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Greek Talks Collapse, Default Looms

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Both sides in the Greece/creditor negotiations have said they have reached the limits of what they are prepared to give.

Talks on Sunday fell apart after a mere 45 minutes. The immediate impasse is an inability to bridge the gap on what the IMF surgically calls “making the numbers work” or meeting the creditor’s primary surplus target of 1% for this year. Greece had proposed in its 47 page document a target of 0.6%, which it increased to 0.75%. The difference between the two sides the path by which Greece gets to a stringent primary surplus level of 3.5% a year by 2018 is a bit under a €2 billion per year gap. The lenders pushed for more cuts in pensions, higher taxes on energy, and VAT increases, and the Greek side would not budge.

The locus of decision-making is again at the political level. The key date is JUne 18, when the Eurogroup meets. However, ECB chief Mario Draghi is speaking at the EU parliament today at 13:00 GMT, and the ECB also has one of its regularly scheduled two week meetings this Wednesday at which they decide whether or not to increase the ELA.

Even though an IMF default is not a bright white line, June 30 is not just the date when Greece will default absent somehow cinching a deal, but it is also when the bailout will expire unless the Eurozone countries all agree to extend it. The sour mood on both sides makes that seem well-nigh impossible. More former supporters of Greece are siding with the Troika. For instance, Sigmar Gabriel, the head of Germany’s Social Democratic party, which has taken a more sympathetic stance towards Greece, took a much harsher tone in an op-ed in Bild over the weekend. A translation from the Financial Times :

“The game theorists of the Greek government are in the process of gambling away the future of their country…Europe and Germany will not let themselves be blackmailed. And we will not let the exaggerated electoral pledges of a partly-communist government be paid for by German workers and their families.“

The key creditors all appear to have reconciled themselves to loss recognition. One of the fallacies we’ve seen in both media and financial commentary is that a Greek default will trigger a loss. Assuming the creditors don’t have a way to finesse it, what it instead triggers is loss recognition and a wrangle over who absorbs how much of it.

Even though the financial media keeps citing the face amount of Greek debt, that’s not what is at issue. Like a house that someone bought at $200,000 but is now worth $90,000, everyone knows that Greek loans are less than their face amount. As we’ve stressed, they’ve already been cut in economic terms by extensions of maturities and reductions of interest rates. The creditors fully expected to take more economic losses; had Greece gotten through the bailout and gotten its €7.2 billion in bailout funds, it was set to roll right into a new negotiation over debt levels, which the lenders have called the third bailout (with the 2010 and 2012 rescues as the predecessors; confusingly to those without a scorecard, the €7.2 billion “bailout” at issue now is part of the previous deal).

Good economics tells us that the Greek debt burden should have had a severe haircut three years ago at the latest. That’s not what happened and yes, that was a mistake. However, now that everyone’s been watching this for years there’s just no possible political manner in which this demand could be accommodated. Because the citizens in those other eurozone countries understand all to well that it is their tax money which has been lent to Greece. And if there’s a haircut then it’s their money that is being lost. Whether this is true or not doesn’t matter: but the Northern Europeans view the Greeks as work shy people who retire very early on indeed. And they simply will not put up with having to pay for that. Again, that’s it’s mostly not true simply does not matter: politics is about what people believe.

There are ways to do this and no one will complain. In fact, it’s already been done. By lowering the interest rate that Greece has to pay, offering capital repayment holidays, extending the terms (some of this debt need not be repaid for 50 years) the net present value of what is owed is rather smaller than the headline amount. Those eurozone citizsens have already lost ther money but it’s been lost to opportunity cost and inflation, not to a haircut that they can actually see. There’s undoubtedly another iteration of that which could be done to lighten the burden again upon Greece. But, Tspiras, for his own domestic political reasons, needs to have that headline cut. The very thing the other eurozone governments cannot give him if they are to keep their own holds on political power.

Now again, remember, the creditors were willing to provide more in the way of covert haircuts; indeed, they fully expected to do that. And many commentators’ assumption was that the political unpalatability of having to financially unsavvy voters know that all that Greek debt that their governments hold has been written down in a big way was a third rail issue. That in turn would mean Greece had a negotiating trump card without having to go the Grexit route (which is remains unpopular with Greek voters). A default would mean loss recognition which would put elected European officials in all sorts of hot water.

We had concrete evidence that ‘fessing up to Greek losses wasn’t the Eurozone leader political death threat Greece believed it to be in May. Remember that Tsipras said Greece would default in mid-May, only a few days later to have Greece borrow against an IMF reserve account to pay the IMF. The creditors did not offer any concessions then to forestall a default.

I thought at the time that the creditors holding their ground meant they had some sort of trick up their sleeve, that they might not have to recognize the losses (as in write them down) even if Greece defaulted on the IMF, which is the most senior creditor. But the willingness to tolerate a Greek default may be the result of something simpler. The creditors have succeeded in moving public opinion in most Eurozone countries even more to their side (witness the Bild op ed), so that if Greece defaults, the elected officials believe they can pin enough of the blame on Greece so as to limit any damage to them personally.*

A Greek default is not a “get out of paying” card. When countries default against mere private lenders, they don’t get away with not paying. The debt gets restructured, as in written down in economic terms to something that the borrower can hopefully meet, and the various lenders scrap among themselves. And remember, official creditors are in a much better position to extract what there is to be had than private lenders.

The ECB may lower the boom on Greece. The creditors, assuming they can reach agreement, may try a last “offer you can’t refuse before the Thursday Eurogroup meeting. The ECB would be the most likely enforcer. Mario Draghi is speaking later today, so he may show a bit of steel. Peter Spiegel of the Financial Times mentions one option we have discussed previously, that of a repeat of a brute force move used successfully against Ireland and more recently Cyprus, to remove the ELA :

…. eurozone negotiators may resort to the “take it or leave it” strategy used on Cyprus at a eurogroup meeting two years ago.

On that occasion, an ECB representative warned that without a deal, the central bank would be forced to cut all emergency funding to Cypriot banks — essentially laying waste the country’s financial system. There have been similar pressures on the ECB in the past week to take the same stance with Athens.

However, my guess is that the ECB will not do this immediately, although it might based on what Greece does in the coming weeks (as in they’d like to be able to pin the blame firmly on Greece). It may well depend on their reading of how much sway Varoufakis and like-minded members of Syriza have on Tsipras. Varoufakis has long been opposed to a Grexit, and has written forcefully that it’s not at all like an Argentina-style mere severing of a currency peg. The viability of the ECB playing the heavy is reinforced by the fact that….

The Left Platform is still pushing for a Grexit .I’m not sure It’s distressing to see the Left Platform, which has a far more acute grasp of the

power dynamics of the negotiations that the Syriza mainstream has, to be so out of their depth as to what actions to take in response. While a default is less destructive to the Greek economy, the Ambrose Evans-Pritchard reports that the Left Platform has called for an “Iceland-style default”. Remember, Evans-Pritchard is a Euroskeptic and has regularly taken a Syriza-sympathetic position. Even so, he feels compelled to stress why Greece sin’t at all like Iceland :

Iceland’s internal banking system was rebuilt from scratch under state control with public funds equal to 30pc of GDP, and was shielded by capital controls. The boards were sacked. Some executives were prosecuted….

Iceland gradually recovered and has since racked up impressive growth. Contrary to apocalyptic warnings, a 50pc devaluation proved to be part of the cure. The krona has since strengthened slightly against the euro.

However, Iceland has a very different society and economic structure. Quick stabilisation was possible only because the IMF and the Nordic countries stepped in with a $5bn rescue package.

Greece has already exhausted its IMF quota in the two failed rescues of 2010 and 2012, and is now at daggers drawn with the Fund’s team in Athens.

To put none too fine a point on it, Iceland has a population of a bit over 300,000. A $5 billion rescue package is massive relative to the size of the economy. Iceland also had been through a sustained boom before its bust, so its citizens took a big hit from a starting point of prosperity and a well functioning government (albeit one that was lousy at bank supervision). And it already had its own currency, so it did not face the trauma and disruption of a having to scramble to implement a new one (we have a post coming up shortly on the operational issues of a Grexit**).

The resolution of the Greece/creditor deadlock may also mark Peak Neoliberalism. It’s possible, but only remotely so, that Greece and its creditor overlords will back off from their collision. But as we’ve said for years, Germany is wedded to incompatible goals, namely running large trade surpluses but not financing its trade partners. It is destined to burn them down if it fails to find a new course of action. Greece is also wedded to incompatible goals, namely getting a real break from austerity while staying in the Eurozone.

On the current trajectory, Greece will suffer horribly under a default or Grexit. The creditors have the incentive and the means to make either one more painful than continued austerity so as to force Greek citizens to capitulate and vote in a more compliant government. There is a bloody-minded faction that includes Finland, Latvia, Spain, as well as some ECB governors that is eager to punish Greece and sees that as necessary to preserve the Eurozone. We’ll see soon enough whether these austerity radicals that we call the ultras persuade enough key players to put their plans into action.

But even in a less punitive scenario, a default or Grexit will do very serious damage to an already fragile and deeply depressed economy. Those who assert that Greece will bounce back quickly don’t have an economy this close to being a failed state as a comparable.

Our view has been that the most likely scenario is a default in the Eurozone, and that the authorities have likely underestimated the damage if the impasse ultimately leads to a Grexit. Even if they are correct that financial contagion is contained, political contagion over the next few years is another matter entirely.

But on a bigger frame, no matter how badly things turn out for Greece, the institutions at the core of the European project will emerge with their image badly damaged. The dirty secret has long been that the program of European integration was designed to produce rule by technocrats. Those technocrats, by being captive to bad ideology, have failed to deliver on the basic obligation of government: to provide for the safety and well-being of their populace. In a capitalist society, that means producing enough decently remunerated jobs.

However, even if neoliberalism winds up receding as a result of the brutal Greek negotiations, it’s naive to assume that the exposure of the bankruptcy of neoliberalism means a return to the old European model of more social welfare and (at least in theory) democratic accountability. Ironically, the train wreck we are seeing now can be presented as a prime example of the dangers of democratic rule: a democratically elected government in Greece demanding better treatment from its jailer/creditors, when the most of the debt is held by democratically elected governments who are not willing to give Greece the breaks it wants. And as we’ve stressed from the outset, the fact that the two sides can’t come to agreement is that Syriza’s red line of pensions is also a red line to voters in the states that have provided funding to Greece.

Thus even if the Greek denouement does represent Peak Neoliberalism, that does not mean that social democracy will emerge victorious. It simply means we will grope towards a new political order. Only if citizens are vigilant and engaged do they have a hope of coming out as winners.


* Some observers are placing more stock in a blog post by Olivier Blanchard of the IMF that is warranted. in which he argued both sides need to make concessions. Blanchard is head of the research side, which has no role in the “program” decisions being negotiated with Greece. In fact, for years there has been a noteworthy disconnect between IMF research, which is often anti-austerity, and program design and implementation. While Blanchard does take up the IMF position, that Greece needs more writedowns, that’s not news since even the program team has been calling for that since at least April 24 (at the last Eurogroup meeting). Given a leak in Faz over the weekend, that Lagarde reversed herself on a proposal by Juncker to let Greece fund pensions for the poor by cutting military spending by €400 million, it seems that the IMF is holding fast to its hawkish position. And Blanchard reinforced the notion that Greece would have to cross red lines to get a deal done:

….the Greek government has to offer truly credible measures to reach the lower target budget surplus, and it has to show its commitment to the more limited set of reforms. We believe that even the lower new target cannot be credibly achieved without a comprehensive reform of the VAT – involving a widening of its base – and a further adjustment of pensions. Why insist on pensions? Pensions and wages account for about 75% of primary spending; the other 25% have already been cut to the bone. Pension expenditures account for over 16% of GDP, and transfers from the budget to the pension system are close to 10% of GDP. We believe a reduction of pension expenditures of 1% of GDP (out of 16%) is needed, and that it can be done while protecting the poorest pensioners.

So Blanchard is fully in line with the program team’s position. He’s just trying to put a nicer spin on it.

** I am sure some readers will point to a Wolfgang Munchau piece today, Greece has nothing to lose by saying no to creditors. in which he advocates a Grexit. Munchau is normally a sound columnists, but this article is a marked departure. I’ve pre-debunked some of its assumptions above, such as the notion that Greece can somehow pay private creditors but not official ones, and so they will face enormous losses. That’s not going to happen. Start with the fact that defaulting on the IMF means Greece loses access to trade finance. There are other implements of enforcement that official creditors that private ones don’t. And it ignores, as we and Worstall pointed out, that large losses have alrready been taken in previous restructurings. Moreover, its claim that Greece is “relatively closed” is technically accurate but substantively misleading. Nathan Tankus will discuss the issues regarding trade in his next post on Greece, but the short version is that Greece has a low ration of import value in its exports. One of the implications is that Greece really does use (and by implication, need) its imports in its domestic economy. Think of pharmaceuticals and machine parts as a proxy for Greek imports. When those go up radically in price as a result of a Grexit, it means many already strapped buyers (consumers and businesses) go without. That has knock-on effects (health risks, loss of revenues to already fragile business leading to increased failure rates).

We’ll have more nitty-gritty detail on the operational issues of a Grexit on Tuesday or Wednesday. Stay tuned.

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