Greece and Germany: It Took Two to Tango

The Popular Statement of the Issues:

Michael Lewis in his recent book has written that in Greece, cheap credit from “the banks” led the government to put everyone and their brother - or so it seemed - on the public payroll. It didn't matter if none of them actually worked. Since few in Greece admit to paying taxes, the public debt quickly exceeded the government's ability to repay. As a result, Greece is now prepared to go where few believed a sovereign state could ever travel - into insolvency.

Which are “the banks” that Lewis refers to? Surprise: They are not only Greek banks, but also the banks, major and minor, and bond trading firms of northern Europe and to a lesser extent of the United States. From this point we take a step back and take a broader and slightly deeper look at the matter.

History and Culture:

Greece: What are some of the salient features of Greek history and culture and concomitant traits of the Greeks that should be taken into account in examining the Greek sovereign debt matter?

1. The legacy of Ottoman/Moslem occupation:

a. “Western minds and Eastern emotions” is a phrase I heard over and over again in my student days in the mid-‘50’s at the University of Athens. Greeks equate intelligence in Thomas Edison’s terms with “genius,” i.e., acuteness and quickness, but have relatively less tolerance for “perspiration” or the virtues of deliberation and application over the long haul.

b. The predominance of family and local loyalties over loyalties to the state or to the society as a whole. Notwithstanding, the Greeks are ferociously tribal and united when the nation is attacked, for instance by Mussolini in 1940 or by allegedly technocratic EU statisticians sent in to measure the “true deficit,” but they tend to revert to clan and family loyalties when the pressure is reduced.

c. The difficulty of forging national loyalties manifests itself in an inability or unwillingness to think in terms of national economic development or the focusing of the economy of the entire country into strategic enterprises or business lines, such as computers and software or other high tech areas. Why did Greece never become the “California of Europe

d. The Sultan in Constantinople and the local pasha were the enemies of the Greeks for four centuries. Any governmental entity above the village level today is the successor enemy of individual liberty. The Greeks avoided taxes owed to the Ottoman Sultan. No self-respecting Greek since Greece became independent in 1835 has seen any reason to change that view of the government since. They have never paid taxes, and there is a serious question whether the great majority of them see any reason to start doing so now. Everyone who bought the Greek bonds that are now at issue knew at the time they lent Greece the money that tax laws were poorly enforced. This has not been news for 600 years. As friends recently told us, “Greece is a very rich country. It is only the government that is poor.”

2. The lack of natural resources, including the dearth of arable land. It has always been understood that for a Greek to make his fortune, he must leave Greece. For example, Onassis and the now legendary ship-owners.

3. The aftermath of German occupation during World War II and subsequent Communist civil wars

a. A phrase I heard repeated again and again when I was a student in Athens: “We build up our lives and wealth only to have them torn down again and again.” This referred to decades of successive economic downturns and wars.

b. The Greek civil war against Soviet aided insurgents was not ended until 1950, leaving Greece with a five or ten year late start relative to the rest of Europe in rebuilding the economy after World War II.

c. Urban/rural mutual distrust has remained strong over the years. The junta dictatorship of 1967 through 1974 can be viewed as an anti-urban reaction.

4. Twenty or more years under the European Union:

a. The EU can be viewed as the instrument for the forging of a bland type of European from the fiery Zorba of the past (both extreme stereotypes) and the undermining of Greek nationalism and traditions. The Greek has been taught to forget the virtues of the War of Independence from the Ottomans of 1821 and to become a compliant, socialized European. Greeks today have all of the passion of a cold café au lait.

b. A new, largely urban generation has arisen that regards itself as international, that has had access to educational opportunities anywhere within Europe and that has never lived under the Drachma or what they regard as the old, “oriental” ways.

Germany:

All of Europe, Americans and Japanese bought Greek bonds, but today it falls to the Germans to be the focus of all that is good and bad about Europe, what can and should be done to cure the debt crises of southern Europe and what has gone wrong with the unified currency system.

1. Culture and psychology:

a. The Germans are reasonably intelligent and more or less well educated. They are deliberate but not quick. They are comfortable in groups and not individualistic. As among Europeans and Americans, and at least until twenty or thirty years ago, the Germans had one outstanding virtue – they worked harder than anyone else. Notwithstanding, one might oversimplify and say that by themselves the Germans have never gotten much done. In the mid-eighteenth century, King Friedrich Wilhelm I had to import Dutch craftsmen into Potsdam to build the city because the local peasantry was ham-handed and inept. One wonders if Germany would have developed much beyond agriculture, Bach or Kant and Hegel without Jewish and Huguenot immigration.

b. In my student days in Europe in the 1950’s the only good universities were Oxford, Cambridge and any university in France. German universities were coming out of the Nazi years and the devastation of the war and were considered lax havens for lazy young adults to avoid working for as many years as possible. Literature, art and music were essentially on hold for 25 years after World War II. Germany was an isolated cocoon because the Nazis forbade circulation of any ideas or trends from the outside.

c. The Germans, for no reason necessarily apparent to an outsider, have often in the past felt inferior to the French and the British cultures, and residues of this inferiority persist to this day. Forget what you were taught about how beastly the Germans were to the French from 1870 on. Germany could occupy and destroy France five times over and still not match the destruction caused to Germany by Napoleon. This was remembered at least through the first half of the twentieth century. The British were superior because of empire and riches

d. The Germans caused death and destruction in Europe and Russia during World War II and they perpetrated the Holocaust. What could the Germans of today do to expurgate the guilt of their grandfathers? Could one answer be to submit to the discipline of the Euro?

f. The Germans of the early nineteenth century invented the concept of ancient Greece and the worship of what they configured almost out of thin air as classical civilization. Every German student memorized the first few lines of the Iliad and the Odyssey. How could the Greeks be excluded from the European Union when Greece had founded Europe and its civilization? Certainly the irregular balance sheet and tax collection practices of this tiny state could be overlooked in the face of the indebtedness of Europe to ancient Hellas.


The Worldwide Debt Meltdown of 2008

The Greek debt crisis has not occurred in a vacuum. Other nations and large financial institutions from Spain, Italy, Lehman Brothers and Bear, Stearns have taken the spotlight from time to time in the last five years. The Germans, supposedly fortified by a culture of austerity, thrift, risk avoidance, frugality and non-attraction to luxury or a sybaritic life style theoretically should have been spared any grief from the worldwide credit paralyses, but they were not. True to form, they have not borrowed beyond their means. They have, however, suffered horrendous losses as lenders to deadbeats far beyond what anyone could have predicted as recently as five years ago.

The Germans, for example, were strong buyer of U.S. securities backed by so-called sub-par mortgages. Michael Lewis in the September 2011 issue of Vanity Fair, gave an account of one German banker who directed large-scale purchases of such securities. Lewis also interviewed American bankers on the other side of the loans. Seemingly with no regard to their traditions and practices of skepticism and prudence, the German banks saw US triple A rated bonds with a yield that exceeded their own costs of money and poured billions into the program. Individual German bankers are quoted as saying they found it impossible to doubt the triple A rankings regularly bestowed by infallible rating agencies or to take issue with the reputations for probity and effectiveness of American bankers or the SEC and other U.S. regulatory bodies. The poorly compensated bankers in their high-rise Frankfurt fortresses tried to emulate American bankers, and they were no good at it. The Germans continued to buy bonds backed by sub-par mortgages mindlessly and according to formula even after the first defaults by Bear, Stearns and Lehman occurred. One response was to take all the rules of investment banking as then understood literally, a characteristic of the German character. “If I tick off all the boxes, then there is no risk.” No German banker would make a risky loan internally, but loans to foreign borrowers carried no risk.

In New York, the Americans allegedly routinely described the German bankers as gullible “muppets” who would buy any package put before them. The Germans had gotten rich and were on a roll. They and many other international bankers had been taught by Walter Wriston and his successors one lesson for over forty years: A sovereign cannot default.

How and Why Did Greece Come to Grief?

Here we find ourselves in some confusion. On the one hand, I have read that total levels of private and sovereign debt in the Eurozone are lower than in the UK, the US, and far lower than in Japan. One article continues: “Greece’s debt levels are around 250pc of GDP, at the lower end of the developed world. The reported numbers vary considerably. Spain’s sovereign debt is admirably modest at around 65pc. Italy’s household debt level is the envy of the rich world. It has a primary budget surplus. Italy has many problems, but the budget deficit is not one of them.”

Notwithstanding all of that, it is conceded that Greece has been living beyond its means since even before it joined the euro. After it adopted the euro, public spending soared and public sector wages practically doubled.
By the middle of 2009, as a result of a combination of international the world financial crisis and ‘uncontrolled’ government spending, the Greek bubble popped. It was revealed that successive Greek governments had consistently and deliberately been misreporting the country's official economic statistics to keep within the monetary union guidelines. The annual deficit was not 6% but over 13%. Alleged underreporting had enabled Greek governments to spend beyond their means, while hiding the actual deficit from the EU overseers. It was explained that the deficit numbers reported by the Conservative government were not false so much as based on a loose methodology – involving something we know about in the United States – off-balance sheet financing of various quasi-governmental entities. Nonetheless, the figures came as a shock, and the damage was done. Pimco, Mohamen El Erian’s bond trading firm in Newport Beach, immediately sold their entire portfolios of Greek, Portuguese and Spanish bonds. From there, contagion took hold, and borrowing costs for the southern tier and Ireland have been continually increasing.
Is Europe Undergoing a Classic Liquidity Crisis?
So what was going wrong outside of Greece?

The recession coincident with the so-called credit crisis of 2008 has been largely treated as a liquidity crisis afflicting the European banks by government officials, bankers and journalists. In over-simplified terms, this apparent lack of liquidity and concomitant valuations of banks as under-capitalized has been caused by falling valuations of the banks’ holdings of sovereign debt and by write-downs due to the business slowdown. The IMF and others continue to insist that the banks must increase capital and thus be able to lend more into the economy to get business moving again.

Bear in mind that when the EU was formed, the Greeks were led to believe that the European nations were now one for all and all for one, i.e., that any nation would be aided by the others if it got into financial trouble. In contrast, the Germans were promised two things: There would never be any bailouts of defaulting nations, and the European Central Bank would operate as conservatively as the German Central Bank, the Bundesbank. Instead, the ECB has just been a heavy participant in the latest Greek bailout, and it has been printing money as fast as it can – on a par with its brothers at the Federal Reserve. The Germans are afflicted with a racial memory of the catastrophes of hyperinflation. They don’t want to go back there.

The “Structural Imbalances” Within the European Union

An increasing number of commentators, however, now say that bank liquidity is a secondary issue. The real problem in Europe is the structure of the EU itself and the imposition at the outset (of course it was a welcome acceptance at first) of a single currency on all the member states. Germany itself at the beginning appeared to take one for the team when it accepted an exchange rate between the Deutsch Mark and the Euro that undervalued the Mark. Of course what that really did was to devalue German currency and increase its export capability within and outside the EU. Countries like Greece gained advantages at the beginning – witness Cretan peaches, for example – but in the long run it has made both Greece’s imports and exports too expensive.

The argument continues: The EU is fatally beset by structural imbalances that from the start doomed the union to failure. One writer estimates that there is a 30 percent gap in competitiveness between North and South. From the adoption of the Euro, low interest rates (negative real interest rates) were set by the ECB to serve German exports. This fueled over-consumption in southern Europe – another way to state the Greek deficit problem. All member states other than about five in the north became less able to withstand recession effects. Deficits increased greatly. The Germans, not surprisingly, have refused to reflate (i.e., increase domestic demand so that southern Europe can export to Germany.)

What has happened, let’s say in the past five years? In shorthand, the Greeks, Spanish and Portuguese got hooked on German cars. The Greeks borrowed money at 3% to buy the cars, and the Germans lent it to them as fast as they could so they could continue to keep their production up and their unemployment down. Trade imbalances mushroomed. Then in Greece, things really turned sour. With the Greek conservative and socialist parties running neck and neck in the elections and the polls, each succeeding Greek administration would borrow more money and spend it on newly created, non-productive government jobs just to get votes for the next election. The 2008 recession was the coup de grace.
Today we have bitterness and recriminations on all sides. The Germans say that the Greeks are not being quick enough to impose “structural reforms,” i.e., collecting taxes and reducing government employment - but, argues Michael Lewis, really just not becoming German fast enough. The Greeks say that the Germans are trying to keep their profligate banks solvent on the backs of the poor Greeks, who have no hope of producing enough to pay their debts whether they impose more austerity within the EU (they cannot reflate because they cannot control their own currency) or leave the EU and try to get whole by devaluing the drachma.

Because they are inside the Eurozone, the governments of the southern tier cannot rely on their central bank - the ECB - to lend them the money. Nor can they devalue their currencies to regain a competitive edge. Note, however, that the Spanish central bank has recently begun to create Euros on its own, while Germans bankers are somewhat disingenuously being said to be surprised.

Meanwhile, these southern tier countries are being pressured to push through very painful spending cuts and tax rises to get their borrowing under control, even as some analysts argue this is just pushing their economies into recession and reducing tax revenues.

What Are the Social and Political Effects of the Greek Near-Default Within Greece Itself?

Stratfor Intelligence argues as follows: Greece is entering its fifth year of recession with approximately 25 percent unemployment. The unemployment among young people may be as great as 50%, and nothing saps the morale of a population more that seeing its youth unemployed. Allegedly, the benefits of avoiding default and remaining within the Eurozone are becoming less obvious to the average Greek, as are the long-term benefits of increased austerity.

Is there increasing alienation between the political elite and the “people?” Television coverage of riots and destruction would argue yes, but I have never spoken with any Athenian who did not insist that television coverage was overblown and highly inaccurate. The Greek Prime Minister stated on Monday that his polls showed a 70 or 80% support among the public for whatever measures are required to make Greece more competitive. I believe that the gentleman is whistling, but I don’t think it’s in the dark.

There is anecdotal evidence of significant population shifts within Greece. After several decades, there appears to be a reversal of urbanization as people leave Athens and return to the provinces. The FT last Monday reported an exodus of Portuguese from recession-bound Portugal back to Mozambique. We read accounts daily of the increasing popularity of far left parties. Can revivals of far right parties be far behind? There appears to be a significant economic migration of the educated class to foreign countries. Great numbers of foreign students are not returning from their studies abroad.

Pressure is increasing from around Europe for tighter immigration controls, although it has been an open secret for years that Greece has been the landing spot for illegal immigration. Athens has suffered its own Koran burning incidents.

Yet, for many Greeks under 40, as I have noted earlier, leaving Europe and returning to the Drachma is unthinkable. They are Europeans. Victor Davis Hanson wrote in his blog on March 18:


The alternative of default and a return to the drachma would destroy contemporary Greece as we know it. Bankruptcy would lead to political isolation, a scarcity of fuel and medicines, exorbitantly expensive imported consumer goods, the inability to purchase key military hardware, and a virtual cessation of overseas travel — in other words, a return to the impoverished Greece of the 1960s.

A Tentative and Strained Conclusion:

Going forward, the only thing certain in my mind is that both the German and the Greek taxpayer/worker has taken a substantial hit without being told that what was happening or why and that Greece will once again become the poor country it always was, probably going back to the fourth century.