The way we see it, history is needed to guide us. Greece cannot continue indefinitely in depression, and it cannot pay. There is no good outcome. The people of Greece need a political outcome to give them a victory.
Let’s move to today.
Greece remains the main focus of attention and officials seem to be inching closer toward a deal, as the Greek government is running out of cash. However, the risk of Greek default is rising. A EUR 201 mln interest payment to the IMF is due Wednesday.
– Action Economics, global edition of Action Weekly, May 4, 2015
Five years after the initial bailout of Greece, the Athens government again is teetering on bankruptcy. The gap remains wide between the EU-led by Germany and demanding further reforms in exchange for the credit Greek needs to stay afloat – and the Greek government that is overseeing an economy suffering from a deep depression. Devaluation traditionally has been the palliative for such economic pain. Remaining in the common currency removes that possibility.
– Randall Forsyth, Barron’s, May 4, 2015, p. 5
For the last few days we have been engaged in economic exchanges about Greece with friends and colleagues around the world. We have been discussing all sides of the Greek debt/economics/governance problem. The opinions about the probable outcomes are diverse. The predictions and recommendations range from default, Grexit, and devaluation (my ultimate forecast, although when is uncertain) to further extension of credit (the can-kicking solution to the present crisis), to contagion avoidance and eventual Greek economic recovery (how long that might take is uncertain).
And there are mixed versions of these outcomes as well as two currency proposals (euro external and drachma internal), Russia as Greece’s benefactor, and all sorts of other scenarios. Funding by the IMF and other institutions of enough money to repay the loans owed to those same institutions would amount to a minimalist, recycling approach. It would net no new money for the Greeks, and for the existing lenders it would be a rollover at the same excessive risk level. In the interim, the runs on Greek banks and nearby banks in six other countries continue. The Greek banking system is avoiding failure only by obtaining Emergency Liquidity Assistance (ELA) with the grudging approval of the European Central Bank. Watch what happens with the banks if a single institution faces an exhaustion of cash. We will see the Greek version of the British Northern Rock bank run. Risk of this type of accident is rising every day.
A good friend and policy maker wrote the following. We shall preserve anonymity.
As someone who has served in the capacity of economist within a political environment, I can say that my victories were to avoid the worst possible outcome. I apply the same criteria here. Grexit is not the better economic outcome when considered all in. And it is not the political choice. So, what needs to happen to get us to avoid the worst possible combined outcome, especially within the political constraints? The problem is that there are two political constraints – Euro group and Greece. There is a menu of reforms (we know what they are) that meet the conditions to satisfy both political sides. The grandstanding on Greece's side isn't in their domestic economic or political interest.... At least not of Tsipris although perhaps that of Varoufakis.... Hence the new internal divisions within the Greece side. I remain hopeful of sanity.
We invoke a quote from Albert Einstein: “We cannot solve our problems with the same thinking we used when we created them.” Einstein also defined insanity as doing the same thing over and over and expecting a different outcome.
The retired chief strategist of a major global firm disagrees. He wrote:
It seems to me that being unwilling to bite the bullet ensures its ultimate travel to the heart. History reveals many examples of this lesson. In this case, the biting should have come quite a while ago, but better late than never.
A detractor (me) wrote:
Greece came into the euro with faulty data and then revised after entry. And there was no way to deal with a prevaricating new member. So the euro system powers at the time bit the bullet. Then Greek debt was downgraded. Again the euro system leaders allowed rule changes. Then Greece defaulted. Euro system leaders extracted penalties and extended more financing. Now the game is played again. I also would note that when Greece did restate and revise its GDP in order to comply with the required level, it did so by raising the services portion. When you dig into that detail, the highest upward revisions came in money laundering and prostitution. If the euro system leaders extend more credit, what do you think Greek behavior will be?
My comment brought some harsh criticism regarding the reference to adding to GDP by counting prostitution in the growth of the service sector. However, we do not factor that into GDP in the US. My good friend Bob Parker is an expert in statistics who honed his superb skills as the Chief Statistician of the United States. He sent me a note and a link and gave me permission to cite his “ongoing research on implementation of international standards for measuring GDP.”
Here is the link from Bob to an article that discusses how European statistical agencies deal with prostitution, drugs, and other underground economic measurements. Readers may enjoy this one.
A former chief European strategist, also retired, of a major global firm took the other side. He wrote:
No matter how aggravating Varoufakis & Co. may be; no matter how tenaciously investors resist a new haircut, the underlying challenge in a "Grexit" is that markets then turn their attention to the huge bubble in euro-denominated government debt. If the markets home in on the real elephants in the trading room, Italy and France are the obvious targets since they have done almost nothing to cut public spending. (While Greece, Spain and Ireland have.) Such pressure on Italian and French government bonds would sharply increase market volatility and weaken the euro to such a dangerously undervalued level (meaning, in relation to the overvalued USD) that it would force the G7 to take Louvre Accord-type action to stabilize FX markets. I remind those euro sceptics who would welcome Grexit that the ECB estimates total euro-denominated debt issued by résidents to be in excess of EUR 14 trillion.
Remember too that up to seven years maturity of the euro-denominated government debt market is now priced at negative yields. Do you really think the 10-Year bund yielding 29 bps or the OAT yielding 57 bps, are realistic investments? If you want serious turbulence in that giant euro debt market, then Grexit could trigger it. Brace yourselves for a financial crisis that could dwarf that of 2007-2009 at a time when the Fed and ECB are virtually out of ammunition and our elected political ideologues refuse to take appropriate fiscal action.
The newest Greek government knows its history. Greek people wish for a 21st century Ulysses. They feel the chill winds that come from beyond the mountains of the north, blowing in from the bureaucratic caverns of Frankfurt and Brussels.
The final chapters of Greece’s story are yet to be written.