One more post on Greece, possibly not the last one.
Markets are more worried about what is going on and there is more and more talk about the possibility of and exit of Greece from the Euro area. As I have argued in my previous posts, exit will not be the choice of the Greek government, it will be the only solution for Greece as the ECB refuses to provide liquidity to Greek banks as depositors run to avoid capital losses on their Euro deposits in the scenario of Greece leaving the Euro.
Let me start by repeating (as I have expressed many times in this blog) that I find that the economic policies followed in Europe have been a disaster, that the suffering that countries such as Greece had to go through during the last years should not have taken place. And I am convinced that in many of these countries, austerity has produced higher debt-to-GDP ratios, as opposed to lower ones. A real disaster.
But this is not what this negotiation is going to be about. The reality is that the crisis has had an impact on the way we all see the experiment of sharing a single currency, the experiment of EMU. While in the early days we all talked about optimum currency areas, the synchronicity of business cycles, the absence of a fiscal transfer mechanism, what we now realize is that the real issue is how to handle a full-blown crisis that puts governments at the edge of default and creates bank runs among Euro countries (something that many l thought it was impossible). The role that the ECB plays in those circumstances is not the typical role a central bank plays and one cannot ignore the political aspects associated to the difficult decisions they face.
And while it is true that Syriza has been chosen by the Greek voters and as such it is a victory of democracy, there are also voters in other countries that also feel they want their say heard by their governments.
And here is the question that I think is fundamental: if voters had a choice now, would they choose to join the Euro area given its current membership? What if they were allowed to change some of the members? There is no doubt that in some countries voters would like a different configuration of the Euro area. No doubt that Germany would be happier with fewer countries, in particular the "trouble makers".
And this decision will not be just based on economic arguments, some of it will be about the emotions generated by the crisis and some of it will be generated by the first statements of the Syriza government (and proposing a rethinking of the sanctions to Russia does not help).
So if the current membership does not work anymore, what do we do? There is no explicit process for this. Countries can opt out of the Euro if they do not like what they see. But the current negotiations with Greece will be seen by some as an opportunity to change who is in and who is out of the Euro.
If (big if) contagion can be avoided, Germany and Brussels have all the power in these negotiations. Greece does not want to leave the Euro.
Can contagion be avoided? The answer to this question three years ago was a clear no. And that's why this was not an option. Today I am not so sure. Three years ago Spain or Ireland or Italy were facing very difficult economic conditions that looked similar to Greece. Today that's not the case. Growth is very low but deficits are under control, debt to GDP ratios decreasing in some countries and interest rates are low and not reacting much to the Greek elections. The possibility of contagion today could come more from the political side. If voters in other countries decide to elect similar parties, we might repeat the same scenario in a few months in Spain or Italy. But will voters do this if they see that exit from the Euro is a possibility? Remember these political parties do not want to leave the Euro. Most citizens even if they are critical with European policies do not want to leave the Euro. My guess is that an exit of Greece from the Euro area will change political outcomes in European countries relative to what we see in the polls today. And this will limit the possibility of "political contagion".
Interesting times. More to come.
Antonio Fatás
Wednesday, January 28, 2015
Sunday, January 25, 2015
Grexit: it is not the debt, it is the future.
A follow up to my previous post now that we know that the Syriza party has won the election. What comes next will not be easy. And it is not because the policies proposed by Syriza are that radical or unreasonable and certainly they are not worse that what has been done in Greece since the crisis started. The real issue is that this is a wake up call for the Euro area (and possibly the European Union). A wake up call that without a consensus on what is the purpose and processes of a monetary union, this will be a failed project. The reality is that so far EMU has been built in an asymmetric way: the ECB was designed as a strong anti-inflation central bank with the Bundesbank in mind and that served a purpose (for everyone including Greece). The strict criteria to enter into EMU (low inflation, low budget deficits) were a great excuse for politicians in some countries to do policies that otherwise they could not have done internally. There was no doubt who was in charge and what was the ideology that prevail when it came to define policies. And that model worked well in times of economic growth when everyone, including Greece, enjoyed the benefits of stability and growth.
But the crisis made everyone realized that the model was not perfect, that there was no consensus around economic policy and, more fundamentally, that for monetary policy to function properly we needed some amount of risk sharing, something that no one had been willing to discuss before.
And the elections in Greece yesterday have made it even more clear that the consensus is gone. That the model that worked well until 2008 is being challenged by several countries. And without a minimum level of consensus, EMU cannot work. The problem is not that anti-austerity policies might stop in some countries. This is likely to benefit everyone in the short run including Germany. The problem is not that we might need to restructure Greek debt again, that is feasible from an economic and political point of view. The real issue is how to move forward, what will be the way in which the European Commission will deal with future budgetary plans of Euro members, how will the ECB treat sovereign debt in the future, how will markets perceive the risk of future default.
From the perspective of Germany (and other countries that share the same view and economic situation), any agreement with Greece that signals to the market that this would be the solution for any future crisis, would be a disaster. Germany needs a strong commitment from Greece and others that this would be the last time that this happens. But that is unlikely to happen. There could be promises but I cannot imagine how to make those promises credible.
So either Germany gives up and runs the risk of having similar negotiations later in the year with Ireland, Portugal, Cyprus, Spain and Italy. And it accepts the fact that we will be starting a new cycle of accumulation of government debt until the next crisis. Or it throws the towel. And I see this happening in two ways, either it refuses to be flexible in the negotiations with Greece and the ECB holds its promises that liquidity will stop unless there is an agreement, which will push Greece out of the Euro. Or Germany decides to leave the Euro and leaves the other countries to manage what is left. Both of these scenarios are likely to cause a crisis. The first one could potentially be more contained assuming the other Euro countries support Germany. The second one would be a major economic disaster for Europe and the world.
No, Syriza's policies are not that radical, crazy or absurd but the negotiation that starts today is between parties that are either scared by what has happened so far or are not willing to be members of a club that cannot commit to not doing this again. I still do not see how they will agree on a model to move forward.
Antonio Fatás
But the crisis made everyone realized that the model was not perfect, that there was no consensus around economic policy and, more fundamentally, that for monetary policy to function properly we needed some amount of risk sharing, something that no one had been willing to discuss before.
And the elections in Greece yesterday have made it even more clear that the consensus is gone. That the model that worked well until 2008 is being challenged by several countries. And without a minimum level of consensus, EMU cannot work. The problem is not that anti-austerity policies might stop in some countries. This is likely to benefit everyone in the short run including Germany. The problem is not that we might need to restructure Greek debt again, that is feasible from an economic and political point of view. The real issue is how to move forward, what will be the way in which the European Commission will deal with future budgetary plans of Euro members, how will the ECB treat sovereign debt in the future, how will markets perceive the risk of future default.
From the perspective of Germany (and other countries that share the same view and economic situation), any agreement with Greece that signals to the market that this would be the solution for any future crisis, would be a disaster. Germany needs a strong commitment from Greece and others that this would be the last time that this happens. But that is unlikely to happen. There could be promises but I cannot imagine how to make those promises credible.
So either Germany gives up and runs the risk of having similar negotiations later in the year with Ireland, Portugal, Cyprus, Spain and Italy. And it accepts the fact that we will be starting a new cycle of accumulation of government debt until the next crisis. Or it throws the towel. And I see this happening in two ways, either it refuses to be flexible in the negotiations with Greece and the ECB holds its promises that liquidity will stop unless there is an agreement, which will push Greece out of the Euro. Or Germany decides to leave the Euro and leaves the other countries to manage what is left. Both of these scenarios are likely to cause a crisis. The first one could potentially be more contained assuming the other Euro countries support Germany. The second one would be a major economic disaster for Europe and the world.
No, Syriza's policies are not that radical, crazy or absurd but the negotiation that starts today is between parties that are either scared by what has happened so far or are not willing to be members of a club that cannot commit to not doing this again. I still do not see how they will agree on a model to move forward.
Antonio Fatás
Monday, January 5, 2015
And this is how Greece might leave the Euro
An interesting month lies ahead for the Euro area. On January 22 the ECB will meet and they will either announce a QE-style monetary policy action, as most expect by now, or they will disappoint markets with yet another statement suggesting the need to wait for more data and the effects of what has been done so far. On January 25, three days later, elections in Greece will decide whether the first political party with strong views against austerity and with an explicit proposal for a serious haircut on its government debt reaches power in the Euro area.
No doubt that the outcome of these two developments will determine the fate of the Euro economy over the coming years but it is also possible that it determines the fate of the Euro area -- at least the current membership.
Rumors have started reaching the press that the Germans will not negotiate with Syriza and that they are ready to let Greece leave the Euro. We have seen this before and we know the outcome: Back in 2011 and 2012 when the fear of Greece leaving the Euro was at its peak (and the threat of Syriza winning the elections was also real), the contagion to other countries, in particular Italy and Spain, forced the Germans (and the ECB) to come to the rescue. A haircut on Greek debt plus the "whatever it takes" statement from Draghi saved the day and ensured that no country left the Euro area.
But the situation is very different now for many reasons. So far, contagion has not spread to other Euro countries, possibly because the other countries are seen as having stronger fundamentals. But what really matters might not be economics but politics. In some of the other Euro countries we have political parties with platforms that are very similar to the Syriza party in Greece (for example, Podemos in Spain). They (and the citizens of these countries) will be looking very carefully at what is happening in Greece. If Syriza wins and their negotiating strategy is successful, it is likely that we will see similar political changes in other Euro countries and a revolt against the current Euro economic policy. This is the last thing that Germany wants.
How does Germany avoid this outcome? Let me be cynical and argue that they only have one potential strategy, a very risky one. Let the ECB be nice on January 22 and let them go ahead with a full-blown QE policy involving government bonds. Let the Greek decide on January 25 if they want to be part of this. If they Greeks vote for Syriza then the Germans will not negotiate and will only leave Greece with one alternative, to leave the Euro. If that happens, the financial system in Greece is likely to be under enormous pressure with a high chance of bank runs. While the risk might spread to other countries, the ECB could be very aggressive to avoid contagion. If a bank run happens in Greece and the ECB refuses to provide liquidity, Greece will default and be out of the Euro. This will lead, at least in the short run, to a deeper crisis in Greece with strong disturbances to the banking sector and businesses. This is exactly what the Germans need to scare the other countries in the Euro area not to follow the same path and stay in the Euro. The cost are the potential losses on Greek debt but at this point very few people believe that Greece will be able to pay its debt.
This is a serious gamble. It requires that the German voters accept the new ECB aggressive policies. That the potential losses associated to a Greek default and exit from the Euro are contained and that the other Euro countries play along with this strategy. Very risky.
But maybe I am wrong and the Europeans will find once again a way to kick the can further down the road without neither a proper solution nor a final crisis but I feel that this time is different and the possibility of a serious political challenge to the status quo is too high to ignore the possibility of a very volatile period ahead.
Antonio Fatás
No doubt that the outcome of these two developments will determine the fate of the Euro economy over the coming years but it is also possible that it determines the fate of the Euro area -- at least the current membership.
Rumors have started reaching the press that the Germans will not negotiate with Syriza and that they are ready to let Greece leave the Euro. We have seen this before and we know the outcome: Back in 2011 and 2012 when the fear of Greece leaving the Euro was at its peak (and the threat of Syriza winning the elections was also real), the contagion to other countries, in particular Italy and Spain, forced the Germans (and the ECB) to come to the rescue. A haircut on Greek debt plus the "whatever it takes" statement from Draghi saved the day and ensured that no country left the Euro area.
But the situation is very different now for many reasons. So far, contagion has not spread to other Euro countries, possibly because the other countries are seen as having stronger fundamentals. But what really matters might not be economics but politics. In some of the other Euro countries we have political parties with platforms that are very similar to the Syriza party in Greece (for example, Podemos in Spain). They (and the citizens of these countries) will be looking very carefully at what is happening in Greece. If Syriza wins and their negotiating strategy is successful, it is likely that we will see similar political changes in other Euro countries and a revolt against the current Euro economic policy. This is the last thing that Germany wants.
How does Germany avoid this outcome? Let me be cynical and argue that they only have one potential strategy, a very risky one. Let the ECB be nice on January 22 and let them go ahead with a full-blown QE policy involving government bonds. Let the Greek decide on January 25 if they want to be part of this. If they Greeks vote for Syriza then the Germans will not negotiate and will only leave Greece with one alternative, to leave the Euro. If that happens, the financial system in Greece is likely to be under enormous pressure with a high chance of bank runs. While the risk might spread to other countries, the ECB could be very aggressive to avoid contagion. If a bank run happens in Greece and the ECB refuses to provide liquidity, Greece will default and be out of the Euro. This will lead, at least in the short run, to a deeper crisis in Greece with strong disturbances to the banking sector and businesses. This is exactly what the Germans need to scare the other countries in the Euro area not to follow the same path and stay in the Euro. The cost are the potential losses on Greek debt but at this point very few people believe that Greece will be able to pay its debt.
This is a serious gamble. It requires that the German voters accept the new ECB aggressive policies. That the potential losses associated to a Greek default and exit from the Euro are contained and that the other Euro countries play along with this strategy. Very risky.
But maybe I am wrong and the Europeans will find once again a way to kick the can further down the road without neither a proper solution nor a final crisis but I feel that this time is different and the possibility of a serious political challenge to the status quo is too high to ignore the possibility of a very volatile period ahead.
Antonio Fatás
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