The Varo­ufakis Ef­fect?

Financial Mirror (Cyprus) - - FRONT PAGE -

In his end-of-2015 mis­sive, Hol­ger Sch­mied­ing of the Ham­burg in­vest­ment bank Beren­berg warned his firm’s clients that what they should be wor­ry­ing about now is political risk. To il­lus­trate, he posted the di­a­gram (

show­ing how busi­ness con­fi­dence col­lapsed in Greece dur­ing the late spring of 2015, and picked up again only af­ter my res­ig­na­tion from the fi­nance min­istry. Sch­mied­ing chose to call this the “Varo­ufakis ef­fect.”

There is no doubt that in­vestors should be wor­ried – very wor­ried – about political risk nowa­days, in­clud­ing the ca­pac­ity of politi­cians and bu­reau­crats to do un­told dam­age to an econ­omy. But they must also be wary of an­a­lysts who are ei­ther in­ca­pable of, or un­in­ter­ested in, dis­tin­guish­ing be­tween causal­ity and cor­re­la­tion, and be­tween in­sol­vency and illiq­uid­ity. In other words, they must be wary of an­a­lysts like Sch­mied­ing.

Busi­ness con­fi­dence in Greece did in­deed plum­met a few months af­ter I be­came Fi­nance Min­is­ter. And it did pick up a month af­ter my res­ig­na­tion. The cor­re­la­tion is pal­pa­ble. But is the causal­ity?

Con­sider the fol­low­ing ex­am­ple. Busi­ness con­fi­dence fell in Septem­ber 2001 (fol­low­ing the ter­ror at­tacks on New York and Wash­ing­ton, DC), while Paul O’Neill was US Trea­sury Sec­re­tary. Would Sch­mied­ing la­bel a chart show­ing that de­cline the “O’Neill Ef­fect”? Of course not: the drop in busi­ness con­fi­dence had noth­ing to do with O’Neill and ev­ery­thing to do with fears about global se­cu­rity. The cor­re­la­tion with O’Neill’s ten­ure was ir­rel­e­vant.

Sim­i­larly, in the case of Greece, the col­lapse in busi­ness con­fi­dence hap­pened un­der my watch. But the cause was that our cred­i­tors, the so-called Troika (the Euro­pean Com­mis­sion, the Euro­pean Cen­tral Bank, and the In­ter­na­tional Mon­e­tary Fund), made clear that they would close down our bank­ing sys­tem to force our govern­ment to ac­cept a fresh ex­tend-and-pre­tend loan agree­ment.

Be­fore th­ese threats were is­sued, busi­ness con­fi­dence was ac­tu­ally pick­ing up in Greece. In­deed, the day af­ter I pre­sented my re­form and fis­cal pro­pos­als to the City of Lon­don in­vestor com­mu­nity, stocks ral­lied im­pres­sively. (In­deed, dur­ing my ten­ure in the fi­nance min­istry, real GDP grew more than it had done dur­ing the last two quar­ters of 2014, which Sch­mied­ing iden­ti­fies as a pe­riod of in­creas­ing con­fi­dence.)

So, what caused the huge drop in busi­ness con­fi­dence dur­ing my ten­ure? Was it my pol­icy pro­pos­als – jointly au­thored with Jeff Sachs (with in­put from Nor­man La­mont, a for­mer Tory Chan­cel­lor of the Ex­che­quer in the United King­dom, Har­vard’s Larry Sum­mers, and James K. Gal­braith of the Univer­sity of Texas) – that were re­spon­si­ble? Or was it the Troika’s ex­plicit threat of bank clo­sures (which were ac­tu­ally im­posed when we dared to put our cred­i­tors’ ul­ti­ma­tum to the Greek peo­ple in a ref­er­en­dum last July)? In other words, was ef­fect”?

To an­swer this ques­tion in ways that are help­ful to in­vestors, an an­a­lyst must at least make an ef­fort to es­tab­lish whether the ob­served cor­re­la­tion points to a causal link. Read­ing our pol­icy pro­pos­als and com­par­ing them to the Troika’s pro­gramme would have helped. Un­for­tu­nately, this would have re­quired work that some an­a­lysts pre­fer not to do.

The rel­e­vant ques­tion is whether we were right to con­front the Troika – a cen­tral plank in our Jan­uary 2015 elec­toral plat­form – or whether we should have signed up to our cred­i­tors’ “Greek pro­gramme.” My view is that we had no al­ter­na­tive but to re­sist the Troika’s plan.

The rea­son is sim­ple: the Greek state be­came in­sol­vent in early 2010. From May 2010, this in­sol­vency was ad­dressed by means of se­quen­tial ex­tend-and-pre­tend loans on con­di­tions that were guar­an­teed to shrink na­tional in­come, in­vest­ment, and credit. A case of in­sol­vency was made in­creas­ingly worse by con­tin­u­ing to pre­tend that it was a mere liq­uid­ity prob­lem.

Was the Greek econ­omy on the mend in late 2014? Of course not. Nom­i­nal GDP never stopped shrink­ing, pub­lic and pri­vate debt con­tin­ued to be­come less and less sus­tain­able, and all along in­vest­ment and credit re­mained co­matose. With­out debt re­struc­tur­ing, a low tar­get for the

it the “Varo­ufakis

ef­fect” or the “Troika pri­mary bud­get sur­plus (net of debt pay­ments), a “bad bank” to deal with non-per­form­ing loans, and a com­pre­hen­sive re­form agenda that tack­les the worst cases of rent seek­ing, Greece is con­demned to per­ma­nent de­pres­sion.

Alas, the Troika was in po­lit­i­cally mo­ti­vated de­nial and deeply un­in­ter­ested in our pol­icy pro­pos­als. Time and again, they sim­ply de­manded ca­pit­u­la­tion.

To be sure, we could have han­dled that con­fronta­tion bet­ter. But for an an­a­lyst to blame the vic­tim of such fi­nan­cial vi­o­lence is not only morally rep­re­hen­si­ble, but also con­sti­tutes ter­ri­ble ser­vice to his clients (who, for ex­am­ple, may be lulled into a false sense that Greece is on the mend now that Varo­ufakis has been forced out).

Thank­fully, there are dili­gent an­a­lysts, like Mo­hamed ElErian, to whom sen­si­ble in­vestors can turn. And their ver­dict is clear: Greece’s down­turn in 2015 was due to the “Troika ef­fect.”

Yes, political risk in Europe is clear and present. But it em­anates from the Troika’s un­will­ing­ness to re­form it­self and to re­think its failed poli­cies.

Newspapers in English

Newspapers from Cyprus

© PressReader. All rights reserved.