\t\t\t\tI am travelling for most of today and so haven’t much time to write a blog. I am typing this on the train to Sydney airport. The press has been increasingly highlighting the on-going Greece situation. What is important to note is that the neo-liberals are no longer honey-coating the fiscal austerity in terms of “fiscal contraction expansion”. The Greek finance minister is now saying that the Greeks have a choice between disaster and total disaster. Other are juxtaposing sacrifice with chaos. I have noted that in recent months that a lot of commentators have been asserting that an exit would be a disaster – far worse than the current “disaster” of 4 years recession and more to come. But rarely do you read any coherent analysis of what might happen should Greece exit the Eurozone. My view is that while the dislocation would be intense and costly it would, in the longer-term, be less costly than the current alternative – which is persistent recession for the foreseeable future and a savage erosion of real living standards, especially for the next generation. As on commentator put it over the weekend (full quote provided later) – the current austerity approach with “deep structural inequalities and its rigid adherence to a failed economic ideology, protects neither democracy nor human rights. Stiff-necked and punitive, it prefers to eat its children
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\nIt is ironic that the fiscal austerity argument is often phrased in terms of needing to take the “crippling” debt burden off the future generations. However, the damage that the bailout packages are doing to those generations is highly significant yet that irony is never noted.<\/p>\n
The UK Guardian article (February 12, 2012) – As Greece stares into the abyss, Europe must choose<\/a> – made this point emphatically:<\/p>\n \nSix inches from the riot policeman’s shield outside the Greek parliament last Friday, a tall, pale boy was shouting at a man who could have been his uncle: “It’s your generation that brought us to this point, but it’s mine that has to pay for it. You have to take responsibility for what’s happening here.”\n<\/p><\/blockquote>\n Please read my blog – The rising future burden on our kids<\/a> – for a discussion of why fiscal austerity imposes a heavy burden on the future generations.<\/p>\n The Greek Finance Minister was quoted by Bloomberg<\/a> (February 13, 2012) as saying in relation to the current political impasses in Athens that:<\/p>\n \nToday at midnight, before markets open, the Greek Parliament must send a message … We must show that Greeks, when they are called on to choose between the bad and the worst, choose the bad to avoid the worst.\n<\/p><\/blockquote>\n Reinforcing the Finance Minister, the Troika-installed Prime Minister told the Greek people via TV that:<\/p>\n \nWe are looking the Greek people straight in the eye with full knowledge of our historical responsibility … The social costs that come with these measures are contained in comparison to the economic and social catastrophe that will follow if we don’t adopt them … We have to sacrifice a lot so as not to sacrifice everything.\n<\/p><\/blockquote>\n The Prime Minister he replaced obeyed the Troika script by saying:<\/p>\n \nWe must speak honestly and tell Greeks what bankruptcy really means. It means chaos.\n<\/p><\/blockquote>\n It should be noted that bankruptcy only applies to the nation’s status as a user of a foreign currency (Euro) and becomes irrelevant once the nation restores its own currency. As I discuss below, under those terms, it can duly re-denominate all foreign-currency obligations in terms of its new currency and solvency then becomes guaranteed.<\/p>\n It is interesting that there is horror expressed by commentators about the possibility that the Greek government could enforce creditors to accept Drachma instead of Euros, the same horror is not expressed when the Troika propose a PSI arrangement that could carve up to 75 per cent off the value of current Greek bond investments (in Euros).<\/p>\n I will come back to the political assessments later but you note that they are no longer making the mainstream macroeconomic argument that has been justifying the imposition of austerity – that growth is just around the corner once the private sector realises that the deficit cutting will reduce future tax burdens and as a consequence they stop saving and start to spend again.<\/p>\n That nonsense – was always nonsense – and its bald-facedness is now being exposed.The future for Greece under current policy is bleak and the private sector know it.<\/p>\n The Troika (EC\/IMF\/ECB) operating through the agency of the Finance Ministers Summit initially wanted Greece to impose further – huge – cuts in net public spending in return for the next bailout installment that would see that nation pay up on its impending debt commitments.<\/p>\n The ridiculousness of the whole deal was that the Greeks were expected to achieve certain fiscal targets by this time. The progress of the Greek cutbacks is reviewed every three months by the baleful bureaucrats within the EC and the IMF. What they expected to happen each three months is of some confusion. The indications are that they actually expected the fiscal situation to improve.<\/p>\n But it was always obvious that under current conditions – fiscal austerity would lead to an increasing budget deficit and rising public debt ratio – as aggregate demand continued to contract.<\/p>\n All the real GDP estimates of the Troika have been shown by unfolding events to be over-optimistic. The Greek economy is in a severe downward spiral and has been getting worse for the last 4 years.<\/p>\n The recession is now entirely self-imposed by the Troika and its henchmen\/women in the Greek polity.<\/p>\n But it is now well-known that the Finance Ministers acting turned nasty on Greece last week and demanded even harsher cuts including a 22 per cent cut in the nominal money wage (a much larger cut in real terms), drastic cuts in pensions and public sector employment cuts of up to 15,000 workers by 2015.<\/p>\n These additional cutbacks are the equivalent of about 7 per cent of GDP over the next three years and under those circumstances the Greek economy will remain in recession at least over that period.<\/p>\n It is inconceivable that a nation would tolerate 7 or 8 years of enforced recession when it is largely unnecessary.<\/p>\n The Germans have been claiming that even with these latest proposed cuts the public debt ratio will remain above 120 per cent of GDP. <\/p>\n The media is also perpetuating the claim that chaos would follow a Greek-exit from the Eurozone.<\/p>\n The UK Guardian article (February 12, 2012) – There’s talk of an exit – but default would have catastrophic consequences<\/a> – claimed that the “break-up would bring banking chaos”.<\/p>\n The article said that a “Grexit … would send shockwaves throughout the world economy”.<\/p>\n Apparently:<\/p>\n \n… default and “re-drachmatisation” would be a costly and chaotic process … in the short term banks across the eurozone might have to be closed to prevent a run on the single currency as investors speculated about which country might be next. A new wave of bank nationalisations would be likely to follow as lenders counted their losses on now worthless Greek debt.<\/p>\n Capital controls would have to be imposed and borders shut to stop money flooding out of Greece. Portugal, Italy and Spain would come under intense pressure from investors wary about the risk of another victim. Banks everywhere, already reluctant to lend, would cut back hard, nervous about their exposure to the bonds of all Europe’s crisis-hit states.<\/p>\n For Greece, a drastic devaluation … could at least provide the hope of an export-led recovery. But unlike Argentina, which defaulted on its debts in 2001 after a wrenching political and economic crisis, Greece has neither the advantage of plentiful natural resources nor a boom in the world economy to ride.\n<\/p><\/blockquote>\n So you get the message – chaos – drastic devaluations etc. No mention of the recent ECB initiatives to provide at virtually zero cost massive long-term funding to European banks.<\/p>\n No mention of the growth that the Greek government could engender immediately if it regained currency-sovereignty.<\/p>\n Further, the implication that capital controls are chaotic would not sit with Malaysia during the Asian crisis. The IMF has also released research showing that capital controls are effective and beneficial.<\/p>\n Please read my blog – Are capital controls the answer?<\/a> – for more discussion on this point.<\/p>\n Also revealed over the weekend was the secret conversation between the German Finance Minister Wolfgang Schaeuble and his counterpart in Portugal Vitor Gaspar recorded before last Thursday’s Eurogroup meeting of Finance Ministers began. The conversation was recorded by the Portuguese station – TVi24.<\/p>\n This meeting upped-the-ante on Greece by demanding an extra \u20ac325 million extra in public spending cuts before this coming Wednesday in order to get the latest bailout.<\/p>\n Further, the bailout money would be sequestered and the Greek government would have to prioritise debt repayments over general government spending. It is estimated that 70 per cent of the bailout money will be prioritised in this way. In other words, there’s not much there for the Greek people. <\/p>\n It is clear that “divide and conquer” strategies are being used as the German indicates to the compliant, almost simpering Portuguese finance minister that Germany would “adjust” the Portuguese bailout conditions as long as the decision to enforce even harsher sanctions on Greece went through.<\/p>\n The conversation went like this (with the segments marked … being inaudible):<\/p>\n \nWolfgang Sch\u00e4uble: … we need an adjustment to the programme, after our substantial decision on Greece … Not to [unclear]. If then there will be a necessity for an adjustment for the … programme, we would be ready to do that.<\/p>\n V\u00edtor Gaspar: That’s much appreciated.<\/p>\n Wolfgang Sch\u00e4uble: As long as my fellow members of the government … that public opinion in Germany don’t believe that our decisions are serious, because they don’t believe in our decision on Greece.<\/p>\n V\u00edtor Gaspar: We have made quite substantial programme on the European framework.<\/p>\n Wolfgang Sch\u00e4uble: You have, yes.<\/p>\n V\u00edtor Gaspar: That we have. And now we must work today …\n<\/p><\/blockquote>\n This You Tube video<\/a> presents an interesting analysis of the body language between V\u00edtor Gaspar and Wolfgang Sch\u00e4uble – “the petitioner and the petitioned”!<\/p>\n The New York Times article (February 10, 2012) – Amid Efforts to Rescue Greece, a Lack of Trust From Allies<\/a> – interpreted the exchange as an indication that:<\/p>\n \nThe conversation … illustrated a stark fact as the euro zone’s debt crisis enters its third year: While Portugal, Ireland and other countries may be struggling, Greece has found itself in a category of its own – a nation the rest of Europe no longer trusts.\n<\/p><\/blockquote>\n One hypothesis about the behaviour of the Germans and French (and other northern European leaders) over the last few years in relation to Greece it that they have been buying time. The process of grinding Greece into the ground has allowed the rest of the Eurozone to shore up the dykes!<\/p>\n This point is made by the UK Guardian’s economics editor Larry Elliot in his article (February 10, 2012) – European debt crisis pitches Germany against Greece<\/a>.<\/p>\n He says that “(t)he Germans want the Greeks out. That is the clear message from the decision by Europe’s finance ministers to reject the offer of a fresh package of austerity measures”,<\/p>\n He considers that the time is now ripe to get rid of the Greeks because the Germans now have the view that “the actions taken by the European Central Bank over the past couple of months have been sufficient to ensure no contagion effects from Greece to the other debt-stricken eurozone members and, just as importantly, to the fragile European banking system”,<\/p>\n I tend to agree with that assessment.<\/p>\n It is probable that what has been taken to be bumbling by the political leadership in the Eurozone has also been a process of buying time while the European banks – assisted by the ECB – have been reducing their exposure to the Greek economy.<\/p>\n In that context, are these claims of chaos justified? I think not unless Greek society is so unstable that it is likely to disintegrate anyway.<\/p>\n The Citibank recently released a Report (I cannot link to it because it is subscription only) which introduced the term Grexit into the lexicon. More importantly, the discussion acknowledges that the financial markets are now openly considering the exit of Greece from the Eurozone.<\/p>\n Citigroup estimated that probability as having risen from 25-30 per cent in November 2011 to 50 per cent within 18 months in February 2012.<\/p>\n So what would happen?<\/p>\n First, it is claimed that the bond markets would stop funding the peripheral EMU nations (Portugal, Spain, Italy) for fear that they would also exit. The reality is that if Greece actually got away with wiping off a substantial portion of its public debt (via the so-called PSI arrangement) it is likely that the other beleaguered nations would demand similar relief.<\/p>\n Would a negative bond market reaction become chaotic? Not in the least. Ask yourself – who has the ultimate power in this situation – the markets or the ECB? The answer is obvious.<\/p>\n The ECB can simply shore up the EMU member states and all the private banks should it choose to do so. Its long-term lending program to the banks and the Securities Markets Program (where it is buying significant quanties of government debt in the secondary markets) is already effectively doing that.<\/p>\n Under those circumstances the bond markets are not in a position of power to dictate to anyone.<\/p>\n The Citigroup analysis supports that assessment:<\/p>\n \nPolicymakers in the EA have the technical ability\/capacity to respond to exit fear contagion. The heavy lifting would likely mostly be left to the ECB, but the recent 3- year LTRO has highlighted that policymakers have plenty of ammunition left to respond to non-fundamental contagion and hysteria.\n<\/p><\/blockquote>\n So if the Euro leaders really want to preserve a wider Eurozone – beyond a German-centric Deutschmark-zone – then it has the capacity to do something about it.<\/p>\n My assessment is that the financial markets have already been taking into account the likely exit. Currency flows out of Greek banks have already occurred.<\/p>\n The Citigroup analysis also supports this conclusion:<\/p>\n \nDirect (and some indirect) exposures to Greece of foreign banks, other investors, and non-financial corporates have been reduced substantially and contingency plans have been made by a likely large number of public and private institutions. This process has been going on for the past 18 months, but by now the reduction in direct exposure to Greece and the extent of contingency planning may well have reduced the direct effects of Grexit to a level that could likely be absorbed by most relevant (non-Greek) institutions without major disruption.\n<\/p><\/blockquote>\n In real terms, the fate of the rest of the Eurozone would not seem to depend much on Greece. Its overall impact on trade for the rest of the EMU is small (nations such as Romania and Bulgaria are more exposed).<\/p>\n The Citigroup analysis says:<\/p>\n \nGiven the limited integration of Greece into regional or global supply chains, the supply effects of Grexit on world output or trade would also likely be minor.\n<\/p><\/blockquote>\n