased 9 times in value and the real estate market 3 times.

To show how dramatic the growth was, Lewis mentions that in 2006 the average Icelandic family was 3 times as wealthy as they had been in 2003. As a result of the seemingly fool-proof system, many men left jobs in the fishing industry (Iceland’s primary export) and flocked to the financial industry. People trusted the Icelandic people, as they culturally had a reputation for being very rational, and it’s likely that many assumed Iceland was too small to really make a difference in the grand scheme of global financial markets. So this boom went relatively undetected.

But as exemplified by the sudden and dramatic boom between 2003-2007, the exodus from fishing to finance appeared to be a smart and beneficial decision. However there were several faults which proved to be the downfall of Iceland and solidified their contribution to the global financial crisis.

The first major fault was Icelanders knew very little about the banking system. As Lewis frequently points out, they were historically a country centered around fishing exports, so they were playing in a business they knew relatively nothing about. The second major fault is the size: Iceland is a country of about 300,000 people, and it boomed way too fast. This matters because people were borrowing large sums of money from foreign banks, investing it, and reselling the investments to family and friends within their small “community”, resulting in the huge stock and real estate booms.

They did this because at the time, local interest rates were at 15.5% and the cost of the krona was rising in tandem with the increase in assets, so when Icelanders wanted to buy something they would borrow in a different currency such as yen or francs and pay a mere 3% interest, it benefited them (1) because they made tons of money on the currency exchange and (2) the increased spending added to the value of the krona.

The third major fault: Iceland operated on the assumption that they should buy as many assets as possible with cheap foreign money because asset values could only appreciate. The small population comes back into focus again because Icelanders traded within their small community, swapping assets back and forth with each other, which created perceived, yet fake, capital because they were sold at inflated values. In 2007, they owned 50 times the amount in foreign assets they did in 2002.

If the downfall were pegged to a specific event/time it would be in September 2008 with the collapse of the Lehman Brothers. People had entrusted money to the historically rational Icelanders, and they in turn invested it, but when panic set in they wanted their capital back, a classic bank run occurred. Lewis interviewed an Icelandic fisherman-turned-banker who said shortly after the collapse people could be seen around Reykjavík carrying large bags filled with any type of foreign currency they could pull out from the banks, and they would then hide them in their homes because the market for krona had disappeared.

The aftermath of this panic was devastating for Iceland, the previous loans denominated in yens or francs still had to be repaid, however the value of the krona was now less than 1/3 of its peak value. To make matters worse, Iceland imports practically everything apart from fish and heat, so the decrease in value made imports ever more pricey. By the end of the crisis, the stock market had collapsed 85% and the debt amassed to 850% of GDP. To frame the severity– as Iceland’s population is minuscule compared to the debt amassed, the 300,000 citizens of Iceland found themselves responsible for $100 billion worth of banking losses, which equates to $330,000 per man, woman and child.

Eurozone Countries GDP Growth Rates

Monday, January 26th, 2015

Eurozone GDP Growth

Video: “The European Debt Crisis Visualized”

Monday, January 26th, 2015

“The European Debt Crisis Visualized” by Bloomberg.

For people who are visual learners, this video nicely summarizes the European Debt Crisis.  They note the cultural differences among countries as one source of the problem.  In the end, they assert that perhaps the only way to fix the problem would be to create a fiscal union to act in unison with the Eurozone’s monetary union.

Click here to view the embedded video.

Quantitative Easing Infographic

Sunday, January 25th, 2015


Quantitative easing (QE) is the European Central Banks (ECB) new tool towards fighting stagnant growth. The ECB hopes that lower interest rates will spur consumer and business spending. Inflation caused by QE may not seem like a problem at all to the ECB, as they struggle to fight off a relatively low inflation rate (target rate is 2%, current rate is 0.3%). A boost in spending may possibly stop potential deflationary prices while increasing economic growth, reviving the eurozone from its economic slump.

Exit polls announced Syriza Wins Greek Election

Sunday, January 25th, 2015

On 25 January the Greeks held elections that will undoubtably have an impact on the EU and the fate of the Euro. The exit polls have announced that Syriza (the Greek acronym), also known as The Coalition of the Radical Left, won between 36-38% of the total vote, and the current ruling party, the New Democracy party, only garnering between 26-28%. If the exit polls are correct Syriza could hold between 148 and 154 parliamentary seats, they need 151 to hold a clear majority.

So the real question is what does the newly elected Syriza party mean for the Euro? If Syriza does indeed have the majority, this will give party leader Alexis Tsipras a mandate to address Greece’s program of austerity imposed in return for pledges of 240 billion euros in aid since May 2010. Tsipras is faced with the challenge of balancing his election promise of a write down of Greek debt, while also avoiding an exit from the Euro. With Syriza in power, the Greeks most certainly voiced their opinion against austerity polices.

Syriza says that Greece’s 322 billion euro public debt is not sustainable and that the target set by creditors such as the European Commission, the IMF, and the ECB is unattainable. Their plan for Greece is to implement a “nonnegotiable” social spending program which is said to cost about 11.5 billion euros which will be financed from funds from inside the country. According to the Syriza’s head of economic policy the program will not require additional borrowing. This program includes “subsidized electricity and food stamps for 300,000 Greek households living below the poverty line, free health care for unemployed Greeks, subsidized transport and a Christmas bonus on pensions below 700 euros a month.” They say they will achieve this after a debt write down which implies that Greece will not need to sustain such a high primary budget surplus. 

The outcome is less than desirable for their German counterparts who warned against abandoning the specified bail-out program. The Syriza party is calling for extensive debt restructuring, which will undoubtably come at the expense of the Germans. The confusion and uncertainty is likely to blame for the recent fall in the value of the Euro. Many are skeptical that QE is the answer to Europe’s problems and with the emergence of Syriza and a possible debt restricting, the Euro is reflecting these risky times. The following quote is from a Financial Times article, “The Eurozone: A Stained Bond”  by a senior MP for Angela Merkel’s CDU: At this time [Ms. Merkel] is more skeptical. My impression is that she has some doubts about whether QE will work.”

Syriza says they are fully committed to keeping Greece in the Euro. However, the also fully reject the austerity measures they say are imposed by Germany and is in continual support of the ECB buying sovereign bonds. A Bloomberg article explains that Syriza “wants a euro-region accord on public debt, similar to the London Debt Agreement of 1953, in which it was agreed to write off 50 percent of some of Germany’s external borrowing”. Party leader Tsipras said in a speech in December 2014, “while generosity was extended to Germany, Germany refuses to extend the same generosity.”

This issue is likely to grow into a much larger problem as European Union officials say that Greece is not allowed to stay in the euro if it fails to meet its bailout commitments.