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It’s now a commonly held view to say that Greece would have been better off exiting the euro, returning to their own currency in 2009, let it devalue and restart from scratch.

picture of Greek Europa face watermark on a euro 10 banknote

Greek Europa watermark on new series euro banknotes (credit: ECB website)

Devaluation is no panacea

GDP and real incomes are down about 30% since the beginning of the crisis. It’s a lot, but how much it would have been down in real terms (in hard currency) with an exit? Even if we assume no redenomination costs (untangling contracts denominated in euros, etc) and no adoption issues (Greeks keeping using the euro for some of their daily usage because they didn’t trust the new currency, see below) the typical fall in such cases would be likely at least 50%. Then you would get a bounce in nominal drachmas but where would they be now in real terms? -30% maybe? The historical experience of other countries doing devaluations, say Argentina, does not show it as a certain path to unbridled prosperity.

It is likely that the numbers would have looked better at PPP (purchasing power parity) as all local services and goods go down in price in a devaluation. Greece is though a small country which is far from self-sufficiency and imports many goods, including energy, that are not produced locally, thus ensuring the impact of a devaluation would be felt by all.

So, while it’s not impossible that real GDP would have done a bit better with a devaluation, it’s certainly not a given.

Distributional impact of devaluation and Kosovo-isation risk

Perhaps the one advantage of the devaluation route is that it makes everyone with nominal incomes in the national currency poorer. This is sort of good for social equality — we’re all down together — although in the case of Greece it wouldn’t apply to shipping magnates or owners of tourist-oriented businesses (whose products are world-priced in competition with alternative destinations) so the one percent (or a section thereof) would have done okay either way.

For recipients of social transfers, it’s also not obvious which way is best. A pension halved but still in hard currency may buy more than a devalued one. The distribution is different (cheaper haircuts, higher cost energy) so who knows which is better.

One case where it would be worse for the poorest is the “Kosovo-isation” scenario, where people in employment or with any form of foreign income keep using the euro despite the introduction of a new currency, so the currency is only used by state employees and benefit recipients, who spend or exchange it as soon as they can to avoid it losing value. Some say the state collecting taxes in its own currency gives it value, but not necessarily: people can just convert from euros, or whatever the street currency is, to the tax currency the day before a tax payment is due. In this case the new currency may just go into a death spiral which is combining the disadvantage of a hard currency with those of a local one.

Tsipras is the Troika’s child

Creative destruction has a bad name, but it does, to an extent, work. A problem with everybody getting poorer together in a devaluation is that there are fewer reasons to change bad habits and people can just plod along in their mediocrity until the next round.

Greece had and may still have a dysfunctional state with poor tax collection and poor value for money when delivering services, that is not providing a well working framework for a modern economy. For example, clientelism is central to Greek politics which means people are given jobs they may not be qualified for or productive in as a reward for political support. This is not only a direct net cost to the Greek taxpayer (compared to employing productive people at market rates), but also an opportunity cost as these people may have otherwise found more productive use for their time. Even for the beneficiaries of state largesse, being stuck in dead end careers in comfy but meaningless jobs may not be that fulfilling.

The crisis has allowed Greece to make some progress on this, no doubt with some collateral damage. To know if the devaluation solution would have been better, we would need to know whether there are net benefits to the shock therapy, and how they compare with reforms possible, or not, under a devaluation scenario.

There may be more progress to come as Tspiras, being an outsider can break lots of allegiances that were untouchable for the incumbent. It is quite plausible that his government makes some progress that would have been impossible, or taken decades more, in a sleepy repeated devaluation cycle where a newcomer like Tsipras would have remained permanently unelectable. If Tsipras is the Greek Lula, and the euro crisis made him possible, it may not be a bad thing for Greece.

What now?

In any case, whether the benefits of devaluation then would have been real or imaginary, it’s a bit too late. Exit at this stage would probably be the worst of both worlds, by creating a real term depression at a moment where there are not many benefits left from it. Both Tsipras and the Greek electorate seem to be wise to that.

The main remaining open question is whether they obtain a satisfactory compromise on the large debt stock. Tsipras has new reforming powers to bring to the table. Many of his proposed reforms are compatible with fiscal responsibility (anything that attacks clientelism, or the economic privileges of the Orthodox church, or effective tax collection from the rich). Besides it seems they understand they need to keep the nominal debt untouched, which allows Northern governments to sell a deal to their own electorate more easily. What they need is lower outgoing cash flow for the next couple of years, which any combination of rescheduling, lower interest, or interest capitalisation can do. The situation further ahead can be dealt with later on. A partial (or total) conversion to GDP bonds would also be a good compromise: Greece pays if it does well (as it would with the current setup) and doesn’t if it doesn’t manage (in which case the current setup produces sooner or later a hard default).

The tricky point for the negotiation is perhaps whether they manage to isolate Greek banks from the Greek treasury. If Greek banks were either self standing, or taken over by a eurozone body (EFSB or whatever) then the Greek treasury could suspend, or threaten to suspend, official sector repayments without as such causing a disaster. They could be kicked out from the eurozone for that reason, though that would probably, ironically, require a treaty change and unanimity, that is it would be practically impossible unless they behave really really badly. And if everyone knows that, they’ll do a deal before we get there.

Maybe in 20 years time historians will see that the euro, somewhat inadvertently — or perhaps by design if we consider the euro as a federalist pre-commitment device — helped Greece extricate itself from its own failings. And perhaps save the EU from it own failings in the process too.

First trade of the year on the main Obliquity Portfolio has been to exit Dignity, the undertaker consolidation firm, and double down on Tesco.

Too shady in the cemetery

Dignity is a business that is natural fit for the obliquity strategy: stable, boring, hard to like. But, and it’s something I had not understood well enough when I took the position, it’s designed more as a financial derivative than a business. Heavily leveraged and constantly adding to debt to maintain the high leverage, via copious dividends and capital returns (which produce an administratively annoying share split every year). With ever decreasing interest rates this works well, but could become a bit risky in any credit contraction cycle. Besides the management seems more interested in financial trickery than the underlying business. As they buy stable small/family firms that do something pretty predictable, it’s hard to cock up in the short term, but I expect long term neglect to lead to loss of market share and customers. Investment bankers just rarely make good businessmen. The position has been quite profitable (more than doubled) so seems a good time to exit, and it also now doesn’t pass the obliquity criteria any longer, via 4 criteria fails: management (I don’t trust them), balance sheet (too leveraged), diversification (none) and price action (too much momentum).

Tesco

Tesco woes are well known, and to some extent it was an error to buy in when they had fraudulent management and the wrong priorities in customer service (trying to outwit people with clubcard tricks), though it’s also a natural match for the portfolio and even with imperfect product and a fail for management it would pass. I believe that they’ve now got the right management and understand what they got wrong. It will take a while.

I doubled the position which takes it back to a full large cap position (it had almost halved since inception).

Loews: quirky conglomerate

An earlier acquisition, funded by accumulated dividends, during the autumn was Loews, a baroque US family conglomerate doing hotels, insurance, and energy exploration, that is managed in a Buffett-style kind of way. Not the best timing just before the energy prices crash but I trust they will survive it. It’s sort of a miniature obliquity portfolio on its own, and should make a fair long term holding that is structurally unglamorous and thus discounted.