Time converts the improbable to the inevitable – Stephen Jay Gould
[TL;DR 50% odds Greece leaves euro this year. Odds eurozone breaks up eventually: 100%]
If you don’t care too much about the Super Bowl today, here are some things you could be reading about Greece:
- Daniel Davies: Greek games and scenarios
- The Economist: Go ahead, Angela, make my day
- Martin Wolf: Greek debt and a default of statesmanship
- Paul Krugman: Thinking About the New Greek Crisis
- Michael Lewis: Beware of Greeks Bearing Bonds (2010)
- Yanis Varoufakis’s Modest Proposal, which is sort of a New Deal for Europe shoehorned into existing treaties. Also Varoufakis: Europe needs a hegemonic Germany.
- Mario Draghi: Stability and Prosperity in Monetary Union. Things the euro needs to be stable: 1) mechanisms to enable economic convergence, ie fiscal union 2) mechanisms to cushion pain of divergence, ie at least temporary transfer payments. When countries are better off outside the euro than within, they will leave.
1) Greece cannot service its debt.
- Debt % of GDP: 175%
- 10-year bonds: 11.4%
- At that rate, nominal GDP growth needed for ratio of debt/GDP to stay constant: 20%
Admittedly, the rate Greece actually pays is much lower, but you get the picture. Even at 2% rates, in a zero-inflation environment, Greece would have a tough time.
2) What cannot be repaid will not be repaid (Martin Wolf). So why does Europe insist on no debt reduction? Two reasons:
- EU politics: Debt is a cudgel to exert political control over Greece. Every so often, Greece has to come back to Europe for a round of ‘extend and pretend’, which Europe hinges on political ‘reform’ conditions.
- Domestic politics: Merkel and Eurozone leaders don’t want their political opponents to claim voters’ tax dollars are bailing out Greece.
3) The ‘profligate Greeks’ is only very partly true.
The main issue is, the upper classes and the oligarchs don’t pay their taxes. (Death threats forced me to quit: Greek tax head.) That’s why debt went to 100% of GDP. It went to 175% as GDP shrank 25% and the debt was rolled over in the bailouts, which were really bailouts of European banks that would have gone broke if Greece defaulted.
So, if you’re an oligarchic shipping magnate, when Greece went into the euro at a too-high drachma rate, you were able to offshore your fortune in a hard currency at a great rate, while benefiting from living in a corrupt tax haven.
If you were a low income worker, then tourism, agriculture like yogurt and olive oil took a hit from moving into a stronger currency. You still paid your 20% VAT. Then when the economy went south, you lost your job, with unemployment reaching 28%, people burning garbage to stay warm, global pharma companies halting shipment of drugs to hospitals because they weren’t getting paid.
Far from profligacy, ordinary Greeks have paid an extraordinary price. Being stuck in the euro, Greece didn’t get benefits of either default or devaluation that would help tourism, agriculture, manufacturing. Benefits of the bailout went to euro banks, Greek oligarchs.
5) End game
From Greece’s standpoint:
- Status quo is unacceptable: 25% unemployment, inability to pay debt, perpetual harsh bailout conditions.
- Default and euro exit would be another disaster with unpredictable consequences.
- Greece would be a financial pariah state.
- Potential for very high inflation in a return to the drachma without access to global finance.
- Unpredictable and potentially very high cost in the short run, but default and weakening of currency would bring back tourism, agriculture, export industry, and pave the way to recovery in the medium term.
From Germany’s standpoint:
- Hard to offer debt forgiveness, less austerity to Greece while demanding same from rest of periphery.
- Domestic politics of taxpayer money going to Greeks.
- A euro exit would be very damaging to the euro project. Possibly fatal in the long run, as bank deposits in Italy, Portugal and Spain would be viewed as less safe than bank deposits in Germany. In effect, southern euros would not be the same as German euros.
- Geopolitical factors figure strongly as well. No one wants Russia or China to establish a foothold in the heart of the Mediterranean. (Russia’s navy access to the Mediterranean is a factor behind the messes in Syria and Ukraine/Crimea.)
Clearly there is a deal to be made. Forgive unpayable debt over time. Allow a little more fiscal space to ease the burden on ordinary Greeks. Continue structural reform focused on bringing oligarchs and affluent into tax system, privatizing without fire sales.
It’s an ultimatum game.
6) How does the ultimatum game get resolved?
I don’t know. 50/50 a deal, or one party defects, or events overtake both of them, like a run on banks, bank holiday, and market collapse.
It all hinges on how each party feels about how bad the best alternative to a negotiated agreement (BATNA) would be, how much the parties trust each other to uphold an agreement (Does Syriza have the will and competence to accomplish structural reform?), how credibly they are able to communicate what the true red line is.
The clock is ticking. Every time Tsipras draws a line in the sand, more euros will flee Greek banks to Germany, forcing ECB to replace them with liquidity assistance which would, of course, go up in smoke in the event of a default.
At some point, Tsipras’s best deal is Grexit, and blame Germany. Likewise, at some point it’s better for Merkel to say Grexit was the Greeks’ fault, they’re an exceptional case and this could never happen to Spain, Italy and Portugal
7) Will the euro hold together in the long run?
Even if Greece stays in the euro, it’s hard to ignore that they have some developing-world political and economic dynamics and only heroic measures will have kept them in the euro.
Ultimately, the euro only works in the long run in the context of full political, fiscal and economic European integration.
It’s worth noting that QE only came to pass as a result of Draghi using all his political capital, including possibly floating resignation threats. Draghi himself has said the eurozone does not meet the minimum criteria for sustainability, economic and fiscal union are needed.
It’s as if the US entered into a currency union with Mexico.
The US and Mexico have divergent economies, but separate currencies. Suppose both countries make cars. Mexico is, hypothetically, a poorly performing economy, with poorly educated, unproductive workers, inept management, high taxes, inefficient government regulation and services, resulting in low quality, expensive cars.
Mexico will have a hard time selling its cars domestically and exporting them to the US. The US will export cars to Mexico.
As consumers buy fewer Mexican cars and investors have little reason to invest in car factories there, the Mexican dollar will tend to decline vs. the US dollar. But as the peso declines, Mexican cars will start to get cheaper relative to US cars in both countries, allowing more to be sold. Poor productivity growth leaves Mexicans with a lower relative standard of living as imports get expensive, but they can still sell cars and maintain employment, and the adjustment in the currency cushions the impact on production and the domestic economy.
Now suppose the two places we’re talking about are Michigan and Alabama, which share a currency and a common Federal government. Alabama’s car manufacturers do well, Michigan’s do poorly. Michigan can’t devalue its currency, since it shares the dollar with Alabama. Its auto sector shrinks. People are laid off from Michigan car factories, and some of them move to Alabama, where car workers are in demand. The overall US economy is doing no better or worse than before, and as Alabama booms, taxes are generated, and help the Federal government pay for unemployment benefits, retraining, pension benefit guarantees, social security as older workers retire, and other help for Michigan. There is no currency cushion, but labor mobility, sharing of taxes and transfer payments cushion the adjustment.
Now let’s return to the first Mexican example, and suppose the US and Mexico shared a currency, the ‘amero’. Mexico can’t devalue, so its cars remain uncompetitive and manufacturing shrinks. Workers lose jobs, but can’t easily move to the US due to language and cultural barriers. Mexico’s unemployment rate goes up, tax receipts decline and the Mexicans have to borrow to pay unemployment benefits and cut services. They start to run deficits and eventually they’re on the brink of default and ‘amero’ exit. They turn to the US for help. US taxpayers feel they did everything right, so why should they bail out those lazy Mexicans? Mexican taxpayers feel like those hegemonic Americans are telling them what to do, and running a currency and interest rate policy that impoverishes Mexicans.
When the ‘amero-zone’ status quo becomes politically unsustainable, one of two things can happen. 1) The Mexicans go back to the peso, which depreciates sharply, making it impossible to pay back dollar debts. They default on sovereign debt. They institute capital controls which make it impossible for their companies to pay back ‘ameros’, and maybe rewrite the rules so foreign debtholders can’t take the assets in bankruptcy.
Or 2) the US goes back on the dollar and Mexico stays on the amero, which depreciates sharply. Now the Mexicans can pay back their debts in cheap ameros, and there is no need for a messy default.
Either way, any poor suckers who end up with Mexican assets and US debts get taken to the cleaners, including banks which will be busted and have to be taken over by the government or get massive bailouts.
Substitute EUR for amero, Greek drachmas (and Irish punts and Portuguese escudos) for pesos, deutschemarks for dollars, and you get the picture.
The fundamental problem is that, if Greece shares the euro, and it doesn’t have an FX policy or monetary policy, there needs to be some mechanism to drive economic convergence. If not, it will have the wrong policy at the wrong time: 28% unemployment and a pro-cyclical policy of more austerity the worse things get.
Europe’s monetary integration is way too far ahead of the economic, social and political integration. In fact, I just don’t think Europeans want American-style political and economic integration. Perhaps a bailout can be arranged this time, but the next one may be politically and economically impossible.
Unless the political and economic integration catches up, a sufficiently big crisis will inevitably rip up the Euro zone. Either a hard core centered in Germany will secede from the Euro, which seems less damaging and therefore more likely, or some peripheral countries will undergo Latin American style political and economic upheavals (or both).
Maybe we’re witnessing the slow motion breakup of the euro zone. Or maybe the Big One is still out there.
Either way, it will be a big mess.