The Greek Experiment

Who wud have thunk it of Greece?

The country with Europe's most reactionary political tradition (around 15% of voters still go for outright communist and sundry left-wing parties, plus another 10% vote for right-wing/populist ones) is presently implementing a Chicago School economic blueprint in everything but name.  The nominally "socialist" government is lowering wages, freezing pensions, increasing retirement ages, imposing higher consumption taxes, downsizing the bloated public sector, etc.

All  of this in a  rather chimeric quest to mollify lenders and obstinate rating agencies by transferring peoples' wealth, previously borrowed from mostly foreign lenders, back to those same lenders.  It's yet another bailout plan characterized by money flowing from the "poor" masses to the "rich" financiers, albeit with a well-justified and heavy dose of salt being rubbed onto old, self-inflicted wounds.  Still, I can hear Milton Friedman chuckling in the heavens.

The Greek government is betting that it will be able to reform the country's astonishingly inefficient  and unproductive economy.  For example, labor productivity per hour worked is the lowest in EU-15, at only 70% of average.  Greece needs to resume growth (4Q2009 GDP was -2.5%), before the rising tide of debt sinks it to the bottom.  It's a fair wager and I would have given them a better than even  chance of success - if it weren't for the aforementioned reactionary nature of Greek society.  As it stands right now, I'd say 40-60 are better odds.

While most Greeks understand that tough measures are necessary to avert national banruptcy, they are also really pissed-off at the long-standing tradition of widespread tax evasion, corruption and back-door dealings between politicians, businessmen and high-income professionals.  As the Minister of Finance himself recently said there are only 5,000 Greeks who declare annual income over 100,000 euro.  Absurd, of course, given bloated asset prices in Greece (see further down).  

Greek society is currently precariously balanced between grudging acceptance and outright rejection of the government's course of action.  If people do not see quick results on the economic front their patience will be sorely tested and the balance may well tip into another Greek tradition: revolution and violence.

So, let's look at the economy.

Despite recent moves to diversify into the wider Balkan economy through banking, retailing and telecoms, the Greek economy still stands on the same three-legged stool it has used  for many decades: tourism, shipping and agriculture.  It is, thus, very far from being a "modern" global economy.  As I frequently quip, "It is time for Greece to, finally, enter the 20th Century.."

Let's look at each "leg":

• Tourism - the largest sector - is geared towards low-income group travellers from Britain and Germany who seek sea, sun and cheap booze.  Yes, there are boutique hotels and classier customers than  400 euro/week all-inclusive types, but they are a small percentage of the lot.  Given the recession and price sensitivity of lower-income travellers, Greece faces stiff competition from destinations  offering the same product at cheper prices (e.g. Turkey and North Africa).

• Shipping is not exactly a domestic business, but it generates thousands of well-paid jobs and demand for high-value financial, legal and technical services.  Besides, the country had  until recently benefited from the investment of surplus capital from rich Greek shipowners wallowing in the biggest-ever bull market in shipping rates and vessel prices.  They were buying everything that moved, from housing and hotel properties to retail chains and private hospitals - but no more. Shipping has recovered somewhat from the abysmal lows reached at the end of 2008, but it is still very far from "healthy" (see chart below).

                                                                     Time Charter Rates                                Chart: Dryships, Inc.

• Agriculture accounts for a huge 12.5% of Greek employment  vs. an average of just 3.5% in EU-25 (Eurostat 2006 data).  This is indicative, among other things, of a low value-added economy, particularly in times of global recession and depressed commodity prices.  Furthermore, the EU is about to sharply reduce all agricultural subsidies, a matter of  overarching concern to Greek farmers who are greatly dependent on them.

The Greeks and their government well understand these dismal fundamental facts, though they may not all agree on who is to blame.  They also know that they carry an onerous debt load, which expanded sharply  in the years after Greece adopted the euro.  The total of government, corporate and household debt is set to reach 220% of GDP in 2010 (120% government, 50% corporate, 50% household).   And this does not include short-dated trade debt that circulates in the form of post-dated checks, a uniquely Greek form of shadow finance.  (No one really knows how much that is, but some estimates range upwards of 250 billion euro, or 100%+ of GDP. I find that number too high to be credible, but what we do know officially is that "bounced" checks reached 3 billion euro in 2009, up from 1.3 billion in 2008 and 630 million in 2002).

Households, in particular, got into a fast and furious borrowing spree after entry into the euro.  Completely unfamiliar with debt in the past environment of double digit interest rates and tight banking regulation that made consumer borrowing well nigh impossible,  they went from  nearly debt-free  in 2000 (30 billion euro, 22% of GDP)  to now owing 120 billion euro or 50% of GDP.

The Greek economy fell victim to the South Med strain of the Anglo disease.  Greeks got rid of production and manufacturing (gone to China, where else?) and, instead, borrowed to improve their lifestyle and pump up "assets", mostly real estate.  It may surprise you to know that a simple 100 sq. mt. apartment in a middle-class Athens neighborhood  costs upwards to 350,000 euro, while in a tonier suburb it goes for up to 800,000.   Detached houses? One million euro and up is standard for euphemistically-called "villas" built on postage-stamp plots of 250-300 sq. mts.  Dreaming of a real villa by the sea in Attica?  Be prepared for a shock: eight figures.  

How do these sky-high prices square with low incomes? Simple:  Debt Bubble.  Mortgage credit expansion was running wild until last year, with amounts outstanding rocketing a torrid eightfold within ten years (see chart below).  By comparison, the U.S. mortgage industry was a popgun.

                                                          The Greek Mortgage Bubble                      Data: Bank of Greece

There are inefficiencies everywhere you look in the Greek economy, from the way the government collects  revenue  (dozens of tax  and social security offices, one each for every town), to hundreds of  thousands of small and tiny businesses all offering the same products/services at similarly-high prices.  For example, there are some 8,000 gasoline stations in Greece, one for every 1,400 residents.  In Germany there are less than 15,000 - one for every  5,500 residents.  

Another example: if you need anything done in Greece, you are required to produce a bunch of official certificates, signatures, stamps and permits. (A friend tells me that he needed to suspend his annual membership to a private gym for a few months because he was going out of town.  That way he wouldn't have to pay for the time he missed.  He had to procure an official declaration form, fill it out with everything including his mother's maiden name and to have his signature officially verified.  Don't ask why, the answer is too.. Byzantine.  One can only shudder at what is required to open a business, say something as substantial as a newspaper kiosk...?)

So, endless hours and days are spent going back and forth to various "offices" collecting a trail of bureaucratic debris.   A few years back another government decided to do something about it.  Great! What do you think they did?  Did they pass a law saying that citizens are considered to be telling the truth prima facie, did they stop the paper-trash war?  Oh, no!  Instead, they established a new official service, with hundreds of bureaus across Greece that will do the paper collecting for you.  Naturally, thousands upon thousands of new bureaucrats were born.  Pricelessly Greek..

Before the euro, the country coped with its structural problems the "easy", monetary way: high inflation and constant currency depreciation.  Obviously, such an economy had no business adopting the hard-currency euro without a prior major overhaul to make it more efficient and competitive.  But Greece completely punted this opportunity when it chose, instead, to gild its statistics lilly in the mid-to-late 1990's and to enter the eurozone at a politically convenient timeframe.  There were several reasons why the rest of the euro-group allowed this to happen, most importantly because its banks, pension funds and speculators made a huge pile of money during the years-long euro - drachma convergence period.

It is highly ironic and disingeneous that Germans (and many others) are now pointing their fingers accusingly at "Greek Statistics", claiming to be "shocked".  What utter, undiluted  nonsense.  They knew all along what was going on, but there was lots and lots of profit in looking the other way. At the root of the Greek Crisis olive tree there lays a huge, smelly manure heap of convenient ignorance, if not outright complicity.

Be the past as it may,  what is important to Greeks, other Europeans and, indeed, the rest of the world is the outcome of the Greek Experiment.  Can fiscal neo-conservative rectitude a la Chicago rapidly solve Greece's deeply ingrained problems, so that pain in its real economy is short-lived and social unrest does not boil over?

Let me provide just one troubling fact: Greece is home to at least one million economic immigrants (10% of the population), most of them undocumented and working off the books.  This acts to mask the real unemployment situation;  while the official unemployment rate was 10.2% in December 2009 vs. 8.9% in December 2008, the actual number of people out of work is certainly much higher.  What's more, the makeup of illegal immigrants has radically shifted in recent years.  There are now many more Iraqis, Afghans and Pakistanis who are essentially impossible to repatriate, instead of the neighbouring Albanians, Bulgarians and other Balkans of years past.  Crime is  on the rise, with armed bank and shop robberies a daily occurrence.

Despite all of the above, I still give the whole thing a 40/60 chance of success - higher than most others, including CDS traders who score the five year cumulative probability of Greek default (CPD) at 22% - ninth highest in the world.  The reason for such relative optimism is... fat.  Unlike uber-efficient Germany, Greece can trim away layer upon layer of economic fat and embark on a crash course of reform, finally bringing the country into the core of Western Europe, if not the 21st century just yet.

Let me put it another way: Greece's cup is, indeed, half empty.  But this is exactly what opportunity is made of, the chance to succeed in filling it to the top.

Here's, then, to the ultimate success of the Greek Experiment.  Bottoms up! Literally.

Oh, and P.S. ..

Look at the Greek government bond maturity profile in the chart below.  Explains a lot, in my humble (but particularly informed) opinion.  If ever a picture was worth a couple hundred basis points to greedy lenders, this is it.

                                                Greek Government Bond Maturity Profile       Chart: Greek MOF - PDMA

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A Parable As Epilogue 

Once upon a time there lived in the Kingdom of Hesperia a chubby belle, Olivia was her name.  She was a vivacious lass and enjoyed a good party, as well as a good meal.  Or two. Or three.  All at once.  But she had an infectious smile and a bubbly personality so she was quite popular despite her girth.

Before long she became favourably known to the Palace and the courtiers decided to invite her to the reception to celebrate the Kingdom's founding.  The gala event was to be held in exactly one year, and the copperplate invitations which went out to Hesperia's citizens of note, Olivia included, specified formal dress and ball gowns.

Olivia was overjoyed and immediately went shopping for a dress with her best friend Greta.  As women frequently do when vanity rules and time permits, Olivia chose a fabulous, knock-your-socks-off gown three sizes too small for her present Raphaelesque-plus curves.  This is my coming out party, she chirped to Greta, and damned if I won't slim down and look simply gorgeous, darling.  After all, she had a whole year ahead of her.

But, Olivia loved her food and try as she may she found it nearly impossible to resist her craving for treats.  As happens in parables, time flew oh woe, and found  on the Gala's eve Olivia's curves  two sizes too big for her fabulous gown.

What can I do? poor Olivia cried to Greta who was thin as a rake and would wear a dinner napkin to the ball.  Well, I told you so, sniffed Greta who had done no such thing a year ago, but no matter.  I know this corset-maker who does wonders with cases such as yours.

And before you knew it Olivia was fitted with a steel-reinforced truss, squeezed into the fabgown and arrived at the Gala all smiles, if somewhat paler for the effort.  Oh joy, she beamed and sparkled under the crystal candlelight. She flirted with the beaus who feigned amazement at her instant transformation.  Experienced courtiers had seen it all before, of course.  (Waggish tongues hinted they got  kickbacks from the corset-maker.)  The night is young, thought Olivia, and... and... the tables are simply groaning, laden with delicacies untold!

So, Olivia succumbed once again.  She nibbled at first, then bit and finally gorged on the royal offerings on display.  It would be a shame to let such luxuries go to waste and, after all, she quibbled, am I not three sizes thinner than a year ago? conveniently forgetting the hidden doohickey under the frilly gown that made the mirage possible.

Alas, royals tend to have a wicked sense of humour and Hesperia's Prince was no exception.  At the stroke of midnight the orchestra struck a fanfare and the young Prince bounded onto a raised stand.  Hesperians!, he cried as a cheshire smile creased his face.  We ate and drank, we danced and romanced.  It's now time to play "follow-your-leader". It's good for our constitution, our national fitness.  And  off he went into the gardens and up the hills surrounding the palace. A gaggle of partiers followed, some laughing and whooping, others wheezing and gasping for breath.

Olivia was aghast.  I can barely move, never mind follow this..this billy goat of a prince, cursed be his youthful arrogance.  But what could she do? It was one thing to smile deprecatingly, quite another to disobey a direct royal order.  She edged closer to the double doors leading to the manicured gardens which were already full of people and torch-bearers.

She weighed her options: if she stayed behind she was likely never  to be invited again.  If she attempted to run up the hills in her present state it was sure that her corset would tear apart and her  hitherto artificially hidden curves would burst forth in all their plentitude.
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Thus, we leave Olivia gazing wistfully, once at the ladies' powder room where she can rid herself of the corset and the too-small gown, so to join the revellers-turned athletes;  and again, to the rapidly emptying ballroom.

What to do? What to do?  And that damned Greta is nowhere to be seen...