In his latest Financial Times column Wolfgang Münchau concurs with much of what I have written here (on the Greek social economy’s deep coma) and here (on the reasons why investors are piling in) but goes on to suggest that Greece should seriously consider exiting the Eurozone. In today’s post I offer an evaluation of his argument. In brief, I argue that, while Münchau’s assessment of the situation on the ground is spot on, the use of the ‘nuclear option’ (i.e. threatening to exit the Eurozone) is neither desirable nor necessary as a means of forcing Europe to change its ways.
The Grand Greek Paradox of the day, meaning the impressive rise in the assets of a nation more bankrupt than ever, is neither that grand nor that much of a paradox. There is, indeed, a simple reason that international investors are piling in to buy some of the nation’s paper assets (e.g. the freshly minted government bonds and shares in some banks), even though the country is economically kaput and its government is steeped in long-term insolvency more than ever. What’s this simple reason? The short-term decoupling of the value of paper assets from Greece’s real economy.
Take for instance the new bonds, worth €3 billion, issued last week. This new debt has been added to the existing stockpile of €320 billion for a shrinking economy with a nominal GDP, currently, around €180 billion. To service it next year alone (in 2015), the government must achieve a gargantuan primary surplus of 12.5% of GDP and use it all to redeem debt (while Greeks are in the clasps of untold misery and only 10% of the 1.3 million unemployed receive any benefits). Why would a self-interested investor buy these new bonds, in view of the unsustainability of the country’s overall debt? The answer is, of course, that Berlin and Frankfurt have signalled to investors that there is nothing to worry about. That, while Greece’s debt will be, eventually, haircut with the same probability that the sun will rise against from the East tomorrow, these particular bonds will not be touched. Indeed, they have been led to believe that the ECB (via OMT or some other pretext), perhaps with the participation of the ESM, will stand behind these bonds. Similarly with banks like Alpha and Pireus that are immersed in non-performing loans: the Governor of the Bank of Greece has clearly stated that stress and quality assurance tests should “not be too strict lest they deter investors”. Statements of this sort (by the, by the bye, former VP of Pireus Bank who moved straight to the office of Central Bank Governor) give heart to investors that new shares issued by these banks will be supported by active ‘gaze aversion’ on the part of the regulators; by a committed attempt not to look too seriously into the banks’ asset books.
Thus the Grand Decoupling underpinning the Grand Paradox that lies in the heart of Greece’s current predicament:
- Banks are insolvent and yet attract considerable amounts of international investors’ money.
- The state is insolvent yet, again, investors are queuing up to lend it money.
- Meanwhile, investment in the real economy is negative, credit is non-existent and everyone owes to everyone and no one can repay their debts, while deflation is taking its ugly toll on the sustainability of all these liabilities.
In his regular Financial Times column (13th April 2014), Wolfgang Münchau begins by giving his own, quite apt, account of what I call Greece’s Grand Decoupling. He suggests that Berlin’s strategy for declaring victory over the Greek crisis (not too unlike Mr Bush’s famous speech upon an aircraft carrier off the coast of Iraq) is simple: “let’s generate a massive financial investment bubble and hope some of the money trickles down into the real economy eventually.” Of course, as Münchau adds, “…it would take quite a bubble to get to that point… And this brings us back to the fundamental problem: who in their right mind is going to make a long-term investment in a country with unsustainable long-run debt?”
Quite. No one, is the answer. This is why, most recently, there was a single, depressingly low, bid (of about €85 per square metre) for a vast piece of prime real estate right on the riviera of Athens (the old airport at Hellenikon) which the government auctioned off in order to repay some of its unpayable debts. This is why even Gazprom was not interested in purchasing a gas monopoly of an EU member-state. It is why Greek businesses are shutting up shop and relocating. And so on.
The current Greek government’s tactic is to rely on Berlin’s New Bubble strategy and to pretend that there is no Grand Decoupling; that the New Bubble (in bond and share prices) is tantamount to real growth or to a certain path towards it. Münchau correctly disputes that. And what does he propose? He suggests that the Greek government (perhaps the next Greek government) contemplates the ‘unthinkable’: a full default on all of Greece’s foreign debt, withdrawal from the Eurozone, a new Taylor Rule for running the new monetary regime in a manner that bolsters a credible inflation target, and labour market deregulation that will add the oomph needed to give the Greek economy the necessary exit velocity.
Where Münchau is spot on is in his implication that the current policy, of relying on an ever-inflating New Bubble and trusting in some trickle down effect, is not a realistic option for Greece. In essence, the Greek government must clash with Berlin and with Frankfurt if it is to avoid many decades of stagnation and unnecessary social misery. Regular readers of this post know that I agree with him perfectly on this. Where I continue to disagree is with the assumption that the only alternative, the only confrontational strategy available to Greece’s government, is to pull up stumps and exit the Eurozone.[1] Put differently, I do not see why Greece is confined to this nuclear option (of Eurozone exit) when the EU’s institutional setting gives its government a variety of bargaining cards that it can deploy sequentially within the Eurozone in order to convince its partners of the necessity of the ‘debt conference’ which Münchau agrees would change the parameters considerably and in a manner that renders Greece’s economy sustainable again (and which could include helpful agreements for Portugal, Ireland, Italy etc.).
More precisely, Greece can select a strategy of escalating pressure on Berlin, Frankfurt and (the decreasingly important folks in) Brussels as follows:
- It could begin with a refusal to sign the Banking Union agreements (as it its right) which, as Münchau knows well, Europe in general and Greece in particular are better off without.
- It could then state that, until there is substantial debt relief, Athens will refuse to issue new Treasury Bills or bonds, or indeed to accept the last tranche of bailout funds, in order to redeem the Greek government bonds purchased as part of the SMP program by the ECB.
- Furthermore, it could escalate matters further by refusing to accept any elongation of its existing debts to the troika; an elongation that Berlin is planning to offer the Greek side this coming summer instead of serious debt relief. And so on.
That Greece has the right and the opportunity to deploy these bargaining cards there is no doubt. The important question, that Münchau and many others might pose, is this: What if Berlin and Frankfurt do not budge? What if they tell Athens to ‘go jump of the tallest cliff’? The Greek government currently claims that it has a budget surplus. While I strongly doubt this claim, I suspect that a small primary surplus can be concocted through some additional cost cutting and a leximin squeeze of top public sector incomes downwards (without affecting the lowest incomes, pensions and benefits). That should suffice to allow the Athens government to meet its needs during any medium term standoff with Berlin and Frankfurt, as the Greek state will need no financing either from the official sector or from the money markets. In short, the answer to a German “Go jump” can be: “We shall not jump but we shall stay rock solid within the Eurozone and behind our demand for a debt conference. Just watch us.”
Berlin and Frankfurt will, undoubtedly, be furious. They will issue a variety of threats, including the suspension of structural fund flows from Brussels. But the real battleground will be the banks. As they did with Cyprus, where they threatened the government with an immediate suspension of the island nation’s ELA, so too in the case of Greece they will threaten to pull the plug on the Greek banks. Two points need to be made here. First, the Greek banks no longer hold any Greek government debt, which means that their collateral with the European System of Central Banks cannot be downgraded legally. Secondly, Frankfurt will have to think twice before it issues the threat of bending its own rules to close down Greek banks – since doing this would threaten to engulf the whole of the Periphery’s banking system into another cascading panic. Confronted with such a reality, I have good cause to hope that Berlin will prefer to accommodate the Greek government and to look with a great deal more ‘kindness’ the ‘request’ for a debt relief conference. And if it does not, and wishes to bring the Eurozone down with it, let it do its worst, I say.
Epilogue
Wolfgang Münchau and I are in agreement on the current situation: Greece’s economy is kaput and the German New Bubble strategy for reviving the country is certain to produce decades of unnecessary misery. Moreover, Berlin and Frankfurt will never concede changes to this New Bubble until and unless Athens confronts them. The question is: What type should this confrontation take? Münchau considers the nuclear option of exiting the Eurozone. I submit that there are ‘conventional’ weapons that can do the trick of shifting Germany away from its current position of irrational intransigence. Or forcing Germany to take itself the political initiative of dismantling the Eurozone. In this sense, Greece has no reason to volunteer to take the blame for the common currency’s fragmentation as long as there are legitimate and legal moves with which to confront Berlin’s and Frankfurt’s intransigent position within the Eurozone.
“I am not advocating exit” concludes Münchau before finishing off with the useful reminder that “Greek voters and foreign investors should however know that Greece is now in a position where there is a choice.” I could not agree more. Which brings me to the conclusion that, so as not to issue threats that Athens would not want to implement, the right choice for Greece is to deploy a series of bargaining cards that it has the right to use within the institutional and legal framework of the European Union.
[1] This disagreement between Wolfgang and myself goes back some time. Here is a post on it dating to July 2013.
