Dan Alpert is a founding Managing Partner of Westwood Capital. He has more than 30 years of international merchant banking and investment banking experience, including a wide variety of work-out and bankruptcy related restructuring experience. In addition to his structured finance expertise, Dan has extensive experience advising on mergers, acquisitions and private equity financings, he has expertise in evaluating and maximizing the recoveries from failed financing vehicles affiliated with a common borrower/issuer.
While we may be hours away from a partial (and certainly a stopgap) agreement in the talks among the Greek government, the troika and private sector creditors, it is doubtful that a deal will emerge in a fully constructed fashion that will survive its application in the real economy.
It is likely that the only common view amongst participants in the various talks is a desire to try to avoid a disorderly default. Beyond that there is a severe disconnect fostered by parallel realities that seem unable to intersect. Accordingly, a deal that can hold up both in the streets of Greece and in the markets is both illusive and unlikely. Here’s why I think so.
Recently I have had opportunities to meet with and question senior members of the economics establishment within the German government and the broader German intelligentsia. Our meetings were held under Chatham House rules so I can’t name names, but – after several meetings with policy delegations from Germany over the past 60 days – I am prepared to sum up what appears to be the pretty-universally-held German policy position as follows (my apologies if the below evidences some degree of frustration – but these encounters leave me quite chagrined):
- Yes, since 2004 we have been in surplus and have benefited tremendously from debt fueled over-consumption in the periphery.
- Yes, we provided the loans (together with our core partners) to irresponsible borrowers who lacked the fiscal fortitude to protect our money. Shame on us, but we still want our money back (Greece is the only exception we believe we will have to make – and even then, only the private sector will suffer losses).
- Yes, we were a little irresponsible in the early days of monetary union, when the periphery was enjoying the benefits of competitive wages and the global situation was not as unbalanced. But we quickly recognized the error of our ways, remembered that we are Germans and took steps to cut our deficit.
- What you don’t understand is that after we entered surplus and could have shrunk our debt-to-GDP ratio using growth alone, we flogged ourselves with policy aimed at limiting consumption, increasing savings and avoiding a renewed encounter with the dreaded One Hundred Trillion (gr. Billionen) Reichsmark Note inflation we fear every day of our lives (Note: I sometimes jot down how long it takes in conversations with German policy folks before Weimar inflation enters the conversation, along with the aforementioned note). We didn’t have to do this but we did it because we are…well, you know. And during the Great Recession we didn’t just lay off all our workers like you did – we are civilized, we shared jobs (kurzarbeit).
- And by the way, before you tell us how to handle our periphery, you must remember that you in the U.S. were incredibly irresponsible too and destroyed the entire world economy and now you are obsessed with deflation and are printing money like mad which will, of course, inevitably result in [the dreaded One Hundred Trillion Reichsmark Note inflation we fear every day of our lives].
- Yes, yes, we studied Brüning and the deflation of the early 30′s that you say really brought about the National Socialism that nearly destroyed us and resulted in global horror, but we nevertheless attribute the trouble to the Weimar inflation.
- Don’t blame us for being incredibly productive and economically abstemious, we can’t help it if we make the best cars and everyone wants to buy them. And it is not our fault that the countries of the periphery are unproductive anachronisms that make nothing anyone wants to buy at the prices they want to sell their goods for. OK, we should have noticed the latter before we lent them all the money (and probably should have looked more closely at their books) – but it was the euphoria of European unification that made us do it, we’re only human.
- No full fiscal union, no Eurobonds….don’t even think about it.
- It’s one thing for Bavarians to share their wealth and income with northern and eastern Germany, but you must be kidding if you think we can get our electorate to support sending their money to support slothful southerners.
- We will never permit the ECB to monetize the sovereign debts of its member countries the way you have done in the U.S., the U.K. and Japan. Not only isn’t that the deal we made with each other but it will tank the Euro and result in [the dreaded One Hundred Trillion Reichsmark Note inflation we fear every day of our lives].
- There will be no exiting of any country from the Euro System. The System was only designed as part of a continuum leading to the full unification of greater Germ…uh…Europe.
- But we are not yet in a position to support transfer of national authorities, we Germans are not prepared to surrender national sovereignty (but we really did think that the suggestion for installing an Oberführer to supervise Greece was a nifty idea and aren’t sure why it got people so upset). [Fine, no one really used the word Oberführer]
- Finally, we believe in the written word – in law and in treaty. We can make more promises to each other and – unlike the last two times – we can this time honor them. Why do you doubt that?
All of this ends with a full-throated advocacy of the concept that has become known as “expansionary austerity” which forms the bedrock of German and other core nations’ policies towards the massively over-indebted periphery: Countries that have been irresponsible borrowers need only to demonstrate their fiscal discipline and prudence, reduce their indebtedness and reform their inefficiencies and over-regulation and investment and growth will resume because markets will once again have confidence in the economies of those countries. Yes, there it is…the return of the same confidence fairy that supply-siders hold out as the magic pixie dust that allows economies to fly once more without regard to the adequacy of demand or the competitiveness of a given nation relative to others.
In other words Tinkerbell Economics.
“[Tinkerbell] was saying that she thought she could get well again if children believed in fairies….’Do you believe?’ Peter cried.” — The Adventures of Peter Pan, J.M. Barrie
There are many quite practical reasons why “Austerianism” will not work, and countless others have written on the subject at length. For the purposes of this essay I will briefly list three:
- The continuing presence of several of the GIPSI’s within the Euro System effectively blocks two of the three transmission mechanisms that would otherwise enable those countries to re-balance trade. They can neither devalue their currencies nor, given their membership in the EU, can they restrict trade and take action (which would be highly unlikely anyway) to internalize production.
- The world in general is fighting over insufficient demand relative to a global glut in the supply of labor, productive capacity and capital. Within the Eurozone, the countries of the core have been the principal beneficiaries of whatever internal and external demand exists. Yes, this results from their superior productivity and manufacturing talents, but – relative to global demand – is substantially enhanced by the weakness of the Euro relative to the value of former or reconstituted core currencies. Even if the German view were to suddenly change relative to ECB monetization, the devaluation would be universal (throughout the zone) and would not re-balance trade amongst the 17 member countries.
- The core-recommended re-balancing transmission mechanism – internal devaluation (falling wages and prices – to the level of depression if the pixie dust doesn’t work its magic) – is functionally impossible. It is the economic equivalent of ancient bloodletting. Not only does it it result in killing off even more internal demand, but it necessitates a level of austerity that cannot possibly be tolerated by citizens of countries that still enjoy sovereign borders and popularly elected governments, merely to repay foreign creditors. They will simply refuse, at the ballot box or through other means. To believe otherwise is very much akin to believing in fairies.
A colleague of mine, present at one of the above mentioned meetings, likened the German response, to Eurozone realities, to Act II of Richard Wagner’s ring series opera, Seigfried. As Fafner the dragon is awoken from his slumber and warned by the conniving Alberich that the hero Siegfried is on his way to kill Fafner, the fearless dragon dismisses Alberich’s warning and returns to sleep.
The world cannot afford the luxury of sleeping on this. What is at stake here is more than the issue of recovering monies lent to Greece. A very substantial amount of European capital is at stake and plans to recover it by placing the populations of the GIPSI’s under indentured servitude to their creditors are the stuff of fairies and pixie dust.
It is past time to tighten the belt at both ends, recognize the money that has been lost throughout the periphery, recapitalize core institutions and bite the bullet on the secession of the defaulting nations. Sorry Tinkerbell!