Germany declares war on Greece

In the lead up to the previous EU summit there were statements from a number of participants that it would be the “summit to end all summits” as it would provide a comprehensive plan for the future of Europe. As I noted at the time, that summit certainly didn’t meet expectations with the “comprehensive plan” turning out to be more of the same.

On the eve of yet another summit there doesn’t appear to be anywhere near the same anticipation of a meaningful outcome, in fact the lead-up to this summit has turned into a bit of a mess.

On Friday, the Financial Times released a rumour and then a document showing that Germany was about to demand that budgetary sovereignty be removed from the Greek parliament:

According to information from the Troika Greece has most likely missed key programme objectives again in 2011. In particular, the budget deficit has not decreased compared to the previous year. Therefore Greece will have to significantly improve programme compliance in the future to honour its commitments to lenders. Otherwise the Eurozone will not be able to approve guarantees for GRC II.

II. Proposal for the improvement of compliance

To improve compliance in the 2nd programme, the new MoU will have to contain two innovative institutional elements on which Greece will have to commit itself. They will become further prior actions for the second programme. Only if and when they are implemented, the new programme can commence:

1. Absolute priority to debt service

Greece has to legally commit itself to giving absolute priority to future debt service. This commitment has to be legally enshrined by the Greek Parliament. State revenues are to be used first and foremost for debt service, only any remaining revenue may be used to finance primary expenditure. This will reassure public and private creditors that the Hellenic Republic will honour its comittments after PSI and will positively influence market access. De facto elimination of the possibility of a default would make the threat of a non-disbursement of a GRC II tranche much more credible. If a future tranche is not disbursed, Greece can not threaten its lenders with a default, but will instead have to accept further cuts in primary expenditures as the only possible consequence of any non-disbursement.

2. Transfer of national budgetary sovereignty

Budget consolidation has to be put under a strict steering and control system. Given the disappointing compliance so far, Greece has to accept shifting budgetary sovereignty to the European level for a certain period of time. A budget commissioner has to be appointed by the Eurogroup with the task of ensuring budgetary control. He must have the power a) to implement a centralized reporting and surveillance system covering all major blocks of expenditure in the Greek budget, b) to veto decisions not in line with the budgetary targets set by the Troika and c) will be tasked to ensure compliance with the above mentioned rule to prioritize debt service.

The new surveillance and institutional approach should be formulated in the MoU as follows: “In the case of non-compliance, confirmed by the ECB, IMF and EU COM, a new budget commissioner appointed by the Eurogroup would help implementing reforms. The commissioner will have broad surveillance competences over public expenditure and a veto right against budget decisions not in line with the set budgetary targets and the rule giving priority to debt service.” Greece has to ensure that the new surveillance mechanism is fully enshrined in national law, preferably through constitutional amendment.

Depending on your economic ideology you may read that document as anywhere from a logic next step to an act of war. However, it doesn’t really matter what you or I think about it, what matters is how the Greeks themselves see it and in that regard the message wasn’t particularly well received:

A Greek government minister on Saturday poured scorn on reported calls by Germany for Athens to surrender control of its budget, as Greece said it was close to a deal with its private creditors.

Greek Education Minister and former EU commissioner Anna Diamantopoulou rejected the notion as “the product of a sick imagination”.

And:

Greek officials reacted angrily to the leaked German proposal for an EU budget commissioner with veto powers over Greek taxes and spending.

“It’s going to be impossible for the Greek government to accept such a deal – I don’t think it would be supported by any of the heads of the parties that are involved in the coalition,” said Mr Yeroulanos.[Greek Culture Minister]

“We have been giving up quite a bit, but I think sovereignty is a red line that no-one would dare cross.

“I would rather resign as a minister than allow anybody to tell us the way we should be spending our money.”

Whether the document was actually intended to be enacted or was just some sort of strategic leak as a final test on what should be done about Greece is an outstanding question, but it certainly didn’t take long for the EU to respond in support of Greece:

The European Union’s executive body is rejecting calls from Germany to establish a eurozone budget commissioner who would directly control tax and spending decisions in debt-ridden Greece.

The European Commission said Saturday that “executive tasks must remain the full responsibility of the Greek government, which is accountable before its citizens and its institutions.”

The Commission, the European Central Bank, and the International Monetary Fund already have unprecedented powers over Greek spending, after negotiating with Athens stringent austerity measures and economic reforms in return for a first, multi-billion euro bailout.

As I have noted previously, while the EU leaders fiddle about trying to decide what to do with the symptoms of their problems, the problems themselves continue to get worse:

Greece’s international lenders think the indebted country will need 145 billion euros of public money from the euro zone for its second bailout rather than the planned 130 billion euros, German news magazine Der Spiegel reported on Saturday.

The magazine said the extra 15 billion euros were needed because of the deteriorating economic situation in Greece, echoing a Reuters report on Thursday.

Der Spiegel quoted a representative of the troika of foreign leaders — the European Commission, IMF and the European Central Bank — saying: “We’re assuming that it won’t be possible to collect missing money solely from the private creditors.”

What I find most interesting about the Greek response is that the entire idea of the new “fiscal compact” is that the Eurozone is supposedly heading towards a fiscal ( and therefore quasi-political ) union. The response from Greek authorities to the suggestion that a centralised European authority should be allowed to control its budget certainly doesn’t support the idea that Greece has the political appetite for a move in that direction. The statements from the EU’s executive body are even more odd given the wording of the latest draft of the EU treaty . As far as I can tell the treaty contains statements that are somewhat equivalent to the latest proposal:

1. The Contracting Parties shall apply the following rules, in addition and without prejudice to the obligations derived from European Union law:

a) The budgetary position of the general government shall be balanced or in surplus.

b) The rule under point a) shall be deemed to be respected if the annual structural balance of the general government is at its country-specific medium-term objective as defined in the revised Stability and Growth Pact with the annual structural deficit not exceeding 0.5 % of the gross domestic product at market prices. The Contracting Parties shall ensure rapid convergence towards their respective medium-term objective. The time frame for such convergence will be proposed by the Commission taking into consideration country-specific sustainability risks. Progress towards and respect of the medium-term objective shall be evaluated on the basis of an overall assessment with the structural balance as a reference, including an analysis of expenditure net of discretionary revenue measures, in line with the provisions of the revised Stability and Growth Pact.

c) The Contracting Parties may temporarily deviate from their medium-term objective or the adjustment path towards it only in exceptional circumstances as defined in paragraph 3.

d) Where the ratio of government debt to gross domestic product at market prices is significantly below 60 % and where risks in terms of long-term sustainability of public finances are low, the lower limit of the medium-term objective specified under point b) can reach a structural deficit of at most 1.0 % of the gross domestic product at market prices.

e) In the event of significant observed deviations from the medium-term objective or the adjustment path towards it, a correction mechanism shall be triggered automatically. The mechanism shall include the obligation of the Contracting Party concerned to implement measures to correct the deviations over a defined period of time.

So once again we get conflicting messages from Europe which is sure to add to the agenda of the EU summit.

As I noted last week , even though they were implicit in creating the situation in the first place, it appears that Germany is giving up on Greece’s ability to rescue itself. I am obviously speculating here, but on top of the ever-worsening financial situation there does not appear the political will to join the “fiscal compact” even with a technocrat government in place. Last week’s vote against extending pharmacy hours is the latest example that Mr Papademos is struggling to push through reforms even though he claims to have complete support.

It is possible that Germany now believes that Europe has the firewalls in place to deal with the fallout so now is the time to force Greece’s hand. Again I am speculating, but I am finding it increasingly difficult to work out what Germany’s Plan B for Greece actually could be even if the PSI+ does manage to get past its perpetual “almost there” phase. If the political will of the country cannot be bent to the liking of the creditors then why would they continue to extend lines of credit. Possibly we will find out more from today’s summit.

One of the other outstanding questions around Greece is what is to be done in the case that the PSI negotiations fail. If that turns out to be the case then Greece will need to enact collective action clauses to force, or at least threaten to force, bond holders into a new deal. CDS issues aside, the problem is that this will require the ECB to come to the table as it holds a large proportion of Greek debt. However, the ECB has previously stated that it does not intend to be part of any such deal and given its position as the “backstop” will not enter entertain any such discussions. Therefore, for a collective action clause to make sense, even as a threat, the ECB will need to offload its holdings of Greek debt to another European institution that could credibly support a collective action against other bond holders.

In this case it would make sense for the ECB to pass its holdings of Greek debt over to the European Financial Stability Facility at cost. That way the ECB is not seen to take a loss and the EFSF can then go into bat against the other creditors and force a deal for Greece. There are obviously some other outstanding issues around this scenario which would have to be worked out, but if we see any announcements out of the EU summit in regards to transferring bonds from the ECB to other European institutions then you can be sure that the threat of collective action is being ratcheted up.

Making the already confusing political situation even more confused is that Angela Merkel is being hamstrung in negotiations around Europe’s future plans by her own party:

Volker Kauder, the floor leader for German Chancellor Angela Merkel’s Christian Democrats, blocked a plan to put unused funds from the euro region’s financial backstop into its permanent successor, Bild am Sonntag reported.

Merkel wanted to endorse combining the lending power of the European Financial Stability Facility and the 500 billion-euro ($659 billion) European Stability Mechanism, the euro region’s future permanent financial backstop. Christian Democrat members of parliament opposed the move because Germany then would be liable for more than the 211 billon euros originally approved, prompting Merkel to drop the plan

But it isn’t all negative on the political front for Ms Merkel. Oddly, she appears to be taking “Merkozy” to the next level:

German Chancellor Angela Merkel is so concerned that a shift to the left in France after the coming French election could derail the German-led austerity drive in Europe that she plans to join French President Nicolas Sarkozy on the campaign trail in the coming weeks to forcefully support his re-election.

In other news, Spanish unemployment has officially reached 22.8%, the Irish want a referendum on Europe’s treaty, European investment banks are forecast to take a hit,  Cypriot officials claim their banks are fine, and finally Fitch joined S&P on the European downgrade tour.

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Comments

  1. “The product of a sick imagination”. I like that – it certainly cuts to the chase, doesn’t it. Would that our politicians expressed themselves so succinctly.

    • The Greek and Australian socio-political landscape and general culture are so very different that it would not be wise to make comparisons on political discourse.

      Australian politicians and politics in general serves very much as a shield protecting and smothering its citizens from anything that could be construed as indecent.

      Greek politics on the other hand thrives – engaging raw emotion, empathy and hatred which to an outsider such as yourself might be seen as refreshing. But the problem is this is simply talk and unless it deals with issues of nationalism the speech is never acted upon.

  2. “I would rather resign as a minister than allow anybody to tell us the way we should be spending our money.”

    From the German perspective they are not requesting that someone tell the Greeks how to spend ‘their’ money. It’s mostly someone else’s money that has been lent to the Greeks.
    They are however pushing for some genuine attempt on the part of the Greeks to reign in the fiscal problems…by putting someone in place to ensure the money lent to Greece is spent according to the plans set out in the agreements surrounding the bailout funds.
    as your article points out…what they are proposing does seem to fit with the latest proposal.
    Whilst it is likely the Greek people will vehemently oppose such a move which removes their financial sovereignty…..continued failure to comply with the austerity measures will simply mean the German people will vehemently oppose lending the Greeks anymore money.
    I think Merkel can already see that Greece is a hopeless case because they will not change their profligate, tax avoiding ways.
    She knows there is no way (rightly or wrongly) that the German people will accept a continued bailout unless the Greeks show a genuine commitment to change.
    Thus Germany is now setting the scene and rationale for a Greek exit.

  3. Nouriel Roubini’s speech at Davos was the winner for me – “Europe is a slow-motion train wreck” with both Greece and Portugal leaving before the end of the year.

    Dr Doom strikes again!

  4. Interesting times in Europe. That plan there sounds like a creditor going in to a company to force the board to prioritise debt repayments over keeping the company as a going concern – if Greece was a corporation it would have been put in bankruptcy proceedings long ago… but such are the dynamics of politics and nationhood I guess.

  5. This happened at the same time the Greeks were voting on further measures to reign in the deficit…

    A while ago a commenter who is based in Greece (A Dim View I believe) mentioned that the Greeks play along while the Troika is in their face but go on their merry way to self destruction as soon as they leave. I believe this is showing the utter frustration by the lack of measures by the Greeks.

    The Greeks aren’t doing themselves favours now… this will be ingrained in people’s minds for decades and will colour how people look at Greece. They will be at the bottom rung for a long, long time. Lying about their financial situation like before will not work anymore either now that the rest of Europe has wisened up. In the end it may not be the Germans who force them to come back to reality but reality itself will.

    They may think that they are successfully playing the game now but after this crisis who will be there to do business with them? Even if they resist reform now, they are cornering themselves and will find that in order to ever be taken seriously again far in the future they cannot escape reform.

    That said, Germany’s proposal seems a bit rich. I think it’s pressure with a grain of frustration thrown in. Kudos for the EU Commission for coming out with such a clear statement.

  6. Great summary DE, and thanks for all the links!

    “Volker Kauder, the floor leader for German Chancellor Angela Merkel’s Christian Democrats, blocked a plan to put unused funds from the euro region’s financial [firewall] into its permanent successor, Bild am Sonntag reported.”

    This is unfortunate. With the monetary backstop (ECB balance sheet) and the fiscal backstop (joint bonds) both seemingly off the agenda for now, I think they really need to increase the firewall (ESM), to see if that will bring the bond yields back down to reasonable levels (particularly those of Italy). In addition, a number of countries outside Europe have said that they would be willing to provide extra funds via the IMF once Europe substantially increases the ESM.

    From Associated Press:
    “To help jump-start the EU toward more growth and employment, the EU Commission is proposing to the summit leaders to redirect euro82 billion in existing funds toward countries in dire need of help to fix their labor market.”

    This is good news. It seems there’ll be at least some discussion at this summit about initiatives to improve growth and competitiveness, rather than just focussing on the “fiscal pact” (and Greece!).

  7. The Greeks have not been able to fund themselves at any time since at least 1980, but managed to get along by growing their economy and gradually increasing their Government debts.

    Even if they receive a bail-out now, they will still be essentially unable to fund themselves, but of course can no longer increase their loans and have a rapidly shrinking economy.

    To achieve control of their debts, the Greeks have to start to do something now that has always eluded them in the past – grow their economy faster than their public debt and faster than their external income deficits. It is not obvious how this can be done.

    Greece ran chronic budget and balance of payment deficits prior to and after joining the Euro, but things really went off the rails in 2008-9, when exports collapsed. Their trade performance has been recovering so that by the end of 2011, exports had reached their pre-Lehman peak but have recently started to decline again. In the meantime, their public sector deficit has soared to emergency dimensions.

    To me, this demonstrates the problems that arise when a Government does not have a lender-of-last resort. This is one the fundamental structural flaws in the European banking/currency system.

    There is no prospect at all that this will change, which suggests that problems such as those that have arisen in Greece will inevitably recur.

    Once again, this illustrates the obstacles to achieving institutional change in Europe. Change is absolutely necessary, and yet it is also impossible. There will be further trouble in Europe because they have done nothing to remove the causes of their difficulties.

    • “grow their economy faster than their public debt and faster than their external income deficits”

      Well, one thing which would assist them in achieving this growth would be to make better progress on implementing the reforms that they have committed to implement. I believe that the main issues holding them back from making this progress have already been identified. These issues need to be addressed. A proposal has been made. Maybe that proposal just needs to be improved.

      “this demonstrates the problems that arise when a Government does not have a lender-of-last resort”

      In lieu of a backstop, the bailout funds they are receiving are meant to protect them from the bond market for a number of years. I think that this should give them enough time to implement the reforms which they have committed to implement, and thus begin to achieve the growth you spoke about.

      • Jeff, I agree they have to implement reforms. They have no choice. And IIRC, their net external income position has been improving slightly, at least partly due to decline in imports – the kind of decline that happens when suddenly you are unable to buy.

        Greece is but a little bubble, but it says a lot about our common economic history in the Greenspan era. Looking at the data, Greece has run a deficit on the trade in goods for decades, and only ever made up part of the difference through services income – mostly from tourism. They have very choppy seasonal income flows, and every now and then have registered small and transient current account surpluses. As well, there is no doubt that a lot of the goods imported by Greece are required in order to provide tourists with the products and services that they expect. In this respect, tourism is not a 100% windfall for Greece.

        Anyway, they seemed to be able to get away with things while everything was expanding at the same time – imports, exports, the economy, government spending all increased dramatically – and they reputedly fudged the numbers for many years as well. For a fairly long time through the 80’s and into the 90’s, even though reported public sector debts were growing, the economy was also growing consistently and the external deficit was falling in relation to GDP.

        It must have seemed to the Greeks that they could have the best of all worlds – an economy that was prosperous, modernizing and growing, manageable public debts and an external sector that was trending towards balance.

        However, in the latter 1990’s and through into the 2000’s, public sector debts blew out to around 100% of GDP and at the same time external deficits started to grow again. Greece had begun to achieve growth by borrowing-and-consuming – the Greenspan special menu.

        It all came apart following the collapse in trade in 2008, a jump in the current account deficit and the onset of economic contraction. A huge spike in the budget deficit ensued during the following year and the fiscal position then tipped into a negative spiral. By 2011 Greece’s public debts had blown out to more than 140% of GDP. Even if a large part of these debts are forgiven – as is now proposed – unless Greece can get its economy to grow again, it will still really struggle to service let alone eventually reduce its public sector debts.

        The economy has been contracting without interruption since 2008/9. Inevitably, this means that enormous destruction will have been caused to the private sector through depletion of savings, business failures and capital repatriation or exile.

        It is really hard to see how Greece can turn this around. “Reform” by itself is not likely to be enough. Even when the rest of the Euro-zone was growing, fundamental imbalances were developing in Greece and it was never able to stabilize its external income position.

        In the absence of strong Euro-zone growth, the Greek economy must unavoidably shrink if it is to attain balance in relation to its recurrent flows, and yet by shrinking it is becoming ever more unbalanced with respect to its accumulated stock of debts. And as it shrinks, I expect it will become less able to mount a growth-rebound.

        And this is the problem – mismanaged public finance and chronic external imbalance have become a prescription for dislocation and depression in Greece. This is just dreadful really. If they default and exit the Euro zone, the Greek people face bankruptcy and generational ruin. If they try to hang on, they face indefinite economic entropy.

        In the meantime, tax avoidance and corruption live on. The Germans grow more reluctant to help. And the EU – weak as ever – has nothing much to contribute at all.

        In these circumstances, it is not surprising that the idea of surrendering national powers to the EU has found so little real support. And yet, this seems like it might be the only way to hold the EU together. This contradiction is so typically-European that it serves as an allegory for the whole situation.

        • Briefly, thanks for the detailed response. You certainly lived up to your name with that one! 🙂

          As you well describe, the situation is complex and the solution is not simple. However, certain aspects are clearer than others. A number of reforms have been agreed and it seems to me that the goal should be to ensure that reasonable progress is made in implementing those reforms. This will not only help to achieve growth, it will also likely encourage the EU (and possibly others) to provide further assistance. But that seems to be exactly what is currently missing – reasonable progress!

          • Thanks Jeff, I will try to stick to the point in future…..:)

            You are right, of course, about implementing reforms and going through with the deal. The Greeks owe this to themselves at least as much as to others.

            They need to bear this fully in mind, if only because their situation is so dire, and they will surely need more help in the future. From what I’ve seen, the bail-out by itself is not going to be enough. Even the IMF are tacitly saying as much.

            The real problem is in finding a response to this situation that will actually work, meaning it will enable the Greek economy to be placed on a sound footing.

  8. I saw an interview where someone said that everyone is talking about Greece defaulting and leaving the Euro but what doesn’t get mentioned is that Greece can actually default and still keep the Euro because there is no mechanism in the Euro system to expel anyone from the Euro once they have adopted it as their currency. He thinks that may be Greece’s best option.

  9. Hi AnonNL (MB’ers)

    The mood in Athens right now is that the people have given up even the pretence that they’re playing along. The economy is being ground into the dirt & the people are taking it back underground as they’re getting into “survival” mode.

    The problem with Greece (and the same around the Med, from anecdotal evidence of other friends in southern europe) is what i call Dysfunctional Saturation. That is that the system of political & economic governance in these states has reached a Dysfunctional Saturation point where any reforms are ineffectual or similar to a defeated general moving around fictituos armies on a map. They power of influence they think they have to make things happen is just a fiction.

    The populations, due to this saturation point have also lost faith in their own systems so therefore ignore or “go-slow” on any directives issued by the authorities. It’s worse here and in italy where the leaders are deemed to have abdicated any authority to technocrats who are seen as yes-men to foreign powers anyway.

    But here is where a localised problem quickly spirals out of control. The solution is a “CTRL ALT DEFAULT” coupled with a re-wiring of the polito-economic system ala Japan in 1945 by the US. The institutions don’t work so need root & branch reform/rebirth. But sovereign states just cannot impose those “solutions” on others (especially in Europe given the over-riding historical pretext).

    So the current arrangements must be struck down. That means the Euro in this case. The Euro is just a monetary expression of political power (and the inherent European imbalances therein). So it’ll fall apart by definition (it’s already begun).

    The mistake commentators are making is in thinking the sovereign debt crisis is just a theoretical economic problem. They’re not seeing the big picture. Europeans aren’t ready to be “Europeans” yet, especially if it means sacrifices in their standards of living.

    The sovereign debt issue is too big to be fixed by conventional thinking. That’s because the elephant in Europe’s room (and for me, the US one as well) is the unfunded social liabilities to come. The system will collapse, the Euro will fracture and new currency blocks will form in desperation to tackle the over-indebtedness, only to fail again. A large reason for that imho, is the traditional shock absorbers of localised currencies & interest rates which let off enough steam to stop Dysfunctional Saturation from spreading have gone.

    Apologies for the scattered & long post but it’s hard to summarise the various threads to this issue in a short space.