Greece, the EU and Aunt Agatha

Dan Davies
Jan 26, 2015 · 5 min read

Syriza has won the elections, and now they are going to have to make at least a stab at their promise of “ending austerity”. I’ve written elsewhere about why I think their negotiating position might be significantly weaker than they think it is; in this piece, I thought I’d have a go at first, explaining why the debt economics of Greece are very different from most budget constraints, and second what kind of options Syriza might have to make things work. But first, a little analogy.

Consider a young man — to make it concrete, let’s call him Jim — who is living rather beyond his means — every month, he has income of £5000 and expenses of £5500. He has to finance this gap by borrowing. He has two sources of financing — the credit card company, and his Aunt Agatha. Because he’s been living this way for a while, he is maxed out on his credit card with £5,000 of debt, and so his only source of funding is Aunt Agatha.

Aunt Agatha is a generous creditor — for the sake of form, she makes Jim sign an IOU and pay interest, but the interest rate is pretty low compared to the credit card, and every time the debt comes due, she is content to extend the term and roll it over into a new loan. Jim has, over the last few years, amassed a balance of £50,000 in debt to his beloved aunt.

Then disaster strikes and Jim’s income falls to £3000 a month. Aunt Agatha is prepared to increased her monthly loans from £500 to £2500, but she has a number of firm conditions attached, and she wants all sorts of measures to be taken by Jim to reduce his expenditure. Some of these are things that Jim has been planning anyway, but some of them — like giving up on his foreign language course — seem counterproductive to him and he doesn’t really want to do them. What should he do?

I hope everyone can see that the following piece of advice would be dreadful

“Well, the problem is your debt/income ratio, which is now around 153%. And Aunt Agatha is by far your biggest creditor. Tell her that you can’t pay her back and need her to write off half of your debt”.

Because Aunt Agatha is a very unusual kind of creditor. She is lending, at concessional rates, in circumstances where no other lender would be prepared to, and most importantly, she is the sole provider of finance to cover Jim’s deficit. If his relationship with her breaks down, he has no other sources of funding and would have to reduce his consumption, immediately, to equal his income.

This was the situation Greece was in a couple of years ago, and bizarrely, there was no shortage of people giving this absurd advice, and even patting themselves on the back for being far-sighted and intelligent enough to do so. Things have moved on a bit since then though. So let’s run the clock forward on Jim.

Jim ended up having to give in to Aunt Agatha’s demands. He now has stabilised his monthly situation, with income of £3500 and expenditure of £3500. But he has an interest bill on his credit card debt of £100 every month, so he still needs to borrow, a bit, from Aunt Agatha (there’s also about £100 of interest on Aunt Agatha’s own IOUs, which she is still happy to roll on to the tab). And he has got a new girlfriend who keeps telling him that he really ought to start the language course again if he is going to have any prospects.

This is the situation Greece is in now, roughly. Primary balance has been achieved and growth is positive again. But the social cost of doing so has been considerable, and the incoming Syriza government wants to make more investment spending. But it seems clear to me that the following strategy is not going to help Jim.

“If you stopped paying interest on Aunt Agatha’s IOUs and told her to write off half your debt, you could afford to take those language courses again”.

Because it’s not true — messing around with the debt interest on the EU debt doesn’t free up any material resources for the Greek state budget, unless the EU can be persuaded to advance more money for that purpose. But if you can persuade the EU to finance some deficit spending, then that’s the problem already solved. Negotiating with Aunt Agatha about the language course would be a sensible course of action for Jim, but it doesn’t seem particularly promising to kick off those negotiations with a load of demands and by forcing her to confront the reality that she is throwing good money after bad.

So, it doesn’t seem to me as if there’s much play here either. But ..there’s an interesting possibility for the near future. The EU program for Greece assumes large primary surpluses for the years 2016–2020. And that changes the dynamics significantly …let’s look forward in a crystal ball to see where Jim might be in a couple of years.

In a couple of years’ time, Jim’s income has reached £4000 a month, but his expenditure is still £3500, per Aunt Agatha’s original budget. He’s paying down his credit card debt at quite a rate. But now he really really wants to get back on that language course.

At this point, the “Tell Aunt Agatha to get stuffed” advice is …well, I still wouldn’t regard it as prudent, even if one ignores the morality of short-changing a beloved aunt. But it’s no longer actively suicidal. If the language course helps Jim get a high flying job elsewhere, then it could kick-start his comeback to a state where he can pay all his debts and persuade the fair Cecilia to marry him.

The rough analogy here is to the anticipated surpluses. If Syriza think that diverting thoses surpluses into fiscal stimulus could make enough of a difference to the Greek economy to kick start a recovery, then it would make sense to ignore the troika and start playing real hardball with the EU creditors. I wouldn’t advise this though, for one very good reason, which the more cynical readers and afficionados of PG Wodehouse novels may already have skipped ahead to …

One day, Aunt Agatha is going to die. When she does, it’s very likely that her will is going to release Jim from his IOUs; although she is much too straight-laced and Calvinist to admit any such awful thought, she is aware in her heart of hearts that she ought to regard the money she’s giving Jim every month as a gift rather than a loan as the chances of getting it back are minimal. Wouldn’t it be a terrible shame to shut yourself off from such a generous aunt, particularly as the rosy future on the language course is far from assured?

One day, fiscal union will happen in the EU and Greece’s debts will disappear into a common pool. Everyone knows this, but it’s not politically acceptable to say so at present. Given that, it makes little sense to risk the relationship for a short term gain. Syriza has a much more appealing strategy in a negotiated settlement, involving less primary surplus and more stimulus spending.

Bull Market

A collection of finance and business writing by @alexisgoldstein, @delong, @dsquareddigest, @DuncanWeldon, @felixsalmon, @jamesykwak, @Mark__Buchanan, @WhelanKarl

    Dan Davies

    Written by

    Senior Research Advisor, Frontline Analysts

    Bull Market

    A collection of finance and business writing by @alexisgoldstein, @delong, @dsquareddigest, @DuncanWeldon, @felixsalmon, @jamesykwak, @Mark__Buchanan, @WhelanKarl

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