By Marc Chandler, Global Head of Currency Strategy, Brown Brothers Harriman
No last minute miracle has the Greeks headed to new elections next month. Syriza’s Tsipras appears to believe he has much to gain from a new round of elections. Polls put Syriza in first place, though the margin of error makes it look more like a dead heat with the New Democracy, led by Samaras. Samaras was a significant obstacle to reaching agreements earlier but now has been outflanked by Tsipras. Tsipras apparently did not drink a sufficient amount of the kool-aid that made Samaras more of a realist.
Many observers are confusing the Greek opposition to austerity regime with a desire to leave monetary union. Judging from the electoral results, a majority of Greeks are critical of the EU/IMF/ECB demands in exchange for assistance. However, polls show that 80% or more Greeks want to keep the euro.
There is room to compromise. Can any one doubt, for example, Keynes’ loyalty to the UK even though he passionately warned that the Treaty of Versailles was poorly thought out and would lead to no good? Are not the Greek people saying the same thing as Keynes was saying then?
First, as Keynes noted then, there is a limit on how much people would sacrifice current output to service foreign held debt. Up until earlier this year, aid to Greece seemed to be largely a stealth bank bail out. After the PSI, upwards of three-quarters of Greek debt is in the hands of the Troika (ECB/IMF,EU). They purposely acted to avoid participating in Greece’s debt relief even though, by most accounts, Greek debt was still not on a sustainable path.
Second, under the conditions of the modern era, Greece has been occupied by its creditors. It was forced to pass a law that prioritizes servicing debt (largely in foreign hands) over other claims on the public purse. Is this not the kernel of truth in Tsipras’ claim that the EU has imposed “barbarous demands” on Greece?
Third, France’s new president wants to renegotiate the fiscal compact that his predecessor helped draft and support. Why shouldn’t a new government in Greece seek to renegotiate the terms of its aid, which is not really so much aid for Greece as it is aid to keep its (now largely official) creditors whole?
Fourth, exacting onerous concessions from Greece threatens to destabilize Europe as much as the onerous demands at Versailles undermined European stability.
Given the extent of the international assistance, TARGET 2 exposures, and commercial bank activity, a total default by Greece could cost Europe (and IMF) an estimated 400 bln euros. With new firewalls (IMF/ESM) and the liquidity provisions (LTROs), Europe is in a better position to cope with this than say a year ago, which belies the derogatory epithet of “kicking the can down the road”, nevertheless, it cannot be confident that the extent of the contagion can be known a priori (see Lehman, six months after Bear Stearns).
There is no mechanism to eject a member of the euro zone any more than there is to evict a state of the United States. Still, life can be made unbearable for Greece within the euro zone. Without a printing press, the Greek government can run out of currency to pay social security and public sector wages. This is partly because Greece still runs a primary budget deficit (budget balance excluding debt servicing costs). That means that tax revenues continue to fall short of spending.
The ECB could also stop lending to Greek banks and refuse to sanction any more emergency lending (ELA) from the Greek central bank. These two steps would leave Greek officials little choice.
German Finance minister Schaeuble who is likely to replace Juncker as the head of the Eurogroup is touting a tough line. No room to compromise. Either Greece adheres to the agreements or it can leave monetary union. We have seen this tactic before. Schaeuble is the bad cop so Merkel can be the good cop.
Spain and Italy have openly acknowledged they will not achieve the budget targets agreed to with the EU. The new EU forecasts showed that other countries will unlikely meet their targets. That is not a cause for ejection, but a case for forbearance.
There is plenty of room for compromises and there is a great deal of posturing, which is part of the brinkmanship tactics. New EIB funds and structural funds are available (and already earmarked for Greece) can be deployed. There is some flexibility with the timing of budget goals.
It is preferable to the alternative of Greece leaving. The contagion impact of Grexit is unponderable. We argue that Greece is largely a symptom of the crisis not the cause. A Grexit could trigger a new banking crisis. It could heighten the pressure on Spain and Italian sovereigns, which in turn would squeeze domestic banks. It could lead to pressure on Portugal (if not others) to join Greece. It would be understood as a failure of European elite in general and Germany in particular.
We have argued that exiting EMU would not solve Greece’s problems. It would exchange them for a more dire set of problems, which would include a collapsed banking system, a deeper recession/depression, higher unemployment and higher inflation.
Leaving EMU and the EU could also impact geo-strategic interests of the US and Europe. An aggrieved Greece could turn to Russia for financial assistance, perhaps in exchange for basing rights, or Iran for its energy needs.
We recognize the risks of a Grexit to have increased primarily as a consequence of brinkmanship tactics from multiple parties. However, we continue to see a Greek exit as an expensive folly for all concerned.