An economic meander - Greece, debt and economic adjustment in a QE world

The election victory of Greece's far-left Syriza party under the leadership of the new prime minister Alexis Tsipras poses new challenges to the EU. The BBC News coverage is quite good - here, here, here, here and on the far right here.

I am not close enough to be able to make really sensible judgments on the implications of the win. Greece has paid a very heavy price for previous maladministration and the subsequent bail-out and associated austerity measures. Since 2008, Greek per capita GDP has fallen by 22%, while Government debt as a proportion of GDP is now higher than it was at the time of the bail-out as a consequence of the decline in GDP. The economy is now expanding, but still at a very low rate. 

It is not clear to me from this distance just how much freedom the new Syriza led coalition government has to move. My feeling is that some compromise will be worked out that will allow Greece to stay in the Euro while undertaking some adjustments at the margin, aided by the shifts that have taken place in EU thinking. 

Meantime, the ABC's business editor Ian Verrender takes a very dim view of the European Central Bank's new quantitative easing package. My previously expressed concern on QE lay in my inability to see a clear exit strategy. That remains my concern. 

In an interesting piece on his blog and one that has relevance to Greece, Michael Pettis argues that:

But when debt levels are high enough to affect credibility, or when liabilities are structured in ways that distort incentives or magnify exogenous shocks, growth can be as much a consequence of changes in the liability side of an economy as it is on changes in the asset side. At the extreme, for example when a company or a country has a debt burden that might be considered “crisis-level”, almost all growth, or lack of growth, is a consequence of changes in the liability structure. For a country facing a debt crisis, for example, policymakers may work ferociously on implementing productivity-enhancing reforms aimed at helping the country “grow” its way out of the debt crisis, but none of these reforms will succeed.

In simple terms, and this is Greece's problem, the attempts to bring about structural reform of themselves cannot deliver the desired results or cannot do so in an acceptable time frame because of the debt burden. This is particularly true where other countries are going through a similar process at the same time. The growth potential required to stabilise the position just isn't there.

In writing, Professor Pettis' primary focus is on China. Here he has been arguing for a number of years that the Chinese growth model is unsustainable and that growth must fall as the economy re-balances. Chinese growth is obviously important from an Australian perspective. Slower Chinese growth, a different composition of growth, affects Australian exports.

Here James Laurenceson .in China Spectator made a useful point.  Even though growth is slower, that growth is coming from a bigger base. Measured in absolute terms, Chinese growth is still substantial even with a decline in that rate of growth. He also points to the exchange rate effect. Because the yuan has appreciated to some degree against the US dollar, the size of the Chinese economy expressed in dollar terms has further increased. As happened in Australia when the Australian dollar appreciated, you can buy more for each yuan.

One of the interesting things at the moment is the way all these divergent trends play out against each other, For example, the application of QE by multiple countries has affected exchange rates in ways that we don't always see because so much is expressed in terms of the US dollar. In this context, I wondered about trends in the Australian Trade Weighted Index (TWI).

The TWI is a is a weighted average of a basket of currencies that reflects the importance of the sum of Australia's exports and imports of goods by country. It provides a useful gauge of the value of the Australian dollar when (as now) bilateral exchange rates exhibit diverging trends.

If you look at the graph, you can see the sharp fall at the end of the 1980s, then the rise associated with the mining boom. The Australian dollar has fallen since, but by less than you might expect based on the shift in the US/Australian dollar exchange rate. It remains quite high.