Greece’s next act

Nearly 4 years ago I authored a post on MB titled “Greece’s inevitable default” in which I outlined why I suspected that Greece would continue to stumble from bailout to bailout while the economy slowly imploded.

… I am simply going to explain what has happened so that I can explain why under the current economic environment it must default on its debt at some point.

The main points are:

  1. Germany continues to pursue a policy of aggressive wage restraint.
  2. Austerity is lowering industrial output in Greece.
  3. The common currency binds European countries of differing productive capacity, leaving labour markets as the single point of economic response flexibility
  4. Financial liberalisation and centralised monetary policy means there is no national credit control mechanisms.
  5. Weak taxation collection and foreign-friendly fiscal policy did not allow Greece to effectively re-capture recycled trade surpluses from foreign nations.

Since I wrote that we have seen default, more bailouts, a number of Central Bank monetary tricks and of course, the inevitable implosion of the ruling Greek political class of the time. The latest round of elections all came to a head on 29th December 2014 when the Greek parliament couldn’t manage to elect a leader forcing the country back, once again, to the polls. As we saw on the weekend Syriza, and its leader Alexis Tsipras, who threatened last time around, swept to victory and has now formed government with the Independent Greeks  party under an “anti-austerity” banner.

Yanis Varoufakis, who many of you may know if you have read naked capitalism over the last few years, is Tsipras’s economic adviser and likely to become Finance Minister in the next few days. If you want to understand what you are likely to see from Syriza in the coming months I advise you to watch this:

In the interview Yanis discusses the delusion of the current EU model and what his party will be offering as a path forward including yet another haircut, GDP link bonds and various other ideas, none of which include a Grexit.

I’ve followed Mr Varoufakis for a number of years, his ideas aren’t far from my own and in terms of describing the inevitability of failure within Europe’s current macro-economic settings, and it isn’t hard to find articles of him talking about far better approaches to dealing with the issues. For example:

Ideally, bond purchases should be proportional to a member-state’s debt overhang and its output gap or investment shortfall. Of course, one understands that the ECB faces political and legal constraints that prevent it from pursuing a sovereign-bond-purchase programme that would work well in practice. For this reason a different type of asset-purchase programme would be preferable, one that bypasses the legal and political constraints that the ECB is currently facing and one that is potentially far more effective in tackling deflation and the chronic underinvestment that has caused it.

…European Central Bank should purchase a single asset in the secondary markets: European Investment Bank bonds. To make this programme macroeconomically significant, the European Investment Bank should at the same time embark upon a large-scale, pan-euro-zone investment-led recovery programme, safe in the knowledge that the ECB is standing by to keep EIB-bond yields ultra-low. Such a partnership between Europe’s two significant institutions, the ECB and the EIB, would:

  • promote monetary stability and an investment-led recovery
  • overcome the ECB’s legal difficulties regarding member-state debt-financing (since no sovereign debt would be involved)
  • avoid inflating asset prices (as the ECB’s intervention would be channeled directly into investments in the real economy, rather than inflating paper values)
  • signal to markets and citizens Europe’s determination to defeat deflation, bolster investment without new government debt, and crowd in private investment

All fair ideas but, as you may have noticed if you watched the interview, it is all a little politically innocent. If I have learned anything from following Europe for the last half decade it is that just because it makes sense in no way means it will occur. There have been a long line of economists telling Brussels they were creating a macroeconomic disaster even before the first euro was minted, but it has made little difference to the outcome. As Europe enters a new era of deflation, the macroeconomic settings aren’t far from where they were five years ago. Portugal and Ireland are better, Italy and France are sicker , Spain much the same, the imbalances may have shifted around but they are still present and German-led core have done little to nothing to adjust their own policies which are half the problem. (See here for more on this )

Obviously the big question now is what next ? With political leaders like Front National leader Marine Le Pen in France looking on in delight and the ever-crazy Italian political system watching on avidly in the corner, Brussels and Berlin are sure to be concerned about this latest development. Germany, through the Troika,  has always been hard-line with the Greeks , even in the face of evidence that it knew its plans were faulty; but this is a new beast. Sure Syriza isn’t running an anti-Euro campaign like Le Pen, but this is a very clear political shift in that direction from the Greeks . If Syriza fails on its own anti-austerity mandate because of what is seen as bullying from the rest of Europe the next step is surely Grexit via a party even further disconnected from the EU. Europe may believe it has it’s firewalls in place to deal with such a thing, maybe it does, but it’s a very slippery slope , especially if the Greeks took it in their stride and came out the other end better off. What then for the likes of Italy ?

But alas, that’s all hypothetical at this point. In the meantime the clock ticks down to the inevitable next “last bailout Greece will need”:

Greece will likely have to ask for a fresh extension to its bailout programme because it expires on Feb. 28, a senior euro zone official said on Friday, stressing that a new government must first be in place to do so.

“I could construct some constellations where it would be possible to finalise the fifth review (of the programme) in February … but I would consider this on the outer fringers probability,” the official told reporters on condition of anonymity.


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  1. There you are. I was about to request a post from you.

    That Yanis Varoufakis video is not showing up. Can you fix that.

    Another little known fact about YV is that he worked as a consultant to video game maker Valve.

  2. It is interesting that the “mainstream” had finally woken up to the reality of the so clearly & fundamentally flawed model of EU after all these years.

    It has been said that a market (read people) can stay irrational for longer than you can stay solvent, but for this long (2 decades)?

  3. People see this all in terms of doom and gloom, and given the recent past record, quite reasonably. While this leftwing shift, now beginning in Greece, but soon to spread to other hard hit countries, could make the Eurozone go into a chaotic breakdown, I see that the galvanizing of the hard left will force the Germans to relent on hard core austerity and since the infrastructure of much of the Eurozone has been neglected since the GFC, much useful stimulus works is there to be done, and done affordably at very cheap rates. This, along with cheaper energy will give a big stimulus to Europe and renewed growth. The danger is if the Germans dig in, but with their own economy now precariously balanced on the edge of recession, I think a possible softening in their attitude towards such useful spending is likely. By the way, both Spain and Ireland have been posting on the upside recently, so I feel there are grounds for cautious optimism.

  4. Good post…

    In late 2011/early 2012 I spoke with senior economists and analysts from 20 odd European banks (I bounced around Europe over six weeks). They were all asked explicitly if they thought Greece could service its first bailout package and if they thought it likely that Greece would remain in the Eurozone.

    Not a single one of them said that they thought that Greece could sustain the debt that was being asked of it. Not all were prepared to go on record about it (I was speaking to them for both private investor/fund purposes as well as journalism purposes), but all were quite forthright about their views off record.

    The only real discussion was about the sort of circumstances which would unfold as Greece was forced to depart, and – importantly where we are today – what the time between then and the Greek departure needed to be used for by the rest of the European banking system.

    Given that Europes economy has not improved over that 3 years, and that it now has sanctions against a nation which was providing it with a capital stimulus, I sure hope they have done something more than paper over the holes in their banking system. But I am not sure they have.

    Nobody is talking about Grexit officially, but there is a yawning gap between the austerity relief position of Syriza and the debt management/austerity/no bondholder haircuts position of the European Commission and the Troika (IMF, EC and ECB) and the backdrop to the discussions that now must be had (on both sides) is that Grexit is a genuine possibility.

    Ultimately if Syriza are to retain political credibility with those who have delivered them power they can’t be seen to have swung around to become yet another Greek government used as a punching bag by the Troika en route to the crudest socio economic experiment visited on any population (let alone one which would purport to be in the developed world) since the Irish famine of the 1840s, in the name of ensuring that bondholders – read European banks and institutions – don’t take a haircut on Greek debt already farmed out.

    As Yanis Varoufakis (who actually has an Australian passport, though he is at a US university from memory these days) says in that Bloomberg video that DE has linked to the Troika handed money to Greece (though it was all destined for debt servicing purposes and ended up with European banks and institutions) when it knew that Greece was insolvent. The critical question from that point is ‘who is responsible, or at greater fault for giving money to someone insolvent: the lender or the borrower?’ The Troika position is that it is the borrower. The Syriza position is that the lenders need to look somewhat at themselves.

    It is worth bearing in mind the size of the exposure of the Eurozone (though there are other exposures these are the key ones) to Greek debt. Here is a chart from earlier this month posted in

    To add some further context to that chart here is an old BIS (circa 2011) chart on where the debt sheets home to. Things have changed only marginally since then in terms of the size and the exposure to Greek debt.

    A look at the debt schedule Greece is currently committed to brings us to this, from the FT last August. As we can see under the current schedule the biggest hump in the road was 2014, this coming year is likely to be similarly onerous, but from 2016 onwards there is some scope for lightening the load.

    Though a look further out than 2020 shows that those debt load is being piled right up out to beyond 2050

    Potentially that provides some scope for the Troika to move from this year out into further years some of that debt. But a brief look at Greece GDP doesn’t inspire. No matter what these guys are going to be doing things tough.

    After thinking about that are other issues to think about. Europe’s economy is listing precariously in heavy swells without a political rudder and nothing looking like driving momentum anytime soon. It is holed beneath the waterline of its official statistics by widespread deflationary sentiment, crippling unemployment, with its structural integrity being corroded by a currency which prevents peripheral nations from making the necessary competitiveness adjustments, while at the same time tying them to running current account deficits while Germany at its core runs surpluses.

    For political reasons it chose to cut itself off from the capital outflows from Russia – which in the period from 2009 to 2014 Q2 amounted to $476 billion USD, about the same size as the Greek debt position, and which were predominantly flows into European banks – by imposing sanctions [don’t get me wrong, there are plenty of reasons to impose sanctions, but ultimately one could ask if there was some form of bureaucratic sadomasochism at play in imposing fiscal sanctions by the EU] while at the same time depriving European agricultural producers (Greece prominent amongst them) of their largest export market.

    It has had 6 years to try and map out a path to growth, yet it is only within the last fortnight that it has gone anywhere near to adopting what the US Fed did back in 2009 (and the Fed stated from the get go it was going for growth and wouldn’t stop until it had it), but in circumstances where the ECB’s ability to prevent a deflationary spiral is being seriously questioned within the Eurozone. The Greeks might rightly ask what is in this for them in the foreseeable future.

    At the moment the most recent Eurostat forecast for Greece has GDP anticipated to grow by 2.9% this year. The forecast of growth 3 times any growth posted in the last three years, which are the only years of growth in a decade, in a Eurozone fending off deflation, speaks for itself. It is laughable.

    While the gap might conceivably be bridged you would have to ask about the European political dynamics at play. For its own domestic internal political cohesiveness/dynamics the EU has to be able to point to the Greeks as an example of the fate which awaits nations if they cannot maintain the discipline required by the EC. So far they have taken depositors to the cleaners in Cyprus, seared migration and unemployment into a generation or Irish, sacrificed a generation to unemployment in Italy and Spain, and pared Portuguese outlays to the bone. Backing off on Greece would have great potential for having all or some of these nations to ask if they can have some too.

    On the other side of the coin nations like Finland and Netherlands have negative short term rates, and would presumably need to explain to their domestic populations why it would be that they need to pony up for another Greek restructuring. Finland in particular (with its Scandinavian neighbours not part of the Eurozone) could well ask if it really needs to be in. Of course the UK goes to an election in May where (courtesy of UKIP) European ties are going to be mightily strained, and other anti EU political parties across the continent are getting some traction. The Germans have their elections in 2017, but Merkel isn’t likely to want to let the Greeks off lightly from here. Draghi and the ECB need both the festering sore on Eurozone sentiment that is Greece , and the banking system questions that Greek debt exposure has for the Eurozone financial system, like a hole in the head.

    If the decision by both Syriza and the Troika is that their differences can’t be reconciled then there is a genuine global financial system shock moment upon us. The most profound would probably be in Greece, where everything would need to be reconverted to a Greek currency in very short order – presumably involving bank holidays to buy time. The banks in the Greek system have become increasingly reliant on emergency liquidity assistance, continuing a trend over the last 3 years, from which they would presumably be at risk of being cut off and would face a run from depositors.

    Should Greece go to a new currency it will have a currency worth its trading performance. And it is for that reason that the EU cannot allow the Greeks to have a reasonable trading performance once it departs the Eurozone – imagine the model held up to Spain or Ireland if Greece is allowed to eject from the Eurozone and generate an economic rebound. Just imagine saying to those deposit holders who had their savings knocked off in Cyprus 18 months ago that they could have kept their money and Cyprus been reasonably plausible as an economy if it just left the EU, or those Irish mortgagees, or the Spanish (or Italians). For mine this means if the Greeks depart they will get heavily cut off from the rest of Europe.

    Things are no less traumatic further afield. After a series of ‘stress tests’ over the last 4 years in which the ECB has gradually pushed banks to firm up their asset bases, just think about the implications of having a major stress test (against the backdrop of EU deflation or near deflation, with major employment issues) across every bank with exposure to Greek debt – and then to every bank with exposure to every bank with exposure to Greek debt – and the societal and political implications that could possibly entail. To some degree for its own survival the EU needs to go the mutually assured destruction line with Syriza and be credible about it, and Syriza needs to push the EU to that line for its political survival.

    • Very good.

      Gunna – re a return to the Drachma.

      I don’t think there ‘needs’ to be a bank holiday.

      A soft re-introduction of the Drachma is possible. This would limit the politics of converting Euro savings into Drachma savings and the inevitable rush on every ATM in Greece to get as many Euros before a conversion to Drachma takes place.

      All the government need to do is to re-introduce the Drachma as a legal currency alongside the Euro and use it for paying for govt services (social security, services etc) and require taxes to be paid using it.

      Banks could create for each depositor a Drachma account.

      People receiving payments from the govt would either deposit them into their Drachma account or convert them to Euro at the prevailing exchange rate and deposit those Euros into their Euro accounts.

      Payment of taxes to the Greek government would come from their Drachma account or they could convert money from their Euro account.

      Businesses would be free to accept Euro or Drachma in exchange for services.

      With modern computing and payment systems less and less cash is actually used so it is not going to be major hassle for most purposes.

      Of course the value of the Drachma against the Euro will reflect the extent to which the Greek government issues more Drachma than it receives in taxes but that is no different to anywhere else.

      Oh – and Greek banks would have no powers of endogenous money creation in Drachma. They would be full reserve – mere intermediaries. None of that zero or fractional reserve loan creation fraud.

      A bit of competition amongst currencies – just what the doctor ordered.


    “The fact is, Brussels is the epicenter of an utterly failed superstate and the ECB is a radically misconceived monetary experiment that has no place to go except toward an eventual violent implosion.”

    The thriple mast vessel prepares to ‘come about’ and many on deck are unaware of the perils of this manoevre.

  6. SkoptimistMEMBER

    It would be interesting to see how much money was transferred out of Greece and into Swiss francs in the last couple of weeks.
    A Grexit would see the complete elimination of the life savings of the average Greek citizen. I am guessing the demographics in Greece are similar to those elsewhere in europe so I cant see how there would be much improvement.
    I guess the question would be who would lend them any money if they they left?. The Russians or maybe the Chinese?
    As a geopolitical move they may consider it. But I doubt they would be as forgiving as the EU.
    In the end Greece needs fundamental reforms that usually only happen when there is no alternative.
    While I havent followed this I havent heard of mass arrests for corruption, so I doubt Greece is yet ready to change.