Macro Weekly – On track to where?

by: Han de Jong

Macro-Weekly_On-track-to-where_26-June-2015.pdf (56 KB)

This is the last Weekly Comment before our summer break. Other commentaries will continue. Service of the Weekly will restart 31 July.

You may need a magnifying glass to see it, but talks between Greece and its partners are still making progress. Movement in the global economy is a little more convincing and is in the right direction. So we are on track. The only thing we need to figure out is: where to?

A couple of observations about the Greek saga

At the time of writing, talks between Greece and the institutions had not reached a final conclusion. There has been some progress all the same. The Greek government has recently made concessions in areas which they had declared taboo. But the institutions want Mr Tsipras to move further.

I cannot look into the heads of the Greek government, but it seems to me that the accelerated outflow of bank deposits has forced Mr Tsipras’s hand. The ECB reviews how much additional liquidity support Greek banks need on a daily basis. That is an indication of the pressure on the system. This cannot go on for very long.

We are being inundated by news and commentary about Greece, so what can I add? Perhaps just a couple of observations I feel are not getting the attention they deserve.

  • While Greece is threatening to run out of money, one needs to realise that its financing needs largely reflect debt service payments. Excluding debt service payments (the ‘primary budget’ in the jargon of economists) Greece is actually close to balance. So it is not as though the government will run out of money if it were to default. When the crisis reached a peak in 2011/12 we argued that defaulting on debt was not likely at that time as the government needed large borrowings to fund its day-to-day running of the economy. We also asserted that a real default would be more likely once the government was running a primary surplus. So that would be now.
  • The snag here is the banks. If the Greek government were to default, the ECB would, most likely, have to stop the liquidity support to Greek banks and that would be the end of them in their current form.
  • Greece’s public debt is unsustainable and something has to happen. The Syriza government wants a formal debt reduction. The institutions are unwilling to give it to them. This is largely for political reasons – a debt reduction is hard to sell to the electorate in other countries. An alternative can be found easily, at least in theory. While the debt is unsustainable at market conditions, the partners can alleviate the burden very significantly by lowering the interest rate and lengthening maturities or even applying grace periods. That has already happened, but the institutions could go further. This really makes the issue of debt reduction a symbolic one.
  • The average Greek has suffered tremendously in recent years. True, Greece has lived beyond its means for a long time, but the average Greek is not to be blamed for that, nor does this admission make it easier to cope with the income losses the Greek population has endured. What the country desperately needs is economic growth. It is shocking that hardly anybody seems to be talking about that. The Greek economy started to recover last year. Experience in Spain and Ireland shows that it takes a while for a recovery to spread sufficiently for large numbers of people to feel it, but Greece was on its way. Unfortunately, the change of government and the unsuccessful talks between Greece and the institutions has pushed the economy back into submission. It is also regrettable that the institutions are not sweetening their proposals with an investment programme which could provide stimulus in the short term and increase Greece’s growth potential in the longer term.
  • There appears to be a perception that no progress was made in recent years in terms of strengthening the Greek economy. That is plainly wrong. The World Bank publishes an annual ranking of countries called “Ease of doing Business”. Between 2008 and 2015, Greece has risen from a dismal 108th position to the 61st. For the sort of country Greece is, that is still a poor ranking on a list of 189 countries, but it shows improvement. The same is true for the World Economic Forum’s World Competitiveness Report. No eurozone country has risen more on that list in recent years than Greece. OK, it is still only just ahead of Moldova, Iran, El Salvador and Armenia, but at least there has been progress. It would be a huge pity to waste that all.
  • Some argue that Greece would be better off leaving the euro. I don’t think so. First, we can safely assume that the initial response would be chaos. A new Greek currency would be weak and the cost of imported goods would rise significantly, further depressing the standard of living. In addition, the financial system would collapse, probably leading to some sort of barter economy. And even with its own currency, the Greek government would have to bring its books in order and improve Greece’s growth dynamic. It simply cannot avoid the measures the institutions are demanding.

What if?

European authorities do not want any country to leave the eurozone as that would imply breaking the euro and inviting a bank run on any country that may get itself in trouble in the future. It is not a precedent they want to create. That said, the vulnerabilities in other countries are much reduced and they are all on the road to recovery, albeit at different stages in that process. I thus find it hard to believe that markets would start pricing in risks of an exit for a variety of countries should Greece default and leave the euro. But this is uncharted territory and one cannot be sure.

Encouraging economic data

Recent data releases in the main economies have been encouraging. The preliminary readings on the PMIs in the eurozone were better than expected in June, although the Ifo index in Germany was weaker than expected. This is something to keep an eye on given this indicator’s track record of signalling developments in the German and European economy. However, the Ifo index continues to indicate above-trend growth. The eurozone economy has been benefitting from significant tailwinds, even though some of these are losing some strength. We believe that the eurozone economy is gradually moving towards a self-sustaining recovery.

Monetary statistics confirm the positive trend. M3 growth slowed in May to 5.0% yoy, down from 5.3% in April, but M1 growth continued to accelerate: 11.2%, from 10.5%. M1 growth is a better indicator for cyclical developments than M3. Bank lending is improving also, slowly but clearly.

Recent US data is suggesting that US consumers, who had disappointed earlier this year, are starting to spend more. Personal income continued to grow in May: +0.5% mom after +0.5% in April, while spending growth amounted to 0.9%. This is perhaps one of the first signs that US consumers are starting to spend the windfall they are enjoying due to lower energy costs. Housing market data showed continued improvement. Business confidence indicators in the US were mixed. The PMIs for June were weaker than anticipated, but the Philly Fed index rose and by more than expected.

Data in Japan suggests that the country may have a better chance than it has had in a long time to escape deflation. Growth in the first quarter was strong and it looks like the economy is able to maintain a decent pace of growth while inflation is modestly positive. Finally, Chinese business confidence data is stabilising. This is an indication that the policymakers are successful at halting the deceleration of growth.

So where to?

I started this commentary by asking where we are moving to. It seems to me that the global economy is moving to a synchronised acceleration of growth in the second half of the year. That is good news. And Greece? Well, we continue to think that a deal will be struck, even if it is shortly after crucial deadlines expire. But to be frank, who knows…