What happens if Greece is pushed too far?

Another week in the history of the European economic mess  and, aside from the Ukraine, it’s all eyes on Greece.

As I mentioned 2 weeks ago I feel this entire episode is far too politically innocent on the Greek side and the idea that the Greeks could simply front up to the Troika and say “let’s not do this your way, we’ve got a better plan” was completely naive and remiss of the last 5 years of economic stupidity in Europe. I also noted that although I thought this was likely to be the first volley in possible a long tussle, the Eurozone core were playing a rather dangerous game.

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 ?

Maybe I should have said Spain instead? It’s early days there, but Syriza was just a tiny blip on the political radar not so long ago , and I don’t expect the likes of Podemos to remain in the shadows for too much longer. It’s starting in Italy too.

Since I wrote 2 weeks ago we have seen the ECB start the sabre rattling  with the removal of eligibility for Greek bonds as EuroSystem collateral, ramping up the ante and pushing more risk back on the Greek government via the ELA. As noted by H&H this move is likely to increase the speed of the Greek bank run but, given it ultimately saps new liquidity from the Greek banking system, it also means that even credit-worthy customers will find it hard to get new loans crimping the economy even further.

Personally I find this meddling (read blackmail)  in the affairs of supposed sovereign nations completely outside the mandate of the ECB, they are unelected officials after all, but they’ve got form on this type of thing (remember Spain and Ireland) and you can never underestimate the madness of a large group of old white men when their power is threatened.

Obama has thrown his support behind a new plan for Greece, and the Austrians look like they could be moved,  but the Germans didn’t budge an inch on outright debt relief.

German Chancellor Angela Merkel on Saturday rejected the prospect of debt relief for Athens, adding to tensions between the radical new Greek government and its international creditors.

“There has already been voluntary debt forgiveness by private creditors, banks have already slashed billions from Greece’s debt,” Merkel said in an interview with the Hamburger Abendblatt newspaper published Saturday.

“I do not envisage fresh debt cancellation,” she said.

As you can plainly read in this week’s cracking post from Michal Pettis Germany has been in Greece’s shoes in recent history only to be dug out by the assistance of its own creditors. But that is another story…

After that message from Ms Merkel, Yanis released the first compromise, telling the Finance Times that his government was not calling for direct debt write-offs, but was proposing to change the metrics of current debt instruments and primary government surpluses.

This was met with the following from the German Finance minister:

“We want Greece to continue going down this successful path in the interests of Greece and the Greeks, but we will not accept one-sided changes to the programme,” Schäuble said.

Schäuble also stressed that the troika, consisting of the International Monetary Fund, the European Central Bank /ECB) and the European Commission, must remain involved in supervising the bailout. This was agreed under EU treaties and according to Schäuble, “you can’t change them.”

Later in the week the Greek and German finance ministers met face-to-face and it was very clear nothing came of it:

Mr. Schäuble stressed that he had a very different view to those of his Greek counterpart but explained that they had “agreed to disagree”. Mr. Varoufakis contradicted Mr. Schäuble, noting that “we didn’t even agree to disagree”.

So even after giving up a major pillar of Syriza’s election promises,  Yanis’ dream of rolling over debt into adjusted/different instruments (lowering rates/extending maturities of existing bilateral/EFSF loans, using GDP-linked and/or perpetual bonds etc) and rolling back the government sector surplus requirements look as distant today as they did 2 weeks ago.

That’s the rub.

This rock is coming together with a hard place. Unlike the old Greek political class, Syriza was voted in on a clear mandate to ratchet back the austerity program. That may have been political naivety on the behalf of the Greek people, but it still changes the battlefield significantly as Syriza aren’t simply going to rollover. Talk of Grexit may be still off the table and, as it was never stated as an option from Syriza, I’m sure Yanis and his party are aware of the pain it would bring if it were to occur. But at this stage I’m finding it difficult to see a path being built that is political palatable to both sides, one they can both take home and sell to their countrymen.

A Grexit still isn’t my base case, I’ve seen the Eurozone pull itself back from the brink time and again, and the Euro is very much a political tool as it is an economic one. But it does pose the question, once again , “if it could happen how much would it cost everyone?”

The answer is … no one knows, as Ewald Nowotny of the ECB said in January:

Greece’s exit from the Eurozone would have unknown contagion effects on the other members of the currency union

There are some primary estimates of around a €80 billion hit for Germany, €40 billion for France, €35 billion for Italy, Spain €25 and so on, but these estimates don’t include private claims and are really just the split of the outstanding government debts on each nation. The Eurocrats of Brussels believe their €440bn EFSF firewall could withstand the attack, but I’m not so sure because it instantly introduces the idea that an exit from the Euro is possible and I suspect financial contagion into other weaker nations would occur swiftly, and this would also include the non-government markets. I suspect as well that is what Mr Nowotny was alluding to in his statement above.

So Greece has all the cards then ?  Yes, if you believe the fairy tale that goes something like this (these are my words):

Greece leaves the Euro and rolls back to “Drachma”. In the short term there would be a large wave of inflation that couldn’t be instantly met with greater production from a lowered currency, you would likely see yet another short term rise in unemployment and the banking system would need to be instantly nationalized with the introduction of strict capital controls. Greece’s stock market would collapse and the country would be locked out of world financial markets for some time. Greece would also likely lose a number of EU subsidies and capital inflows provided by the EU budget.  There is no doubt it would be hard going, worse than it is now for a short period, however, Greece now runs a primary budget surplus and a trade surplus. Dump all the interest payments on debt through default and the country is a viable trading nation capable of meeting its on funding obligations without external help. With a “drachma” currency net exports would likely rise quickly and you would expect to see a sharp decline in unemployment.  Yes, living standard would decline again in the short term, but over time there is no reason why the country couldn’t see a robust economy.

There is only one BIG problem with this story and it’s this:

The biggest chunk of repayments in 2015-2016 are due to the IMF, which as I explained above is owed about €11.7b and has already agreed to roll over about €9b. As a rule the IMF never forgives debt, and I don’t see it making an exception for one of its wealthiest debtors. IMF loans are like US Federal Student Loans: they never go away, however long you’re in default. International aid organizations stick up for each other, so Greece would be a pariah in that community until it made a deal to get out of default.

The third big group of Greek creditors are Greek institutions, mainly banks and pension funds. Of these the biggest chunk is the €13.3b of short-term treasury bills that were outstanding as of the end of September. Greece wouldn’t gain anything by defaulting on these debts, except big losses for its banks. The EU and IMF appear to be assuming that these debts will be rolled over.

And finally there are the holdouts who refused to participate in the 2012 restructuring. So far they have been getting paid 100%, which must be galling for everybody who took haircuts of 53.5% by face value and about two-thirds by net present value. But the holders of these bonds are largely vulture investors, who know how to cause enough pain in foreign courts to make it not worth the fight. And they bought the best bonds to go to court with. I haven’t got the details on how much of these come due in 2015-2016, but I’m guessing it’s less than €2b since there were only €6.4b of holdouts in total and some have already been paid.

So two points to make:

  1. If Europe thinks it can get out of the Grexit unscathed it’s dreaming.
  2. If Greece thinks it can get out of Euro unscathed it’s also dreaming.

And the games continue…

 

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