Can This Really Be Europe We Are Talking About?

In recent days I have been think a lot, and reading a lot, about the implications of Greece’s recent election results.

At the end of the day the only difference this whole process makes to the ultimate outcome may turn out to be one of timing. If  Alexis Tsipras of the anti bailout, anti Troika, party Syriza won and started to form a government then the second bailout money would undoubtedly be immediately stopped. On the other hand if the centre right New Democracy wins and is able to form a government, as the latest polls tend to suggest, then the country would quite possibly try to conform to the bailout conditions, but in trying it would almost certainly fail, and then the money would be stopped. Before the last election results, it will be remembered, this was the main scenario prevailing.

Indeed reports coming out of Greece suggest that the end point may be reached more quickly than even previously thought, since the main impact of recent events is that the reform process in the country has been put on hold, meaning that slippage on implementation by the time we get to June will be even greater than it otherwise would have been.

“The only thing we are doing is waiting,” said a government official who declined to be named. Another Greek official close to bailout negotiations said ministers in the outgoing cabinet have not been authorised to negotiate with Greece’s lenders since the May 6 election. A senior party official said the caretaker government would not publish any decrees and all tender procedures were suspended.

Even before the May 6 election, many reforms were put on the backburner to avoid antagonising voters, officials involved in bailout talks say. These include a plan to slash spending by over 11.5 billion euros in 2013-2014, which Greece must agree by late June to meet a key bailout target.

Other measures Greece should have taken by the end of June include a plan to improve tax collection by 1.5 percent of GDP in 2013-2014, a review of social spending to identify 1 percent of GDP in savings, and a pay cut for some public sector jobs by an average of 12 percent.

One key measure is the budget deficit. Athens was broadly on track in the first quarter with a primary surplus on a cash basis of 2.3 billion euros excluding interest payments on debt, versus a 0.5 billion primary surplus in the same period in 2011.

But low value added tax collection and increased transfers to the social security system to offset weak business and employee contributions continue to be soft spots.

Another problem – which the EU and IMF will check before giving any green light on the accounts – is government arrears. Unpaid debts to third parties for over 90 days stood at 6.3 billion euros at end-March or 3.1 percent of projected GDP this year, according to economists at EFG Eurobank.

EU and IMF policymakers, exasperated by repeated delays on all reform areas over the two years of a first, 110-billion euro bailout, have warned they will not deliver any more aid under the new bailout if Athens veers off the reform track yet again.

Looking at the above list, it is hard not to come to the conclusion that it might be in the interests of all concerned for Syriza to win the elections and force the issue. Putting together another weak government that can’t implement will only lead to more fudging, and put us back where we are now in three or six months time.

Grexit Ahoy?

Either way, it is what happens next that leads to all the speculation. The international press has been full all though the last week of statements from one European leader after another suggesting that Greece may need to exit the Euro. The latest to add his name has been the Slovenian Finance Minister Janez Sustersic, but before him there has been a long list of leading personalities including EU Trade Commissioner Karel De Gucht who told the press that the European Commission and the European Central Bank were working on scenarios in case the country had to leave. European Central Bank President Mario Draghi even entered what are unchartered waters for the institution he leads and acknowledged that Greece could end up leaving the euro area, although if it did he stressed the decision would not be taken by the ECB.

While the bank’s “strong preference” is that Greece stays in the euro area, “the ECB will continue to comply with the mandate of keeping price stability over the medium term in line with treaty provisions and preserving the integrity of our balance sheet,” Draghi said in a speech in Frankfurt today. Since the euro’s founding treaty does not envisage a member state leaving the monetary union, “this is not a matter for the Governing Council to decide,” Draghi said.

This is all a long long way from the days of “Hotel California”, and the Euro as an institution where you can check in but you can’t check out, and other such sentiments which typified the Trichet era, which now seems to far behind us. The decision would not be an ECB one, but what if preserving the integrity of the central bank balance sheet implied cutting of the lifeline to Greece’s banking system? The decision might then be nominally Greek, but at the end of the day it would have been forced on the country by a proactive ECB.

In The Name Of God Go!

While Mario Draghi may have been being strongly diplomatic, ECB Executive Board member Joerg Asmussen was far less so, and told  Handelsblatt newspaper on May 8 that if Greece wanted to remain in the euro, it had “no alternative” than to stick to its agreed consolidation program. The influential German magazine Der Spiegel went even further. Under the header “Time To Admit Defeat, Greece Can No Longer Delay Eurozone Exit”, the magazine said what had previously been the unsayable: “After Greek voters rejected austerity in last week’s election, plunging the country into a political crisis, Europe has been searching for a Plan B for Greece. It’s time to admit that the EU/IMF rescue plan has failed. Greece’s best hopes now lie in a return to the drachma”.

The inconvenient problem is that things don’t look that way in Athens, where even the anti-establishment Alexis Tsipras is only talking about ending austerity, and renegotiating agreements, at the same time making it abundantly clear  he has every intention of staying in the Euro. The fact of the matter is that there are very few Greeks who actually want to leave, and it is hard to believe that those arguing the country’s best hopes are either this, or that, really have the true interest of the country and its citizens at heart. The FT’s John Dizard sums the situation up thus: “There has been an astonishing quantity of nonsense written in the past couple of weeks about the prospect of “Grexit”, or Greece’s exit from the Euro”.

One of the key additional reasons that much of what has been written has been “nonesense” is that few have stopped to think about what the real cost to core Europe would be of a Greek default (see below). But then, they never have been that strong on financial arithmetic in Berlin.

So whether push comes to shove at the next review, or the one after, no one is really clear what gets to happen next, and this is part of the reason why there is so much nervousness in the markets at this point. Many assume that after the tap is turned off the country would quickly run out of money, but there are a variety of devices that the Greek government, in conjunction with the central bank, could use to keep the cash flowing. Some think the country would follow the Argentinian example, and start issuing internally valid scrip money, like the ill fated Patacos or Lecops. But Argentina was not in a currency union with the United States, the country had simply unilaterally decided to peg the Peso to the Dollar. Argentina could not print Dollars, but Greece can – in a variety of ways, the best known being Emergency Liquidity Assistance (ELA) - generate its own Euros, and enable the government to, for example, sell T Bills to Greek banks in order to pay pensioners, civil servants, government suppliers etc.

Then, so the story goes, the ECB would have no alternative but to shut Greece off from the Eurosystem. To some this might seem like an act of war. This wouldn’t be Greece leaving, this would be Greece being turfed out. Yet this secnario was just what the markets got a scare about this week, when the ECB announced it was cutting off liquidity to four Greek banks. Ominous echoes of Mr Draghi’s words about the ECB protecting the integrity of its balance sheet. As it turns out, the move was less sinister than it seemed, since part of the problem was that the Greek government bureaucracy was inefficiently holding up the recapitalisation of some Greek banks, a move which had left them with negative capital, and the ECB was understandably reluctant to continue accepting collateral from them under these circumstances. Part of the problem here is that very few people, as FT Alphaville’s Joseph Cotterill points out, really understand what ELA is, but this is not really surprising as the ECB itself has hardly been forthcoming with information and details on how ELA is being used.

In any event, continuing the supply of liquidity to Greek banks, and including or excluding the Greek central bank in/from the Eurosystem are likely to become key issues as we proceed. As Mr Draghi argues the issue is a political one, not a banking one, which means the bank is going to be very constrained if it wants to act as a bank without the relevant authority. This is the kind of hot potato which is likely to be passed from one desk to the next (Yes, Mr President, but…) with no one really being willing to go down in history as the person who might have torn Europe apart, which leads us to the conclusion that the “muddle through and fudge” stage might last quite a bit longer than many are expecting.

If I Owe You 10 billion I have A Problem, But If I Owe You 300 billion……….

As John Paul Getty famously said, “If you owe the bank $100 that’s your problem. If you owe the bank $100 million, that’s the bank’s problem”. Never a truer word was said in the Greek case, and it is the reality that Mr Tsipras and those around him have, I suspect, understood. Now I fully appreciate that  the Troika are a group of people who are motivated largely by principles not by money, but when your principles could cost you, and those providing you with the money you spend, 200 billion Euros, 300 billion Euros, or whatever, then dare I suggest there is food for them to think.

Estimates of just how much the Troika are on the hook for should Greece default vary, but a common number is somewhere in the 200 billion euro range. Of course, some of this would eventually be recoverable, one day, and assuming Greece were able to pay, but in the meantime (given the super senior status of the IMF participation) it is highly likely that governments and taxpayers in the other Euro Area countries would need to cover the shortfall, and this, to put it mildly, is unlikely to be popular with voters. Yet another reason for “fudge and muddle through”.

There are three main sources of Troika exposure to Greece, bailout loans, sovereign bonds owned by the ECB, and liquidity provided to the Greek central bank thorugh the Eurosystem via what is known as Target2. Now according to estimates by Commerzbank analyst Christoph Weil, between loans and bond purchases Greece owes a total of €194bn, which breaks down into €22bn owed to the IMF, €53bn to Euro Area countries, €74bn to the EFSF and €45bn to the ECB. On top of this there are Target2 liabilities of the Greek central bank vis-à-vis the ECB – and indirectly to the German banks –  to the tune of €104bn.

As Christoph says in his report: “It would undoubtedly be bitter for the German government to have to tell taxpayers they would have to fork out €75bn if the debts were not repaid, but the alternative of continuing to throw good money after bad, would not make it any more popular either”. Methinks he is being a bit too blasé here, since while it is surely the case that a 75 billion Euro bill for the German taxpayer would cause a furore, I’m not sure he has grasped just what a problem this would then present for continuing with further bailouts as needed with other troubled countries.

Can This Really Be Europe?

Nonetheless, despite the fact that Mr Tsipras would now appear to have Germany’s leadership by the short and curlies (something Barack Obama’s US advisers will surely have been spelling out to them in Camp David this weekend), it is not at all clear what turn events will take from here on in. History is, after all, often more about the unintended consequences of unexpected accidents than it is about plans.

Nevertheless, several things are clear. In the first place, the Greek economy is in unremitting decline, under the weight of the healing measures being applied by the IMF and its European partners. GDP was down by approximately 17% at the end of 2011 from its Q3 2008 high. Not as steep as the Latvian 25% fall – but then the IMF are still forecasting a further 5% decline in 2012, and without devaluation don’t expect any sharp bounce back. Both reputationally and infrastructurally the country is being quite literally destroyed. The medicine has evidently been worse than the illness, and maybe it is just coincidental, but the Marshall Plan type aid which the country now obviously needs was originally applied in Europe following the destruction of WWII.

But in Greece it’s going to be worse, since no one back then had the kind of ageing population problems the country is now about to face. And while the problem remains awaiting resolution, industrial output and retail sales continue in what has all the appearance of terminal decline, while unemployment – which hit 21.7% in January, second only in the EU to Spain – is still on the rise.

So something patently isn’t working, and excuse me for saying it, but I find it hard to think of a leading applied macroeconomist who wasn’t warning about this right from the start. But no, the creed of the the micro people and their structural reforms (which, as I keep stressing, are needed) was preferred, and we have ended up where we have ended up.

Right now there are two, and only two, options on the table as far as I can see: help Greece with an orderly exit from the Euro (and crystallise the losses in Berlin, Washington, etc), or print money at the ECB to send a monthly paycheck to all those Greek unemployed. This latter suggestion may seem ridiculous (then go for the former), but so is talk of printing to fuel inflation in Germany (go tell that old wives tale to the marines). If Greece isn’t allowed to devalue, then some device must be found to subsidise Greek labour costs and encourage inbound investment – and remember, given the reputational damage inflicted on the country this is going to be hard, very hard, work.

In fact, as I jokingly suggested on my Facebook (and this is a joke, really) on one reading you could come to the conclusion that what lies behind Paul Krugman’s recent tantalising play on the association between Wagner (Eurodammerung) and Coppola (Apocalypse Fairly Soon), is Ben Bernanke’s idea of a helicopter drop.

Could it be that the message he was trying to subliminally sneak in to camp David this weekend was that unable to afford either Greek exit (colloquially known as Grexit) or Greek Euro Membership, the world’s leaders now find themselves trapped in a Gregory Bateson-type double bind. According to Wikpedia “a double bind is an emotionally distressing dilemma in communication in which an individual (or group) receives two or more conflicting messages, in which one message negates the other. This creates a situation in which a successful response to one message results in a failed response to the other (and vice versa), so that the person will be automatically wrong regardless of response. The double bind occurs when the person cannot confront the inherent dilemma, and therefore cannot resolve it or opt out of the situation”.

The only viable way to cut the gordian knot without confronting and resolving the underlying problem which at the end of the day afflicts many of the countries on Europe’s periphery (devaluation and aided default) would be the organising of weekly helicopter drops of freshly printed Euros all along the beaches of southern Europe (oh, we will fight this one on the beaches, and in the chiringuitos, Mr Tsipras told a shocked group of assembled journalists) at a stroke resolving a large part of the youth unemployment problem, and generating demand for products from core Europe (after all, who would go and work in a dreary old factory when you can get the same income lying on the beach). I can just here them over at the ECB, “whohay, am I on a roll man!”, as the printing presses go to work.

And to cap it all, I can just see Paul requesting to fly one of the choppers. “The surfing looks pretty good down there at the moment, Mr President”. As one commentor said, you can just smell those Euros burning through the morning mist.

But of course, joking apart, Krugman does have a point. The G8 leaders are now in a ridiculous situation, one they should never have put themselves in. Apart from the cost of disorderly Greek exit, just imagine how Spanish or Italian deposit holders would react to the sight of Greek Euros being forcibly converted into New Drachma, or some such.

Then there is the Guardian’s Julia Kollewe, who last week spelt out for us a number of highly unpleasant consquences which would follow, including a rush for the door by a lot of young Greeks. Kollewe indeed paints a bleak picture of Europe’s future:

The Argentinian example shows that a Greek debt default and exit from the eurozone are likely to have dire economic and social consequences, at least in the short term. The country will become isolated. With lending drying up and accounts frozen, small businesses will go bust, exports plunge and the country will lurch deeper into recession. “Consumption could drop by 30%,” says Nordvig. “There will be some pretty extreme effects.”

“Mass unemployment is likely, as is an exodus of young skilled workers. If tens of thousands of Greeks headed to the borders, they might even be closed. Greek soldiers patrolling the roads and ports to keep their fellow citizens in? It is not impossible”.

In fact, the last time something like this happened – in Argentina in 2001 – 175,000 Argentinians arrived in Spain alone.

So I ask myself, is this Europe we are talking about here, or is this some kind of dream I am having? Is this where all those high minded ideals of a European Community have lead us, to a Greece where the young people get locked in, like in the old days of the USSR, or locked out as in the days before Schengen.  Is this what the real outcome of the election of Francoise Hollande as President of France is going to mean? I hope not, since if it is it would surely split Europe right down the middle, and not just by drawing a line running from East to West.

This post first appeared on my Roubini Global Economonitor Blog “Don’t Shoot The Messenger“.

This entry was posted in A Fistful Of Euros, Economics, Economics: Country briefings, Europe and the world, Political issues by Edward Hugh. Bookmark the permalink.

About Edward Hugh

Edward 'the bonobo' is a Catalan economist of British extraction. After being born, brought-up and educated in the United Kingdom, Edward subsequently settled in Barcelona where he has now lived for over 15 years. As a consequence Edward considers himself to be "Catalan by adoption". He has also to some extent been "adopted by Catalonia", since throughout the current economic crisis he has been a constant voice on TV, radio and in the press arguing in favor of the need for some kind of internal devaluation if Spain wants to stay inside the Euro. By inclination he is a macro economist, but his obsession with trying to understand the economic impact of demographic changes has often taken him far from home, off and away from the more tranquil and placid pastures of the dismal science, into the bracken and thicket of demography, anthropology, biology, sociology and systems theory. All of which has lead him to ask himself whether Thomas Wolfe was not in fact right when he asserted that the fact of the matter is "you can never go home again".

23 thoughts on “Can This Really Be Europe We Are Talking About?

  1. But what if, one fine, long, holiday weekend, Greece quits the zone, devalues the Drachma 35%, AND THEN IMMEDIATELY RE-ENTERS AT THE NEWRATE, All obligations,wages,etc, having been marked down, but also discipline re-imposed (well, total chaos averted, at least). If needed, euro zone capital controls could be instituted and penal charges applied to those running inordinate balances – plus or minus – on Target, so closing that particular back door.

    Would this not help overcome some of the worst uncertainties?

  2. Do I read between the lines irritation and a kind of desperation (wrapped in sarcasm)? At least that’s how I feel and maybe most who follow this subject. It has become tiresome and hopeless. Nowadays most comments on this matter irritate me utterly. Not this one however. Excellent article.

  3. That would mean a reward for cooking the books and wasting earlier subsidies. Unless you propose giving more freshly printed money to the north, this is unacceptable.

  4. Pingback: Grexit Ahoy? |

  5. Sigh@*& Dear ‘other Oliver’, The books HAVE been cooked; the losses HAVE been made. It is time to recognise that both lenders and borrowers have been misled/unlucky/negligent/devious (take your pick) and to move on. Moralizing does nether side any good: lenders from the north – if not fully satisfied by whatever debt:equity swaps and renegotiations that can be undertaken – can always exact more rigorous terms in future, just as they should have been doing all these years, had they not been hoodwinked by false EMU optimism and ludicrously low, Bundesbank-sanctioned official interest rates And offering northerners more ‘freshly printed money’ means, what, precisely? That we compound their current misery of having unrealizable non-monetary claims on the south with equally unrealizable monetary claims on goods and services which do not exist, i.e., to condemn them to inflation and hence further losses to come.

  6. It is time to recognise that both lenders and borrowers have been misled/unlucky/negligent/devious (take your pick) and to move on

    We cannot. The potential remedies will have to be voted on. The amount of time it would take to implement them makes sure of that. Due to the justice issue the answer would very likely be “no”. Justice is a basic human desire. It cannot be ignored beyond a certain point. Neither can sacrifices be demanded beyond a certain point and, probably more important, for more than a certain time.

    That is not necessarily even a problem of pesky voters unwilling to sacrifice themselves for the grand European idea, but the demographic impact of the current crisis will become dire if it lasts too long.

    We now need to admit that that the Euro is unlikely to survive and act accordingly.

  7. I was wondering.
    Why don’t the creditors augment the capital of their debtors by incorporating the debt? They (foreigners) would take over the (Spanish banks), make them meet capital requirements and solve the liquidity issue.
    After all the big problem in Spain is private debt (bank debt)

  8. Excelllent article.

    I hope by now sensible people can agree that austerity is counter productive: when nominal GDP falls, Greek’s debt-to-GDP ratio goes up, and the debt is even harder to service. Time to cut losses and think of a new approach.

    It is said that time of crises is also time of opportunities: instead of helicopter drop, how about a new Marshall plan for Greece? Instread of forcing austerity on the Greeks, the core countries can put up a plan which provides fiscal transfers (ie, debt forgiveness and aids) in exchange for radical Greek fiscal and labor market reforms. Economists have long been said that a monetary union will not survive without the fiscal union. Maybe this is the time to jump start the fiscal union.

  9. “Is this where all those high minded ideals of a European Community have lead us”?

    Yes. The Euro was not a very good idea, and those who supported it have much to answer for.

  10. @ Pat:

    “Instread of forcing austerity on the Greeks, the core countries can put up a plan which provides fiscal transfers (ie, debt forgiveness and aids) in exchange for radical Greek fiscal and labor market reforms. Economists have long been said that a monetary union will not survive without the fiscal union. Maybe this is the time to jump start the fiscal union.”

    If through fiscal transfers the eurozone would provide the Greeks with a standard of living that the Greek economy itself cannot support, should the same aid then not also be given to other eurozone members with standards of living that are even lower than those of Greece? Think about Estonia and Slovakia. Wouldn’t it be fair then to lift their standards of living at least to the level of Greece through fiscal transfers?
    Can you imagine the amount of money this would require if for example a relatively poor country like Poland would enter the eurozone.

  11. Jan,

    This idea of EZ is supposed to make Greeks better off than not in the EZ. And Greeks’ gain doesn’t have to be Germans’ loss — it is time to focus on solutions that will lead to “win-win” outcomes, at least in the mediem term. You don’t hear New Yorkers complain about their tax dollars going to West Virginians — what’s the big deal? We are better off together. And I don’t think it’s good for Germany to be an isolated “giant” in a troubled Europe.

  12. Oh, and don’t kid yourself to think EZ will survive once Greece leaves — there is a reason there are no provisions for any country to leave EZ once they get admitted. A necessary (but not sufficient) condition for a currency union to survive is that it has to be like Hotel California (or roach motel): one can get in, but no one can leave. Otherwise, it’s just a matter of time to encounter another crisis — like all fixed exchange regimes have experienced.

  13. Pat,

    I understand your reasoning and I agree that a currency union should also be in some degree a fiscal union. But than all other regions that are poor, not because of a crisis, but just because they are still lagging behind in development, should receive a piece of the cake. The purchasing power of the average Estonian or Slovakian is still significantly lower than of the average Greek.
    But I think that in practice this will be very difficult to implement because of all the different nations that don’t feel connected enough to support this kind of arrangement. I live in Belgium and we have enormous political problems because Flanders is fed up with fiscal transfers to Wallonia. So I can imagine how the richer eurozone members would react to the idea of fiscal transfers to poorer eurozone members.

  14. An interesting paper, somehow damaged by the concluding snip about “Francoise Hollande” (sic) election transmuting a European dream into a nightmare. Blame the French?

    Also, the mix of pre-Schengen Europe and of USSR into the same bag of detestable outcomes seems slightly over the top.

    For the rest I fully agree with Otto.

    Tout ce qui est excessif devient insignifiant. (Talleyrand)

  15. Pingback: Brussels blog round up for 19 – 25 May 2012: The European Investment Bank is rediscovered, Europeans stay at home for their holidays, and are Eurobonds a winning bet? | EUROPP

  16. Jan,

    You are certainly better at judging how feasible some sort of fiscal union, any sort, is to EZ citizens. I am just saying that it seems to me a smaller euro zone is not really a viable option. EZ can either go forward and get the fiscal union going, or forget about this euro project. Yes it might be better that Greece were never admitted into EZ but now that it is in, everyone has to chip in to keep it in, if they still want euro. I wouldn’t worry too much about other poor regions want their transfer, though. The fiscal transfers will come in exchange for much of Greece’s sovereignty, which should make them not so attractive for other regions. In the long run, other regions may also get some transfer, after all, that’s what a fiscal union means.

  17. The fiscal transfers will come in exchange for much of Greece’s sovereignty

    Greece will not accept that. And nobody else would accept it for their own country. If that’s what it takes, it’s over.

  18. Pat,

    I thought you were arguing that a monetary union has to be complemented by a fiscal union. In that case fiscal transfers have to connect all members, not just Greece with the rest.

  19. Pingback: En vit skjorta » Blog Archive » Grexit

  20. ECB is responsible for functioning of European payment system. If the payment system in Greece stops working, Greece can print 200 bn, 500 bn or more of EURO banknotes, in order the payment system works again.

  21. Something like “shut Greece off from the Eurosystem”, or Grexit is not provided by European law. This is German wishful thinking, Law for that does not exist. If something like that happens unlawfully, then it is an act of war.

  22. Good commentary that makes a horible prosepect funny, in a gallows sort of humor.
    Sadly, with all the Rupert Murdocks cheerleading the new “co-ordinated” liquidity scheme, nobody bothers to explain how much interconnection still exists between the Bilderberg Banks, via their derivatives and counterparty swaps etc., etc.. The silence is deafening and should cause any investor, who can connect the dots, to conclude that we are in for a world-wide deflationary depression that will likely result in the pitchforks seeking banker hides to roast, while city tenements take on the look of Dickens’ era slums where it is every Artful Dodger for himself.

  23. This is the Europe the troika are talking about:
    -The state, intervening to change the terms in PRIVATE contracts and agreements with the result that it ends up losing direct and indirect taxes, pension fund support and everyone who can, leaves.
    -Imagine a greek or spanish guy buying a german company, like a Bundesliga team, then deciding he dies not like the players contracts and asks the german government to change them. What do you think if not the german government’s, UEFA’s reaction would be? The moral is that football players are more equal than say engineers.
    -Furthermore anyone who seriously thinks labor is the problem is Greece is doing hard drugs
    -Those who created this mess, i.e. the people who were paid to protect the country’s interest and swore to do so were voting for deficit upon deficit for over 35 years until discovering that debt is a bad thing, threw and keep throwing money down the drain, appointed friends and incompetent party members to key positions and did nothing about public administration and taxes are simply untouchable.

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