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Tuesday, May 11, 2010

Greeks can pay, Greeks will pay

Roborovski Hamster Dwarf by cdrussorusso from flickr (CC-BY)

Most normal blogs' favourite countries to rant about is US, or Israel, or China, or something like that. Not on this blog - my number one target, at least for the last month - is Greece. And I'm really shocked that some of the otherwise sane people I know buy into the whole "can't pay, won't pay" nonsense, so I wrote this short post explaining how it all really works.

Basics of money lending

Let's get back to basics. Why would anybody lend anybody else their money? The most common reason is they want to get even more money back. Now this is in no way the only reason - people routinely lend money to their family members and friends, IMF lends money to countries facing collapse, USA and Soviet Union lent money to support whichever dictator seemed more aligned with their interest, Europe lends money to shit-poor countries out of pity, AIG lent itself taxpayers' money by bribes and threats, and CIA lent money to Osama bin Laden because they're idiots - but while these are all very important cases, most money in the world is lent for profit motive.

This profit-motivated lending is not only largest in volume - it's also most reliable. Political will can evaporate overnight - ask South Vietnam or Cuba if you don't believe me - but speculators can be reasonably counted on to keep lending as long as it makes business sense. Even in the middle of the latest recession and the Great Depression solvent borrowers had no trouble getting loans - the problem was sudden decrease in solvency, not disappearance of the profit motive.

Political and charitable lending is highly complicated and varied form case to case, but for-profit lending is quite straightforward from game theoretic point of view:
  • Lender decides to give borrower money or not
  • Then borrower decides to repay or not
  • Because borrower would much rather get money, and not repay it - no lender would be willing to lend anything without some pretty hard assurance of seeing their money back
  • On the other hand, as repayment might be impossible due to objective circumstances, borrowers would be unwilling to provide too much assurance
  • Level of assurance is based on balance of these two factors.

And what forms of assurance are available? For private individuals there's debtors' prison - a barbaric institution which is still used in child support and tax cases - not coincidentally both being the kind of "debt" which is incurred unwillingly, where the "borrower" has no leverage whatsoever.

Another assurance is forceful confiscation of property, and various kinds of physical abuse - these were routinely used as international debt collection in 19th century, see Egypt, and Haiti for examples - but these rarely happen these days.

Yes, lenders could try to sue Greece or another unwilling country in foreign or domestic courts, but it would be mostly a PR stunt, and they wouldn't even get enough to cover their legal costs. If a country doesn't want to pay, lenders cannot do shit.
Russian Dwarf Hamster Winter White by cdrussorusso from flickr (CC-BY)

Hamster showing what debtors' prison looks like

The final assurance

So what keeps borrowers repaying and lenders borrowing? It's lenders not being stupid. They know very well that if someone didn't honour their debts in the past, they're unlikely to do so in the future - so if you tell the banks to go fuck themselves, you saved yourself a huge pile of money, but you have no chance of getting any money from them in the future. 

When you think about it - it's a pretty weak assurance - it only works when the country is moderately-screwed-up:
  • If country's economic situation is truly screwed up - they won't be able to repay - so banks lose
  • If country's economic situation is bad but not horrible (like most countries now) - they cannot afford losing their credit lines - so they keep repaying - and banks win
  • If country's economic situation is some awesome they don't care about future loans - they can tell banks to go fuck themselves - and banks lose too!

Fortunately for banks, the last case is very difficult to achieve - not only you need zero deficit (before interest) now - something already very hard - you need to be certain of being able to keep this zero deficit essentially indefinitely. Recessions, commodity price fluctuations, wars, terrorist attacks, aging population, floods, tsunamis, volcanoes, epidemics, electing Conservatives, and plenty of other natural disasters can screw your budget essentially overnight - all sending you crawling back to the banks begging for money. And bankers will remember what happened to their old loans.

I cannot think of any country in the world which is financially healthy enough to pull that off. What makes it even less likely is that countries with most balanced budgets tend to have lowest debt levels and borrowing costs as a rule (debts are results of past performance, and past performance is the best predictor of future performance there is) - so for them repaying debts is nearly painless, and provides good insurance in case something screws their economies in the future.

Essentially the only case in which a country can tell the bankers to fuck off, and has debts high enough to make it worthwhile - is one which used to be horribly mismanaged for many decades, and then turned into one of the healthiest economies in the world essentially overnight.

Does it sound like Greece? If you believe so, I have some sovereign debt credit default swaps that you might be interested in.

Greeks simply cannot afford not paying. They can negotiate better terms of repayment, and get some help from EU and IMF, but essentially they will have to get their country in order - cut their bloated civil service and bloated military, cut - and repay their debts, because they simply cannot afford losing their credit lines. And so they will pay.

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