From the unthinkable to the inevitable: Part 2, scattering the pieces
[Continued from yesterday's Part 1.]
Yesterday’s post using the Financial Times as a reference point had reached the conclusion that, bluster from Alexi Tsipras notwithstanding, the Eurozone’s financial leadership will not write another enormous open-ended check:
“The future of Greece in the eurozone lies in the hands of Greece,” Guido Westerwelle, German foreign minister, said on Friday. “If Greece strays from the agreed reform path, then the payment of further aid tranches won’t be possible. Solidarity is not a one-way street.”
With the Greek electorate’s broad-based rejection of any austerity, then the crockery will fall and break – Greece will exit from the Eurozone.
So much for union
Against accusations that it is imposing, in the words of Mr. Tsipras, “barbarous” demands, the core of the eurozone is already positioning itself to ensure any exit is seen as a sovereign decision.
You see, the inevitability effect is already having its inexorable impact.
It’s inevitable that the effect will come into play
This will be extremely messy.
The answer’s in one of these EU policy directives
3. What would exit from the eurozone entail?
Answer: Fiscal chaos in Greece, severe financial repercussions in European government banks.
In a game of brinkmanship, neither Athens nor the rest of the eurozone would want to take responsibility for a Greek exit from the single currency. Recriminations would fly.
Recriminations will be the least of everyone’s problems.
Your fault! No, your fault!
Slippage against the agreed EU and IMF agreements would probably be accepted for a period, so the trigger for exit would be a deliberate rejection by a new Greek government of the requirements for austerity and structural reform in the existing agreement that Athens signed with the “troika” of the European Commission, the European Central Bank and the IMF in February. “It would be more of a case of Greece walking than of Greece being pushed out,” says Willem Buiter of Citigroup.
Skeptical Dutchman being skeptical
Such political finger-pointing will be solely for domestic consumption – Chancellor Merkel cannot very well go to the Bundestag and explain that the money she persuaded Germans to shovel to Greece was a fool’s investment from the start, so she’ll have to claim that the Greeks have lost their minds.
Open for business!
The FT then states the obvious:
Exit would occur because, without disbursements of additional loans, the government would run out of money to pay social security and public sector wages.
We have become so used to bankruptcy reorganization and sovereigns borrowing ever more against their future that we have forgotten one can truly and literally run out of money, and have to be reminded.
No money to pay the poor tax
In addition, the ECB could withhold needed funds from Greek banks, bringing them down. At this point Athens would need to:
The sequence of steps is critical, so let me expand it out.
A. Pass a new currency law
B. Redenominate all domestic contracts in a new drachma
C. Impose exchange controls
D. Secure the borders to limit capital flight
E. Take steps to introduce a paper currency.
They rolled in 1967, will they roll again in 2012?
The reason is simple: exchange controls and securing borders are police functions and the only police force large enough to work in a whole country is its military.
Printing and distributing new notes would be no easy feat. In 2003 the US-led coalition managed to do it in Iraq in less than three months. But that required the efforts of De La Rue, a British specialty printer, a squadron of 27 Boeing 747s and 500 armed Fijian guards to ease the process.
In fact, I suspect there would be a period of a couple of weeks when there was little or no accepted Greek currency. (I expect Turkey to close its border against Greece very soon.) All the banks would close on a Friday evening, the Euro exit/ drachma conversion would be announced nationwide, and when the banks reopened on Monday morning they would be forbidden to accept new deposits in Euros, or to pay out deposits in Euros.
Close on Friday, and maybe you reopen on Monday
After exit, Greece would have to negotiate continued EU participation. The EU treaties have a provision for leaving the union, but not just the eurozone. That negotiation would be all the more difficult if new Greek authorities defaulted on debt to the European Financial Stability Facility, the ECB and the IMF.
It wouldn’t be a negotiation, it would be a pure breach.
Ready to negotiate now?
If the country defaulted on its IMF debts, it would join a small ignominious club of nations – including only Zimbabwe, Somalia and Sudan – that have overdue financial obligations to the fund.
We’re ready to secure Greece, if you pay cash
4. What economic effects will Greece suffer?
Answer: Isolation from the world’s capital markets, and a plunge in living standards.
In any exit scenario, the new drachma would depreciate rapidly.
Everyone would wake up one morning, suddenly realizing that the entire nation of Greece had become an unreliable counterparty. No one outside Greece would accept drachmas for anything, so Greece will be thrown back on its own resources – and as we know, Greece’s resources are horribly less than its contractual and pension obligations.
How far cannot be predicted but the IMF estimates Greece needs at least a 15-20% devaluation against the eurozone average – and considerably more against Germany – just to achieve a current-account balance.
And that’s before pricing in counterparty risk, which with a bankrupt nation will go through the roof.
Something like that
Currency moves tend to overshoot, and US investment bank Goldman Sachs has estimated that to stabilize Greece’s international debts at a reasonably low level – needed to ensure the country can insulate itself against the risk of capital flight – a devaluation of 30% is needed compared with the rest of the eurozone, and more than 50% with Germany.
Translation: Everyone in Greece will be 30-50% poorer than at present, and feel lucky if that’s the sole collapse in Greek living standards.
Such a devaluation would restore competitiveness, but it would be far from the end of the story. A new administration would probably repeal a law that prioritises debt interest over other forms of government spending.
Yes. In for a penny, in for a pound – and once cut off from the capital markets, it makes no sense whatsoever to send any money out of the country. In short words, Greece will have thrown itself into bankruptcy, and will act as its own bankruptcy trustee, and prime its citizens over all creditors.
A new default would occur on the remaining private sector debt and on official sector debt owed to European institutions and the IMF.
Now this is the suicide vest Mr. Tsipras believes he is wearing.
Prepared to commit financial suicide, but not to be photographed?
Even if all interest payments were stopped, additional austerity would still be needed for a period because Greece’s tax revenues still fall short of its public spending – a primary deficit.
And that’s; why Mr. Tsipras’s threats are merely throwing gasoline on a fire. Even if all of Greece’s current debt were eliminated, the country is still insolvent.
Again I return to the observant herd: the Eurozone cannot rescue Greece at this point, because it would be rewarding the worst possible behaviors, and that way lies madness.
The IMF estimates that even if there is no exit there will be a primary deficit of 1% of national income in 2012, a figure that would almost certainly rise in a recession deepened by uncertainties surrounding exit and a bust banking system.
Worse and worse.
There are two plausible scenarios.
Ugly but cheerful?
In the brighter one, a responsible government is able to restart the banking system, run a balanced budget and persuade the public to accept sharp declines in living standards as import prices rise quickly. After a period of deep austerity, rapid growth might be possible.
Can you see any democratic government doing this, after having had the Greek populace so firmly reject austerity?
Under the alternative scenario, a government takes office that seeks to use its new powers of monetary autonomy to offset the effects of devaluation and spend its way to prosperity. The danger is that hyperinflation after short-term relief would be followed by further currency depreciation and money printing.
As far as I can tell, dictatorships end in hyperinflation or war. Zimbabwe, in fact, reached the point where it could no longer print money because the paper cost more as paper than the value of the notes being printed.
One’s worth more than the other, and both are perishable
It will be truly ironic if, as their exercise in democracy, the Greeks have voted themselves into a military junta.
Where will that leave the rest of Europe?
Run away! Run away!
[Continued tomorrow in Part 3.]