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The Original Sinn
Illustration by Julio C. Saavedra

 

The Greek Tragedy

1. The Public Rescue Credit

A Grexit debate raged already back in 2010. At the time, German Chancellor Angela Merkel insisted that the no-bail-out clause of the Maastricht Treaty (Article 125 of TFEU) must be taken seriously and that no rescue funds should be deployed. On 5 May 2010, she said: "A good European is not necessarily the one who rushes to help. A good European is the one who respects the European treaties and the corresponding national laws, and in so doing helps to protect the Eurozone's stability."1

Things, as we all know, turned out differently. On 11 April and 10 May, the EU, under heavy pressure from the United States, France, the IMF and the ECB, decided to rescue Greece with public credit. On 9 May, the ECB Governing Council decided to set up the so-called Securities Markets Programme (SMP), under which all national central banks (NCBs) in the Eurozone were to buy Greek government bonds.2 The programme was later extended to bonds of the other crisis-stricken countries.

Christine Lagarde, at the time French Finance Minister and now IMF Chief, said that policymakers had broken the law in order to save the euro: "We violated all the rules because we wanted to close ranks and really rescue the euro zone." 3 In reality, it was all about rescuing the banks and investors with exposure to Greece, who now demanded bridge loans to make it possible for Greece to repay its debts. At that time (late March 2010), French banks had a 53 billion euro exposure to private and public instances in Greece, the German ones a 33-billion euro exposure, the US 10 billion, and the UK 9 billion. 4

Since the onset of the crisis in 2008 and well before the fiscal rescue programmes, Greece had been helping itself by having its national central bank provide credit to the local commercial banks with freshly printed money, with which these banks financed both the private economy and the government. Under normal circumstances, a national central bank provides the local economy with only so much credit as needed for transactions. Payment orders to purchase goods abroad are financed by money flowing in through borrowing or through the sale of goods or assets to other countries. During the crisis, however, the ECB relaxed its rules for the granting of credit by NCBs, with the result that a monetary overhang was created that was used to finance the current account deficit, pay off private foreign debt and acquire assets abroad.

The key instrument to relax the granting of credit was the lowering of the collateral requirements that the borrowing banks had to pledge to their NCB to receive fresh refinancing credit. The rating was lowered to below BBB-, i.e. below investment grade into junk territory. When Fitch and Standard & Poor's lowered Greek debt to BBB+ with a negative outlook, and Greek banks no longer could pledge their Greek government bonds as collateral for new refinancing credit, the ECB Council lowered the rating requirement and continued to accept this paper as collateral. In addition, the ECB Council also lowered repeatedly the required rating for private debt instruments through an array of individual measures, in order to make it possible for the commercial banks to continue to draw refinancing credit from the Greek central bank. The banks were allowed to bundle debt into asset-backed securities (ABS), which were then accepted as collateral for refinancing credit even though these securities were not traded in the market and therefore lacked an objective valuation. In this way, an increasingly large proportion of the assets held by banks was converted to acceptable collateral that could be pledged to obtain refinancing credit with freshly created money. Furthermore, banks were allowed, by way of expanding their balance sheet, to create eligible collateral themselves by ring-trading own bonds with other banks. 5

When the Greek crisis became more acute in autumn 2011 and culminated in the country's first sovereign default in the spring of 2012, which with a haircut amounting to 105 billion euros at the expense of private creditors turned out to be the largest in history, the instrument of choice became the Emergency Liquidity Assistance (ELA). ELA is emergency credit, but also refinancing credit like any other, the only difference being that the collateral quality is defined by the corresponding NCB, since the fiction is maintained that in case of bankruptcy of the local commercial banks and the collateral losing its value, the respective NCB itself will bear the loss, while in the other cases all NCBs bear the loss jointly. Much ELA credit was granted in Greece against promissory notes guaranteed by the Greek state. The money was then used by the banks largely to buy new Greek government bonds.

The Greek central bank was able to decide itself whether to grant ELA credit; a two-thirds majority in the ECB Council would have been necessary to stop it from doing so. Given that in the years in question the six crisis-stricken countries (Greece, Italy, Portugal, Spain, Ireland and Cyprus) had one vote more than one-third of the total, the two-third blocking majority was never achieved. It was only after the accession of Latvia and Lithuania that the voting balance changed, so that blocking ELA credit has become easier.

Greece made abundant use of the wide leeway for supplying itself with central bank money. By June 2012 it had created altogether 154 billion euros in central bank money through credit operations or open market operations, 6 although according to the size of its economy it should have created no more than 50 billion. 7 The excess money creation was a sort of overdraft facility at the expense of other countries. It made it possible for Greece to issue net payment orders for purchasing goods, repaying debts and acquiring assets abroad, which, by June 2012, had reached a total of 105 billion euros. The payment orders had the effect of reducing the monetary base in Greece, forcing in the process the NCBs of other countries to create fresh money without receiving securities from or claims on the banks in their jurisdictions. They received instead interest-bearing Target claims on the ECB system, which in turn acquired claims on the Greek central bank. Target claims and liabilities are interest-bearing credit between central banks that result from an asymmetric creation of money. They are booked (at times somewhat obscurely) in the NCBs' balance sheets, and they are also booked as Greek foreign debt and other countries’ foreign assets in the European balance-of-payments statistics. 8

The height of the lower area on Figure 1 shows the evolution of Target credit over time. It can be seen that Target credit came back down after its original peak in 2012, as a result of other credit becoming available. Still, by March 2015 Greece’s Target liabilities had again reached a level of 96 billion euros, and by late April, had climbed to almost exactly 100 billion euros.

BOX 1
Meaning of the Target balances

Whenever a Greek citizen issues a payment order to a commercial bank in another Eurozone country, the NCB of this country creates new money that it then transfers to the respective commercial bank, which in turn credits the sum to the beneficiary of the payment order. The NCB carrying out the payment order implicitly grants credit to the Greek central bank, which leads to the booking of corresponding Target claims and liabilities vis-à-vis the Eurosystem in the NCBs’ balance sheets. The “Target credit” is the mirror image and result of the excess portion of the refinancing credit issued by the Greek central bank, since the payment order could not be carried out without causing a liquidity squeeze of the Greek commercial bank were it not offset by an immediate injection of refinancing credit. Target balances are shown in the balance-of-payments statistics as part of a country’s net foreign debt and assets, respectively; they bear the ECB’s main refinancing interest rate.

                The Target balances shown on the NCBs’ balance sheets are not only, as sometimes asserted, mere symptoms of a distortion in the Eurosystem, but indeed overdraft credit between the NCBs. In the USA, the equivalent balances that arise among the twelve District Feds of the Federal Reserve System are settled regularly by transferring amongst them the titles to marketable assets in the SOMA portfolio. Until 1975, the settlement was carried out with gold. A similar settlement mechanism does not exist in the Eurozone. Target overdraft can be drawn indefinitely and without limit, the creditor NCBs being unable to call it due.
                As a rule, Target credit does not lead to an expansion of the Eurosystem’s monetary base, because the commercial banks in the recipient country repay refinancing credit in a volume roughly equal to the incoming payment orders, since they have no use for the extra liquidity. Between 2012 and 2013, the Bundesbank’s stock of central bank money resulting from refinancing credit or open market operations was practically zero (and at times even negative). All of the money circulating in Germany at that time was created through net payment orders from other Eurozone countries, 9 which crowded out the entire stock of German refinancing credit. The German Target claims peaked at 751 billion euros in August 2012. By July 2014 they had retreated to 444 billion euros, and now (April 2015) have climbed back to 532 billion euros.

Figure 1: Public credit given to Greece by other euro countries

Click on image to enlarge

* Liabilities of the Greek national central bank to the Eurosystem due to over-proportionate banknote issuance.

** Greek government bonds purchased from other Eurosystem national central banks (NCBs) under the framework of the Securities Markets Programme (SMP), minus the government bonds of other euro countries bought by the Greek central bank under that programme. These are book values. The monthly values were estimated through interpolation of the yearly stocks adjusted to the overall stock of government bonds held in the books. A corresponding flow of government bonds across borders is assumed.

Note: The fiscal rescue credit is calculated as a net value; it includes the financial help disbursed by the end of each month by the rescue programmes of the euro countries and the IMF. The repayments made to date have been subtracted, as well as the Greek contributions to the rescue programmes. These include Greece's share in the European Financial Stabilisation Mechanism, financed by the EU budget, and also the capital subscription to the European Stability Mechanism. See also Table 1.

Sources: Bank of Greece, Financial Statements; European Central Bank, Weekly Financial Statements; same institution, Capital Subscription; European Financial Stability Facility, Lending operations; International Monetary Fund, Financial Activities; also IMF, SDR Exchange Rate Archives by Month; European Commission, The Economic Adjustment Programme for Greece: Fifth Revue; same institution, EU Budget 2011; European Stability Mechanism, Governance, Shareholders.

 

The Greek central bank did not only grant special credit just to finance, and make possible, the payment orders to other countries, but also in order to offset the cash withdrawals by the Greek population. As of March 2015, the Greek central bank has issued 14 billion euros more in banknotes than corresponds to its key in the ECB capital, which is calculated as the mean value of Greece's share in the total population and gross domestic product of the euro countries. The special credit that underlies the over-proportionate issuance of banknotes is shown in the Greek central bank's balance sheet as a liability to the ECB system.

Just like Target credit, this credit in terms of over-proportionate banknote issuance can be used to acquire goods and assets abroad or to pay off foreign debt. Indeed, there is anecdotal evidence that Greeks have physically brought substantial amounts of cash abroad to acquire foreign assets, such as to Bulgaria, where they have shown up as property buyers. In can also well be, however, that the cash was hoarded in Greece itself. Given that there are no statistics for this, the credit resulting from the over-proportionate issuance of banknotes, unlike the Target liabilities, is not booked in the official EU balance-of-payment statistics as part of Greece’s net foreign debt, although it is entered as a liability in the Greek central bank balance sheet.

The ochre area in Figure 1 shows the help that other countries have indirectly provided to Greece through the purchases by their NCBs, under the ECB's Securities Markets Programme (SMP), of more Greek government bonds than the bonds that the Greek central bank itself purchased of other crisis countries (Italy, Portugal, Spain, Cyprus and Ireland). This value peaked at around 39 billion euros. By now it has come down, through repayment and re-selling by the ECB, to close to 14 billion euros. These bond purchases amount to a granting of public credit to the Greek government, because they enabled it to issue bonds up to the amount of that credit without having to attract private investors (who would have likely demanded higher yields). The purchases presumably led to private capital flows to Greece because the commercial banks that sold the Greek government bonds to their respective NCBs ultimately had to acquire these bonds in the Greek market. These capital flows lowered Greece's Target liability one-to-one, since they gave rise to net payment orders to Greece. Although booked as private capital in the balance-of-payments statistics, this capital flow was in fact a publicly induced credit by the other countries that stand behind the ECB.

The green area in Figure 1 depicts the flow of fiscal rescue credit to Greece. It includes the two Greek rescue packages put together by the euro countries and the IMF. Under the first package, Greece received a total of 52.9 billion euros as bilateral credit from the euro countries. The second package has not been concluded yet. So far, 130.9 billion euros have been disbursed by the European Financial Stability Facility (EFSF), and 11.7 billion by the IMF. Out of the IMF portion of the first package, 11.5 billion euros had been repaid by late March 2015. Greece has also itself contributed to rescue measures, by providing 2.3 billion euros to the capital of the European Stability Mechanism (ESM); through the EU budget, it also participated with around 0.7 billion euros in rescue money for Ireland and Portugal from the European Financial Stabilisation Mechanism (EFSM). Thus, the net sum by the end of March 2015 amounted to 201.3 billion euros. 10

The media has reported repeatedly that public credit to Greece by late March 2015 amounted to some 240 billion euros. But that is the gross amount and includes the sums pledged but not yet disbursed. Furthermore, the repayments that Greece has made and its contribution to the rescue packages for other countries have not been deducted. Table 1 shows how these deductions reduce the gross amount of fiscal help to the net one depicted in Figure 1.

Table 1: Public credit given to Greece by March 2015 – Gross vs. net (bn. euros)

Click on image to enlarge

1) According to the programme. 2) First rescue package: Disbursed sums at the time of the programme's early termination. Second rescue package: 0.95 billion euros was not drawn before the deadline from the sum made available for the haircut. 3) Sums effectively disbursed as of 31 March 2015. 4) The sums defined in units of IMF drawing rights were converted into euros at the exchange rate of the corresponding date. 5) Excluding Greek central bank share; own extrapolation of the stock at 31 December 2014. 6) The same exchange rate was used for repayments as for the corresponding disbursement. 7) According to the ESM treaty. 8) In accordance with Greece’s contribution to the EU budget. 9) Own extrapolation of the status at 31 December 2014.

Sources: Bank of Greece, Financial Statements; European Central Bank, Weekly Financial Statements; same institution, Capital Subscription; same institution, Financial statements of the ECB for 2014, Press release, 19 February 2015; European Financial Stability Facility, Lending Operations; International Monetary Fund, IMF Country Report No. 12/57; also IMF, Financial Activities; same institution, SDR Exchange Rate Archives by Month; European Commission, The Economic Adjustment Programme for Greece; same institution, The Economic Adjustment Programme for Greece: Fifth Revue; same institution, The Second Economic Adjustment Programme for Greece; same institution, EU Budget 2011; European Stability Mechanism, Governance, Shareholders.

The table's first column shows the sums originally authorised, and the second the sums effectively pledged. With the first rescue package, the difference between these two categories is explained, among other factors, by the fact that the 80 billion euros in intergovernmental help agreed by the euro countries could not be completed because Slovakia from the beginning did not partake of the support payments and also because Ireland and Portugal, themselves in financial difficulties, failed to pay in. The original sum shrank thus to 77.3 billion euros. Furthermore, part of the money that was supposed to be disbursed according to the intergovernmental agreement was merged with other money from the EFSF and disbursed through it. In addition, 0.95 billion euros from this fund were not drawn. If the sums disbursed under the old regime are counted together with the new funds of the EFSF as well as the IMF funds proportionally authorised – in which non-disbursed credit from the first package was also carried over to the second – one arrives at 244.8 billion euros. This is the sum that is often quoted in the press.

It must be borne in mind, however, that the funds pledged had conditions attached, the actual disbursement of credit tranches being contingent on their fulfilment. Given that Greece fell behind in the fulfilment of its commitments and that the second rescue programme was extended twice by the euro countries (the IMF programme, in contrast, runs out in 2016), by March 2015 not all the money pledged had been disbursed. This explains the difference between the second and third columns. By late March 2015, Greece had received a total of 215.8 billion euros in fiscal rescue funds.

In this tally, the IMF funds are calculated at the exchange rate valid on the day of disbursement, and are shown on the last column valuated at the exchange rate of 31 March 2015.

If one adds to the fiscal credit the credit granted by the ECB system mentioned previously, in particular the Target credit and the purchases of Greek government bonds by non-Greek NCBs, the total comes to 343.5 billion euros.

This is a gross value, though. To arrive at a net figure, the repayment of IMF credit must be deducted, as well as Greece's capital contribution to the ESM, Greece's 1.6-percent share in the EU funds disbursed under the EFSM programme, and the purchases of government bonds of other euro countries by the Greek central bank. These items add up to 18.1 billion euros. Deducting them from the above total of 343.5 billion euros, the total public credit actually provided to Greece comes to 325.4 billion euros as of 31 March 2015 (or 327.8 billion euros at the latest exchange rate). This is the sum shown at the end of the green area in Figure 1.

In relative terms, the public credit amounts to 182% of Greece's 2014 GDP, which amounted to 179 billion euros. Interestingly, this percentage is similar to Greece's debt-to-GDP ratio, which was 177% by late 2014. This similarity should not distract from the fact that the figures measure different things. The sum shown in Figure 1 corresponds to public credit given by foreign public institutions, including the other NCBs, to Greek banks and the Greek government. The debt-to-GDP ratio, in turn, encompasses credit given by private and public lenders within and outside Greece to the Greek government, without including the Greek central bank. However, it is no mere coincidence that the figures are so similar, since Greece's private foreign creditors have by now been largely replaced by public creditors (more on this in Section 3) and because Greek banks could only buy government bonds up to the volume of refinancing credit they received from the Greek central bank, which in turn led to transfer orders abroad and the accumulation of Target liabilities.

During discussions of a haircut, the Greek side has repeatedly raised the issue of war reparations demands against Germany. Going into this issue exceeds the scope of this article, 11 but this much can be said: the reparation demands from an alleged loan 12 amounting to 476 billion Reichsmarks added up at the time to 5.5% of Greek GDP, which using today’s Greek GDP translates into close to 10 billion euros. Greece itself comes to a sum of 11 billion euros for that loan. Whether this has any legal basis cannot be commented here. 13 In any case, this is a small sum in comparison with the credit that has already been given to Greece.

The exceptional size of the credit given to Greece stands in stark contrast with the recurrent Greek accusation that the Troika, made up of representatives of the IMF, the EU and the ECB, imposed austerity on Greece and that, with its demands for budget cuts, it pushed the country into a humanitarian catastrophe. The truth is obviously the opposite, since it was the markets that imposed austerity, not the Troika. The international community, which exercised control over Greece through the Troika, actually softened with its loans the hardship of market-imposed austerity to a degree unprecedented in history.


Continue to Section 2: Did the Money Help?

 



Footnotes

1 A. Merkel, Regierungserklärung: Griechenland helfen, den Euro sichern, 5 May 2010

2 See European Central Bank, ECB Decides on Measures to Address Severe Tensions in Financial Markets, Press Release, 10 May 2010. Barclays Capital, "ECB SMP: Marking to Market", Interest Rates Research, 6 January 2010.

3 See B. Carney und A. Jolis, "Toward a United States of Europe", The Wall Street Journal, Report on a conversation with Christine Lagarde, 17 December 2010.
See also C. Lagarde, "Wir werden bedingungslos sparen", interview by M. Kläsgen and S. Ulrich, Süddeutsche Zeitung, 23 December 2010. Christine Lagarde said in that interview: "The Lisbon Treaty states that a EU country may not help another EU country in financial difficulties. But the Greek rescue plan leads directly to that. The euro rescue package was not contemplated in the Lisbon Treaty either. But we have nevertheless created a comprehensive rescue system – and we went beyond the existing rules to do that." (Own translation.)

4 See Bank for International Settlements, Consolidated Banking Statistics, Table 9E. Sums converted into euro as per the exchange rate of 31 March 2010 (1 euro = 1.3479 US dollars).

5 For this and the following section, see H.-W. Sinn, The Euro-Trap. On Bursting Bubbles, Budgets, and Beliefs, Oxford University Press, Oxford 2014, Chapter 5: "The White Knight".

6 This includes statutory notes in circulation plus balances on current accounts at the central bank plus deposit facility plus over-proportionate banknote issuance plus Target liabilities. See Bank of Greece, Financial Statement, 30th June 2012, European Central Bank, Consolidated financial statement of the Eurosystem as at 29 June 2012, same institution, Annual Report 2011, p. 215.

7 Share of Greece in the paid-in capital of the Eurozone's central banks times the monetary base of the euro countries as a whole (end of June 2010 in each case).

8 See H.-W. Sinn and T. Wollmershäuser, "Target Loans, Current Account Balances and Capital Flows: The ECB's Rescue Facility", International Tax and Public Finance 19, 2012, p. 468-508. H.-W. Sinn, The Euro-Trap. On Bursting Bubbles, Budgets, and Beliefs, Oxford University Press, Oxford 2014. For the booking in the balance-of-payments statistics, see for example Bank of Greece, Balance of Payments: January 2015, Press Release 23/03/2015.

9 See H.-W. Sinn, The Euro Trap, op.cit., p.207, Fig. 6.8.

10 Summary: 52.9 + 20.3 + 130.9 + 11.7 = 215.8; 215.8 - 11.5 - 2.3 - 0.7 = 201.3.

11 See, among others, F. Schorkopf, "Die Forderungen sind erfüllt", Der Spiegel 12/2015, p. 36, and A. Ritschl, "Debatte um Zwangskredit ist Erbsenzählerei", Zeit Online, 20 March 2015.

12 That this was not a loan, but an arbitrary calculation of the German occupation authority, was shown by M. Martens. See M. Martens, "Die Karriere einer Zahl", Frankfurter Allgemeine Zeitung, No. 63, 16 March 2015, p. 2.

13 476 million Reichsmarks amounted to 0.435% of German GDP for 1939 (109.3 billion Reichsmarks; see German Statistical Office, Bevölkerung und Wirtschaft 1872-1972, p. 260). Greek GDP amounted, according to A. Maddison, to 8.0% (in international dollars) of German GDP in 1939. According to this, the share of the German debt in Greek GDP came to 0.435%/8.0% = 5.46%. See A. Maddison, Monitoring the World the World Economy 1820-1992, OECD Publications Paris 1995, p. 181-184.