Tuesday, November 20, 2012

Self-deception in Berlin impedes resolving Greek problem

Der Spiegel carried an interesting article on how the German government's unwillingness to face up to the losses on Greek debt is causing it to throw good money after bad even when other EU countries and the IMF are saying debt reduction is the way to go.

Regular readers know that Germany's leadership has chosen to implement the Japanese Model for handling a bank solvency led financial crisis.  Under the Japanese Model, policies are adopted to protect bank book capital levels and banker bonuses at all costs.

Bailouts of first banks and then sovereigns are an example of these policies.

Please note that under the Japanese Model debt does not go away.  Rather, the burden of debt service on the excess debt in the financial system is transferred to the real economy.  This deprives the real economy of the capital it needs for reinvestment and growth as capital is instead diverted to paying on the debt.

The alternative to the Japanese Model is the Swedish Model.  Under the Swedish Model, the banks recognize upfront their losses on the excess public and private debt in the financial system.  This protects the real economy and the social contract.

A modern financial system is designed to support the Swedish Model.  Banks with low or negative book capital levels can continue in operations and support the real economy because of the combination of deposit insurance and access to central bank funding.

Deposit insurance effectively makes the taxpayers the banks' silent equity partner when they have low or negative book capital levels.  As a result, there is no need for policies like bailouts to "protect" the financial system as the financial system is designed to be robust in the face of losses.
With elections approaching in 2013, Berlin is blocking a workable solution for Greece. German leaders are eager to avoid angering voters by giving more money to Athens, but their European partners are losing their patience. 
Wolfgang Schäuble is as master of portraying political chaos as a strategy. "We need a solution that lasts for a while with Greece," the German finance minister announced last Thursday. But the truth is that he is determined to continue pursuing Germany's approach of muddling along through the euro crisis, much to the annoyance of Germany's partners. 
In Brussels and at the International Monetary Fund (IMF), there is a growing realization that it's time for honesty, especially because the German government also wants Greece to remain in the monetary union. "Things cannot go on this way," says a European Union diplomat. The IMF is openly demanding a "real solution," and yet that is precisely the opposite of what is happening at the moment.
The Greek rescue is a tale of self-deception.
The Japanese Model is built on self-deception.
In May 2010, officials said that a bailout package worth €110 billion ($140 billion) was sufficient. It is now clear that even the second bailout package, worth a total of €130 billion, is too small -- and this is based on calculations that are only about six months old. 
But now there is another shortfall, this time of €33 billion. It's a disaster for Schäuble and Chancellor Angela Merkel. In the run-up to German parliamentary elections next year, both politicians are determined not to confront taxpayers with a real, and therefore expensive, summary of costs.....
A similar type of self-deception is also going on in the US where politicians are trying to argue that the taxpayer broke even on the bailouts.  In the US, the analysis always conveniently ignores that direct cash injection was only one form of bailout (artificially low interest rates being an example of an indirect bailout).
In the midst of all this, it is clear that Greece cannot support its debt burden, most recently more than €300 billion, in the long term. 
Greece is not alone.  There is also Ireland, Portugal, Spain, France, the UK and the US.

The existence of this debt burden which cannot be supported in the long run is is why I continue to say that every day policy makers have the choice of abandoning the failed Japanese Model and adopting the Swedish Model.
But the chance of eventually recouping the money it lends is the IMF's condition for continuing to take part in the bailout program. IMF Managing Director Christine Lagarde has made it clear that she has had enough of deceptive maneuvers in Europe. 
For Merkel and Schäuble, an IMF withdrawal would be tantamount to an admission of failure, and not just because it was the German government that once insisted that the respected organization participate in Europe's programs. It would also signify the loss of close to €20 billion in promised aid for Greece. The euro countries would have to jump in, with Germany alone having to contribute about €6 billion. Even a political grand master like Schäuble probably couldn't spin that as a strategy anymore.

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