Tuesday, 17 February 2015

Greece and the Art of Liquidity

The war of words with Greece is hotting up. The spin is so great I'm surprised nobody has been sick yet. It's like a fairground waltzer gone mad.

There have been at least six arbitrary deadlines that have come and gone all of which individually signalled 'The End' for Greece and all of which had no effect whatsoever.


Because it is all political rhetoric attempting to frighten the Greek people who, as usual for a people under threat, have doubled down and backed their elected government against the bunch of unelected bureaucrats who have got rather too big for their boots.

Let's look at the reality of the situation. The Eurozone is, at its root, a three layered hierarchy of liability pegs that make the liabilities of all the members the same effective value - which we call the Euro.

Firstly you have the commercial banks in each country. Those all clear their payments via the local National Central Bank. The National Central Banks (NCB) then have an account with the ECB on the TARGET2 system. In return for that they agree to follow the ECB's missives over interest rates and quantities.

In Greece's case the NCB is the Bank of Greece, and it is currently issuing Liquidity Assistance to the Greek banks as deposits leave the Greek banks and go elsewhere in the Eurozone - via the TARGET2 system.

Nothing will happen until the ECB takes a vote at the governing council to suspend Liquidity Assistance to the Greek banks, gets a two third's majority and the Bank of Greece obeys that instruction. There is no guarantee that it will, or will be allowed to by the Greek government, in which case the Greek banks can carry on clearing Greek payments like have before via liquidity assistance from the Bank of Greece.

The only actual sanction the ECB then has is to turn off TARGET2 clearance access and effectively remove the peg between German Euros (let's be honest about who is in charge here) and Greek Euros. At which point Greek Euros start to float.

And all that means is that for a Greek to pay a Spaniard they would have to exchange Greek Euros for German Euros via a third party transaction. Since the transactions are currently well matched, that's a nice little profit opportunity for some enterprising financial organisation.

Of course if the ECB pull the plug, then all the ECB imposed restrictions on the Greek central bank disappear at the same time. The Greek clearing system carries on as before and as we know from MMT a central bank issuing its own liabilities can maintain the banking system pegged to those liabilities for as long as it wants.

But I doubt that will happen. When it comes to pressing the big red button I suspect the bureaucrats will get very cold feet. Particularly if the Greeks are politic enough to assign a few names to that decision rather than allowing them to hide behind the decisions of a committee.

Which then leads to the other side of the whipping table. The so called 'running out of money' argument. Again this is so naive as to be laughable.

It helps if you realise that governments effectively spend bonds.  Then it all becomes clear. There is never an issue with Greece paying anything for as long as their paper is exchangeable for Euros. And there are a couple of very important drivers that make that likely to happen.

Firstly the IMF needs repaying. When you repay the IMF you have to pay them in their currency - the SDR. So what you do is take a bunch of Euros and ask the IMF for some SDR. The IMF then ring around those countries who hold the SDR in issue and get somebody to sell some for Euros. They always can because there are 'market making' requirements in play. The end of that transaction is that some countries have Euros, and the paying country has a deficit which it fills by selling bonds for those very same Euros (possibly via intermediate transactions within the Eurozone).

The IMF has its own liability back and the asset and the liability disappear in a puff of accounting logic (onto the allocation list on the IMF balance sheet in this case). Along with the income stream attached to that asset.

Secondly the ECB is about to undertake €60bn of QE every month starting 'no later than March 5'. What that means is that the overall system will become short of income earning assets as government bonds are drained by the central banks. Greece may be excluded directly from this process for the time being, but importantly it is the only government in the Eurozone that is on an expansion footing. Everybody else is busily digging their own graves by reducing deficits and other such nonsense and so is issuing as little as possible.

So that leaves new Greek government bonds as pretty much the sole source of anything resembling an interest rate in the whole Eurozone. It will be a very interesting test of 'liquidity preference' to see whether all this money that costs banks money to hold on deposit will stay there or whether they will be tempted by the Greek offering.

In other words it ain't over until the Fat Lady fails to show up at the bond auction.

Plus there has to be somebody prepared to press the nuclear button at the ECB - which is very likely to result in the end of the organisation and everybody's job there.

If I were Greece I'd push them all the way this time. There is nothing more to lose other than the chains that bind the nation.

Let's see how brave the bureaucrats are when their job is on the line rather than the countless millions in Greece and across the continent.