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Europe

Round 5 and Greece is Winning

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Alex Tsipras has been called the most dangerous man in Europe, reviled as a modern Goth set to destroy the edifice of the EU, a foolhardy populist whose view of economics and finance is closer to Stalin than to Schäuble. Most of the defamation heaped upon the leader of Syriza was in the two or three years since the last Greek elections, when the left-wing party emerged as a serious contender. It was an obvious scare tactic by European financial elites to scare the average Greek into voting for New Democracy. It was a way of saying: “Things can still get worse.” But in a country where the pension fund is empty, the hospitals are closed, gross domestic product has fallen by 30% and no one has been held responsible, that warning was no longer believed.

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So far, things have not really gotten any worse. Since Mr. Tsipras formed his government, Greek stocks have suffered and the premium on sovereign bonds has increased; but the shifts have been very modest compared to the vast swings at the height of the panic over the likelihood of a Grexit in 2010.

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Besides, these developments mean nothing to the average Greek on the street. They are worried about the lack of jobs, the burden of new taxes and the collapse of social services: the returns on the ASE 10 Index really aren’t keeping them up at night. It is true that deposits in Greek banks fell sharply in January to levels not seen since the height of the Euro crisis in 2010, but the hemorrhage has slowed considerably in February. And movement of deposits within SEPA is highly volatile: since there is no cost to move deposits from a Greek bank to a German bank why not do it at the slightest hint of trouble? Conversely, the deposits flow back very quickly as well, as the 2013 data indicates.

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Much has been made of the European Central Bank’s decision to suspend the ability of Greek banks to use government bonds as collateral for loans from the ECB, but this has been overblown. Much of the deposit flight had already occurred before the announcement was made; if anything, the flow has slowed subsequently though not in consequence of it. The ECB taketh away with one hand, but giveth with the other: at the same time as it was issuing its decree of suspension, it was approving the use of the Emergency Liquidity Assistance facility. The ELA allows a National Central Bank (Greece’s) to provide to a solvent financial institution either Central Bank money or any other assistance that may increase the Central Bank’s balance sheet. In other words, the ECB has merely shifted some of the risk of a Greek financial collapse onto the Bank of Greece, which is now the institution receiving junk collateral in return for additional liquidity. There should not be a short-term credit crisis for Greek banks.

The crisis is by no means over. Both Greece’s short-term and long-term positions are unsustainable without further assistance. The government needs to find a way to roll-over about 20 billion euros in public debt that matures this year, three quarters of which comes due before September. Almost all of this debt is held by the IMF, the European Stability Fund or the ECB. Also the current bailout deal ends on February 28th and there is nothing to replace it yet. For this reason, Greece’s new Finance Minister Yanis Varoufakis has requested a bridge loan of approximately 10.5 billion euros from the European Union while Greece renegotiates the terms of the original bail-out. There is some uncertainty regarding Greece’s ability to meet obligations from now to June, but the real crunch time will come in July…

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If Greece is able to weather the storm this year – however it manages to accomplish it – then the pressure will decrease somewhat for Mr. Tsipras’ government. The maturity schedule from 2016 to 2019 is far more favorable, with the latter year peaking at 14 billion euros in maturing debt. For a democratic government, four years is an eternity: so the real challenge is for Mr. Tsipras and Mr. Varoufakis to survive from now until June.

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Even if they accomplish this feat, the long-term financial outlook for the country is dismal: public debt is at a Japanese style 175% of GDP while the government continues to run enormous deficits (program? What program?). The program Syriza was elected on will cost money: a lot of money. Rehiring government workers, cancelling privatization negotiations and refunding social services are all easy to do and enormously expensive. Getting wealthy Greeks with offshore accounts to pony up their true tax liabilities is enormously difficult. While Mr. Tsipras has promised to do both, it is very likely that he will only succeed with the first initiative. That implies a growth in expenditures without a corresponding increase in tax revenues.

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At least not from the wealthy. Mr. Tsipras is counting on steady job growth to both reduce the government’s bill on unemployment payments as well as expanding the tax base: precisely what happened from 2010 to 2015 in the United States. His economic plan is a purely orthodox Keynesian fiscal stimulus leading to a demand-side recovery, rather than anything from the wrong side of the old Iron Curtain.

How likely is it to work? It seems a long shot. Unlike the United States, Greece lacks the monetary policy tools to support the fiscal stimulus. It is tied to a highly unfavorable currency union over which it exerts little – or no – control. However much of a boon the Euro has been to Greece during the “good years”, it is now a lodestone around the neck of a shipwrecked sailor. The disadvantages of the single currency for markets like Greece, Spain and Portugal has been explored in enough depth that I will not repeat the arguments here.

Why do I say Greece is winning? For a number of reasons:

  • Syriza is being taken seriously by other EU governments. Their rhetoric might not be what some leaders want to hear, and they might not succeed in the end, but no one could say that they have made any major, amateurish gaffes;

 

  • They have already gained an impressive degree of support in line with the respect they are getting from their peers. No less than Christine Legarde, IMF honcho, has grudgingly praised the Greek team sent to Brussels calling them: “competent, intelligent, they’ve thought about their issues.”[1] Given that Ms. Lagarde’s IMF is one of Greece’s largest creditors, her opinion matters; but she is not alone, with Euro-group Chairman Jeroen Djisselbloem also voicing a willingness to negotiate and reach a “reasonable compromise”;[2]

 

  • The Greeks have made all the right noises in their interactions with Europe: determination to repay their debt, agreement to “70%” of the bail-out program, democratic mandate, and all the rest. At home, for the domestic audience, they have not shown so much flexibility; but this is undoubtedly purely for domestic consumption. It seems clear that Mr. Tsipras, who I have always believed to be a pragmatist where the EU is concerned, will make the deal that gives him room for his economic reactivation program. No “haircut”, but a quiet death to austerity: he might crow in Greek, but not in English, to avoid offending the Germans.In my opinion, this is the preferred outcome not only for the Greeks, but for the ECB as well, and it has been in the cards since Mario Draghi announced Europe’s own QE program just days before the Syriza victory. While cloaked in technical terms of long-gestating market movements and concerns over deflationary pressure, it is my experience that nothing happens in politics by coincidence, and the timing of this very political announcement was too coincidental to be true.The trick now is to back the Germans into a corner where they will be forced to make some concessions that they do not want to make for domestic reasons, but without seeming to do so. This may be on the verge of happening, as the German officials have admitted – grudgingly – that their government won’t insist that all elements of the previous program be included in the new one[3]. That is a very significant concession and in that word “all” lies an enormous opportunity to wring out concessions.

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As much as Mr. Schäuble might prefer to swallow a Dachshund whole before bending to the Greeks, there is simply too much at stake and too many unknowns to risk a Grexit. The Germans have spent a lot of money and a great deal of prestige on the Euro; gambling it all on the privatization of a few Greek companies and a couple of percentage points of government deficit seems un-Teutonically short-sided.

Twenty Billion for a New Naval Base? I’ll take it

There is another reason for caution, though perhaps less important that preserving the Euro. Europe (and America) are in a dangerous confrontation with Russia over Ukraine; and more broadly, on Russia’s future role in the European periphery. Imagine Germany decides to throw Greece under the bus, both to keep other anti-austerity parties out of power in Southern Europe and to shore up domestic support from conservatives. Would Russia be willing to pay Greece’s debt, at least in the short-term? Russia is not exactly flush with cash anymore as the plunging price of oil continues to bite into her currency reserves; these have fallen from a peak of $500 billion to around $380 billion. Greece’s total public debt is today around $360 billion (316 billion euros).

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Of course, the Russians aren’t about to hand over $360 billion to anyone, no matter how much a slavophile Alex Tsipras might be. But they might be willing to keep the Greek government afloat. Mr. Putin might consider 20 billion euros a cheap price to pay to pry away a key piece of NATO’s southern flank and gain an advance naval base in the port of Piraeus. And the Greeks might even agree if they felt spurned by Europe and the United States.

All of that speculation seems highly unlikely, but so does Greece’s exit from the Euro at this point. Neither I, nor the markets, consider it a high probability event.

Greece is more than holding its own in this prize fight. If and when agreement is reached between the EU and Greece early this year, it only puts matters off. Greece still has an unpayable debt, a huge deficit and monetary inflexibility. None of that is going away. Additionally, any deal that saves the face of the Tsipras government will give wings to anti-austerity parties in other European nations, especially Podemos in Spain. If the Greek economy improves during a Syriza Administration and if Podemos wins the general elections this year in Spain, Messrs. Tsipras and Iglesias will be in an immensely stronger position to challenge the whole structure of austerity, bail-out and debt that is at the centerpiece of the current EU regime. There could be a counter-reaction lifting the anti-euro parties in Northern Europe, like Alternative für Deutschland and the True Finns.

This is a 15-round fight for Europe’s future and we are only in round 5.


 

Sources and Notes

[1] “IMF’s Lagarde says Greece is competent, thought about issues.” Reuters, 11 February 2015

[2] Janene Van Jaarsveldt, “Djisselbloem, Greece Have a ‘Reasonable Compromise’”, NL Times, 13 February 2015

[3] “Greek shares, bonds return to pre-election levels on deal anticipation,” Reuters, 13 February 2015

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