Why Is Europe Destroying The Chances Of A Greek Recovery?

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Includes: FXE, GREK, IEV
by: Walter Hin

Summary

Germany is benefiting from the Greek crisis as it sees capital inflows of €584.4bn go into its economy.

Greece is hurting because of the lack of initiatives to make it competitive, whereas most of the focus is on austerity.

The ‘euro project’ is beneficial to countries that don’t need to rely on currency devaluation to be competitive (i.e. Germany).

Greece has pushed through eight austerity measures in five years, and the third bailout means more to come.

Another Greek drama is done and nearly dusted, as Greek PM Alexis Tsipras (prematurely) thought the Greeks had a say in the bailout talks by holding a referendum on the bailout package.

The outcome was a 'no' vote. However, the Greeks didn't get a better deal from Europe.

So why didn't Europe (the Germans) blink when push came to shove?

First, Germany has seen it all before with the previous two bailouts, when (the then) Greek PM George Papandreou in 2011 held a similar referendum.

As Alexis Tsipras decided to give the Greeks a say on the negotiations, it acts as a snub to the European proposal for the third bailout between the Greek government and the creditors.

The creditors had other ideas to test the resolve of the Greek people by imposing lending restrictions to the Greek banks of €60/day.

This has the desired effect of saying to the Greek people, 'If you don't agree with the bailout and comply with austerity, then things will become worse for you.'

The trick worked, and Mr. Tsipras gave in to all these concessions and more.

The dubbed 'third bailout' is likely to involve a €86bn package over a three-year period. And in return the ECB and IMF expect Greece to privatize €50bn worth of assets (a privatization program running for three to five years) to repay loans and reduce debt levels. €12bn is used to repay existing ECB debt by mid-August and €35bn (some of the funds has already been lent) from EU funds to commit to economic growth and create jobs.

The deal may seem fair on paper, but Greece has a hard time implementing these proposals because of strong opposition from its people.

What have the Greeks been asked to do, in return for the bailout money?

Answer: A lot of austerity measures and public sector reforms.

It been five years since the first bailout begun, and we seem to have lost track of the austerity measures imposed. But we know what the first bailout package happened in May 2010, the Greek government, along with the ECB and IMF to the emergency aid of €110bn ($147bn) loan.

At the time, the commissioner of the Eurogroup, Olli Rehn, said, "The steps being taken, while difficult, are necessary to restore confidence in the Greek economy and to secure a better future for the Greek people."

The EU Commission President Jose Manuel Barroso said the program "constitutes a solid and credible package."

And the Greek PM George Papandreou said, "I know that our compatriots are being asked to make big sacrifices, but the alternative way would be disastrous and painful for us."

However, the first bailout didn't last for two years before the Greece was asking for another bailout. On Feb. 2012, the Greeks agreed upon a €130bn, bringing the total bailout package to €240bn.

But do we know about the austerity measures needed in return for the money?

And, what effects did it have on the economy?

The honeymoon is over, time for realization to set in. There have been seven austerity measures between the two bailout packages in total and these relate to public sector reforms, tax reforms and, pension reforms.

Public sector reforms since 2010

Since 2010, the Greek government has to find some ways to reduce government spending this is what they came up with:

1. A pay freeze to all government employees and job cuts to temporary workers.

2. All holiday wage bonuses cancelled (equivalent to an extra month of wage).

3. A cut in public wages started with a 10% reduction, then a 7% reduction. In the second bailout package, wages were further reduced by 20%, with some workers losing as much as 30%.

4. In 2010, all state-owned companies will see their salaries cut, and those earning over €1,800 per month face an extra 10% cut.

5. On the level of pay, the government has reduced the minimum wage by 22%.

6. On the issue of state-owned companies, these will be cut from 6,000 to 2,000. And the number of municipalities is reduced from 1,000 to 400.

The number of job losses is unclear.

7. But what is clear is the loss of 150,000 jobs in the state sector by 2015, of which 15,000 employees will lose their jobs by 2012.

Tax reforms since 2010

Next, we have reforms in taxes.

1. VAT has risen from 19% to 23%.

2. Tax rises on fuel to 15%, and imported luxury car tax will rise by 20-40%.

3. A 10% rise in luxury taxes and sin taxes on alcohol, cigarettes, and fuel.

4. Unspecified tax rises include: company profits, those with a yearly income of over €8,000 and an extra tax on an annual income over €12,000. Also, high taxes on rising property values.

5. On the bright side, a 2% tax increase to combat unemployment.

6. There will be a 50% reduction in tax exemptions on property transactions, inheritances and parental donations.

7. Parents with children won't receive any tax-free bonus.

8. The government is restricting help on health care.

9. All social benefits (previously exempted) taxed as salary revenues.

10. A flat rate of 28% income tax for self-employed and enterprises.

Pension reforms since 2010

Pension reforms saw some dramatic changes. Here are some austerity measures on pensions:

1. Limit of €800 per month to 13th and 14th-month pension installments; abolished for pensioners receiving over €2,500 a month.

2. Return of a special tax on high pensions.

3. Both men and women have to retire at the same age. Women's retirement age increased from 60 to 65.

4. The average retirement age for public sector workers will increase from 61 to 65.

5. Pension cuts worth €300 million in 2012.

6. The latest measures include pension cuts on average between 5% and 15% and an increase of the retirement age from 65 to 67.

What was asked of the Greek government in return for a bailout?

If we add up these austerity measures, the Greek government will save a total of €53.9bn.

However, the Greek government is also expected to raise revenue through tax increases and that has totaled up to €13.5bn.

Despite these measures, they require a third bailout.

So, why hasn't austerity helped the Greek economy?

The failure of the Europeans to solve the Greek crisis

First, Greece isn't the only economy to be bailed out. There have been Ireland, Portugal, Spain and Cyprus.

To know why Greece needed a third we look at the obvious economic indicators, comparing it today from 2009:

Greece

2009

Today

Change (%)

GDP ($ BN)

354

237.6

-33

GDP per capita ($)

24,149

18,377

-24

L-T Unemployment rate (%)

3.9

19.4

+397

Employed person (M)

4.5

3.5

-22.2

Exports (€ BN)

17.5

26.9

+54

Capital flow (€ BN)

23.1

0.246

-99

Government spending (€ BN)

12.78

9.6

-25

Government debt (€ BN)

292

312

+7

Government debt to GDP (%)

112.9

177.1

+57

Money Supply (M2) (€ BN)

254

168

-33.9

Consumer credit (€ BN)

36

26

-28

Total bank deposits (€ BN)

240

120

-50

Looking at some of these leading and important indicators of the Greek's economy, we can assess the reasons why Greece needed help:

Unemployment is too high; - The long-term unemployed gone from 3.9% in 2009 to 19.4% today. At the same period, the number of people employed in Greece dropped by 1m people to 3.5m.

With fewer people at work and unable to find productive jobs, how will they contribute to the economy other than receiving unemployment benefits?

The economy is shrinking; - Greece has lost a third of its economy and those at work are earning 25% less than they did back in 2009 (in dollar terms).

So with lower earnings and higher unemployment, how is the Greek government going to collect enough taxes to pay back existing debt?

Government debt is growing; - Austerity obsessed countries like Germany thinks it will shrink the Greek debt, but didn't consider that it will shrink the Greek economy even more. The government owes more debt in GDP terms and absolute terms before it asked for emergency funding from the IMF and Europe.

When will the German admit their plan has FAIL or is this the plan all along?

Greece is experiencing capital flight; - Private bank deposits in Greece have halved, money supply is shrinking, and consumer credit is declining.

So, not only is Greece struggling to pay the debt, the country is experiencing capital flight on an enormous proportion that make it impossible to pay its debt off.

The only way it could pay its debt is if a big economy is willing to pay on its behalf, or the creditors implement debt forgiveness. Neither was going to happen.

So, despite receiving a total of €240bn in bailout money, we should question if the terms of the bailout conditions were fair to Greece?

The bailout that never was

All eyes were on the gigantic sizes of the bailout package for Greece with the mainstream media focusing on the hundreds of billions of Euro of bailout money that Greece is receiving at an interest of 5% or less.

If we study Greece's repayment of debt to the IMF and EU, it is the following:

Year

Repayment € BN

% of GDP

2012

11.7

6

2013

8.9

4.9

2014

17

8.9

2015

20-30

10.7-16

2016*

14

7.7 on 2014's GDP

2017*

8

4.4 on 2014's GDP

2018*

3.5

1.9 on 2014's GDP

*Forecast

The forecast for 2016 onwards is based on the two bailouts. With the third bailout being agreed upon on worse terms, then the repayments is going to be higher.

So with all these repayments that Greece had made, why is the debt getting bigger every year?

In a nutshell, these repayments are not always made by Greece, but the creditors paying themselves and adding it on the 'tab' for Greece to pay.

Secondly, the economy is shrinking in scope and sizes. So with a shrinking economy, the only way Greece is going to meet its repayment schedule is with more debt!

We need to understand the 'Qualitative Effect' on Greece's economy

As mentioned people tend to focus on the 'numbers', but the way the negotiations have gone about in the Greek bailout has dented the confidence of its economy.

The length of time it takes to negotiate each bailout has spook investors and has cost Greece financially.

Take private sector total banking deposits, for instance, that number has halved since 2010 from €240bn to €120bn.

Looking at the Greece's ten-year bonds chart from 2009 we can see the fluctuation of Greek's borrowing costs:

The first time they negotiated a bailout in 2010 the 10-year went towards 10% though investors' confidence is skeptical about Greece's bailout package and its ability to pay back debt.

As borrowing costs surpass 40%, the second bailout package, included a debt haircut equivalent of €100bn coming from private bondholders in 2012. But what is owed by French and Germans banks still needed to be paid in full, although borrowing costs came down to 6%.

When it requires a third bailout, borrowing shot pass 10%, but this time the debt pile is much bigger (despite the debt haircut) given Greece has lost a third of its GDP.

The Result

Private investors no longer have any confidence in Greece being able to stay in the euro. There was a plan to sell a total of €50bn worth state-owned assets to foreign investors back in 2010.

That raised very little cash or €2.5bn in two and a half years!

To summarize the Greek dilemma:

1. Capital flight is happening at a rapid rate;

2. Austerity is counterintuitive if government savings translate to lower tax revenue;

3. Its bailout package getting larger, whereas its economy got smaller;

4. Talk of a likelihood of 'Grexit' has caused capital flight and the failure to find buyers for its state-owned assets.

5. There is no long-term plan to get unemployed Greeks into productive jobs;

6. Assets prices are falling rapidly. Property prices in Athens (home to 25% of the country's population) have fallen by 35%. Therefore, it requires more of Greek's sovereignty to be sold off to raise €50bn.

A bailout that will work for Greece

There are several things the creditors should have done better to make the bailout a success. One way is to stop adding debt on the Greek's balance sheet.

This is because investors assess an economic opportunity for a country like they do with a publicly-listed company.

Imagine Greece is a company, and the people are the shareholders. We know the IMF and the EU are the creditors.

The creditors are calling the shots; they have first claim on Greek assets. The Greece's CEO (or Alexis Tsipras PM) met up with the creditors, and a proposal was drawn up, the CEO looks un-decisive.

On the one hand, if he agrees then further job losses are likely to happen, but there won't be a plan to revive Greece.

On the other hand, it will mean leaving the Euro causing Greece's assets to plummet in value and the shareholders cashing out their 'chips' to preserve its wealth.

No prudent and smart investors would buy into Greek assets knowing the value of the asset is going to drop further in value if it leaves the Euro.

The solution is to make some of the bailout money as a form of foreign direct investment. So, Europe investing in Greece (given how fast labor costs have fallen), it will recover.

Secondly, give a 'grace period' for repayments of loans, until the country is producing surpluses and can make milestones repayment.

Third, Greece should rebalance from the public sector to private sector, and the politicians need to create a mandate to collect taxes efficiently.

Finally, the Greek people need inspiration and leadership from the Greek leaders to get them out of the slump. A leader that inspires would fuel the animal spirits of its people to compete with the rest of Europe.

The Greek bailout really means a German 'bail in', and why they don't care if Greece left the euro.

While Greece was struggling to dig itself out of a slump, the Germans perceived by the media as ultra-prudent, and financially disciplined has been reaping the rewards of Greece's demise.

Take trade, for example. Before Greece was asking for emergency funding, Germany was running a current account surplus consistently. Of the 15 years being in the euro, Germany has run three years of deficits and twelve years of surpluses; before the euro, it was deficit one year and surplus the next.

In terms of GDP, Germany's current account surplus is accounting for 7%+ of the nation's economy.

But something changed in Germany since 2014, and the Germans were getting capital inflows despite running a trade surplus.

Usually in trade, you run a current account surplus while running a capital account deficit because the banks of the trade surplus nation are lending to the trade deficit nations to consume their goods and services.

But in 2014, Germany is running both a current account surplus and capital account surplus simultaneously (see table below):

Year

Current accounts (€ BN)

Capital flows (€ BN)

2009

141.1

-156.4

2010

145.1

-125.5

2011

164.6

-174.1

2012

233.2

-222.7

2013

182

-248.8

2014

219.7

223

2015 (first five months)

92.2

111

total

1,177.9

-593.5

Source: Trading Economics

Normally, you would get current account surpluses being counterbalanced with capital account deficits.

But, Germany has seen an equivalent of €584.4bn go into its economy and twice as much as the Greek bailout packages.

So, Greece owes to German banks €57.23bn. That does not matter to the Germans and is why they're pushing for a tough bailout condition on Greece.

In fact keeping Greece in would make the euro competitive through devaluation against the USD and Chinese yuan, both are big importers of European goods.

So, what happens next?

The third bailout would push the bailout package to over €300bn. The Greek economy is likely to contract in 2015, given that the banks were limited to lending out €60/day.

After further austerity reforms, the Greek people will eventually realize that being in the euro is more a curse than a benefit and would demand a 'Grexit.'

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.