Sunday, January 5, 2014

How Are the PIIGS Doing?

The PIIGS are Portugal, Ireland, Italy, Greece, and Spain. Along with Cyprus, they have been the focus of concern for the economic future of Europe for the last 4 years in this class.

And, at least on paper, the PIIGS are doing OK right now.


Sovereign debt is debt issued by the government. The interest rate on sovereign debt is a key indicator because it shows (roughly) the burden on taxpayers for bad government policies in the past.

A further problem, is that most poorly governed countries exhaust the willingness of their own citizens to lend them money: the citizens come to know that their own government is a bad risk before anyone else does. In turn, this means that many countries end up paying high rates on sovereign debt to investors from other countries. This has been the problem in the European Union: German citizens left holding the bag by the Greek government (and other similar stories).

So, this chart looks pretty good.

But … how did this happen? Unfortunately, a lot of it was from LTRO money from the ECB.

The ECB is the European Central Bank (their Fed).

An LTRO is a long-term-refinance-operation: basically, a long-term, lower interest rate loan.

In Europe over the last few years, this has meant the citizens of the countries that are doing well contributing extra funds to the European Central Bank, which in turn lends it to struggling private banks in countries with weaker economies. And what do they do with it? Well, it’s a cheap source of funds, so they buy riskier assets with it … mostly sovereign debt from their own countries.

Think about that: it’s weird.

The financial crisis in Europe was largely about governments being unable to make payments on debts owed to citizens in other countries (and the countries on the losing end being unwilling to defend their own citizens by enforcing those debt contracts the old fashioned way, with guns).

So, their plan to address the problem of, say, German citizens lending to the government of Greece, is … to have German citizens loan to their own government, which loans the money to the ECB, which makes LTROs with it to private banks in Greece, who then loan the money to the government of Greece. In other words, just inserting additional layers of financing to cover their tracks. In short, it’s money laundering done to maintain the plausible deniability of government officials in Germany who’d like to get reelected. On the plus side, the plans were only approved when some enforcement mechanisms (whose strength must be OK for now) on governments like the one in Greece.

What should we make of all of this? It’s a gamble that the problems of the last few years were special, and unlikely to be repeated. If they’re not repeated, this sort of scheme will work. If they are, everyone will just end up looking stupid.


This is sort of like a family with one sibling with a drug problem, one not, and everyone co-dependent. The kid on drugs is, the government of Greece. The clean sibling is the citizens or banks of Greece. And the parents are Germany.

The kid on drugs gets into trouble, and first tries to borrow money from the sibling.

When the sibling stops lending, the kid on drugs goes to the parents.

When the parent stops lending, the kid on drugs is in real trouble with their dealers.

But the parents want to hold the moral high ground, but also the contradictory position of helping their kid in trouble.

So the loan money to the clean kid, and don’t ask where it goes. And perhaps have a talk with the clean kid about how they need to support their sibling. You can imagine where the money ends up.

Here’s the thing to recognize. We all think this behavior is stupid and counterproductive. But most of us will end up doing the same thing in the same position. It’s a flawed, but very human, response.

And so is the response of the countries in the European Union that are doing well to the problems of government mismanagement in the PIIGS. Get it?

The thing is, in the family analogy, is that it doesn’t address the underlying drug problem, which, after all, is much tougher to fix.

And the thing is, in the European reality, is that it doesn’t address the underlying problem of bad government, which, after all, is much tougher to fix.

FWIW: Some of my earliest memories of network news (which was the only news to watch in the early 1970’s) was about how screwed up the government of Greece was: communist revolutionaries (who in retrospect look like terrorists or morons), military thugs, coups, and picking fights with bigger neighbors (Turkey).

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