The end-game approaches. Or, more accurately, the curtain is about to fall on the charade that has been played out on the European stage over the last five months. It has been a curious spectacle, a blend of game theory (so-called) and defiance, with Finance Minister Varoufakis betting that the opposition would crumble faced with the prospect of Grexit and Prime Minister Tsipras channelling popular anger at what is seen as the attempted subjugation of Greece by its creditors. Whilst the majority of Greeks (still) approve of their government’s negotiating tactics, the cost in economic terms has been significant: Greece’s economy, after tentative signs of revival last year, is back in recession, forecasts for the primary surplus have been cut by more than half and deposits have fled the country, with the ECB having to make good the system shortfall via the ELA mechanism.
As I discussed in my previous posts (It’s a Win for Syriza, but is it a Win for Greece?/Grexit Polls/Grexit or Grin?), the inconsistent desire of the Greek electorate to remain within the Euro whilst rejecting the terms of continued membership – the austerity measures which accompanied the various bailouts of the Greek economy – would most likely manifest in stalemate in negotiations with those creditors. Once stalemate had been reached, Tsipras would have to seek a further mandate from the Greek people via a referendum, which would then become a de facto vote on continued Euro membership (at the cost of further austerity).
We are now at the stage where Greece’s creditors are likely to make their final offer, one which is unlikely to appease Tsipras’ demands for an outright cut in the debt and a considerable easing of existing austerity measures. When this stage is reached, Tsipras’ probable response will be to seek a further mandate from the electorate. Press speculation has recently focused on the possibility of Tsipras calling another general election (rather than holding a referendum). In this instance, voting for Tsipras would potentially give him free rein to take Greece out of the Euro, in the event that creditors refuse to accept his demands. Tsipras’ choice of language is telling. References he has made to Greece being prepared to say the ‘big No’ to its creditors’ demands for more austerity possess uncomfortable historical connotations: the Greek phrase, ‘To Megalo Oxi’, translated as ‘the Big No’, references Greece’s refusal in October 1940 to surrender to Mussolini’s ultimatum to allow Axis powers to enter and occupy Greek territory, an event which effectively brought Greece into the second World War.
What I had underestimated was the potential for the Greeks’ negotiating tactics to almost fully destroy the support it had looked to enjoy from the more moderate faction within the EU. The highly public exasperation with Tsipras’ behaviour recently articulated by EU commissioner Juncker is but the latest fruit of this negotiating strategy. This unwelcome development must raise the possibility that a technical default may well trigger the revocation of Greece’s Eurozone membership. Greece’s creditors are unlikely to be prepared to undergo an indeterminate period that might last a number of months whilst Tsipras seeks further ratification from the electorate and, quite probably, returns to the negotiating table with new-found belligerence. Indeed, if I may be permitted to briefly stray into Finance Minister Varoufakis’ favoured realm of game theory, Greece’s creditors might well consider that, if it must come to pass, the time has never been better for Greece to exit: Euro QE has been well-received and the prospect of the ECB potentially supplying unlimited liquidity in a Grexit scenario will undoubtedly do much to limit the probability of a major market dislocation actually coming to pass. They will also undoubtedly have been encouraged by the way in which Greek sovereign bonds have decoupled from the rest of the periphery since January, suggesting that the market could countenance Greek Euro exit as an isolated and contained event.
Indeed, from the creditors’ perspective, two further significant benefits might accrue: 1) the immediate chaos into which Greece will probably descend as it grapples with the move from the Euro to the drachma is likely to do much to dissuade other Eurozone members from going down the same path – a pre-emptive strike against left-leaning populist parties in Europe such as Podemos; and 2) demonstrating that the Eurozone can survive the exit of one of its members will surely serve to ultimately strengthen the credibility of the Eurozone.
All said, this, in my opinion, significantly raises the probability that Greek intransigence leading to technical default triggers the immediate expulsion of Greece from the Eurozone. If so, a vote for Syriza back in January was effectively a vote to leave the Euro. Complacency over the possibility of Greece leaving the Euro, both within and outside Greece, has been nothing short of astounding.
On the topic of Grexit, I think that the stance taken by some commentators of viewing that favourite Argentinian two-step of default and devaluation as a panacea for Greece’s predicament is somewhat simplistic. The situation is complicated by the fact that a significant proportion of private sector deposits have fled Greece. Whilst capital controls would almost certainly be imposed as the transition is made from Euro to drachma, the high level of corruption and cultural low compliance with government mandates in Greece raises the possibility of a steady trickle-back of hard currency deposits into the country. This might mean that the downward adjustment in prices in hard currency terms might come through more slowly than expected. To go through all the chaos of a Euro exit without the immediate benefits of a devaluation is going to feel extremely uncomfortable, bringing with it the prospect of widespread civil unrest and ill-considered policy response.
Unfortunately for Greece there appears to be no easy solution. The much needed structural reform that should by now have been well underway – notably cutting significant swathes out of the bloated public sector – is now, politically, near impossible to implement: public outcry at the prospect of a further rise in unemployment would be too much for any government wishing to remain in power to enact. But without structural reform of this nature, Greece has no chance of improving competitiveness to the point where continued Eurozone membership is viable. On the other hand, default and devaluation probably spells the end of Greece’s putative attempt at reform, allowing the endemic forces of corruption to flourish unchecked. Moreover, one can’t help but feel that for a country that was effectively isolated from the major cultural developments that took place in Western Europe thanks to four centuries of Ottoman rule, the economic and inevitably cultural isolation that are likely to be a consequence of exiting from the Eurozone can hardly be described as desirable.
Nietzsche commented that the famed Greek philosophical outlook, the so-called ‘griechische Heiterkeit’, rational and life-affirming in its essence, was founded on a full recognition of its chaotic antithesis. Perhaps Greece needs to go through a period of dislocation, such as Grexit may bring, so that it finally rejects the attitude whereby national unity is only triggered by times of adversity and periods of prosperity bring little more than state-sanctioned profiteering, creative accounting and booming demand for tax avoidance schemes. Out of the chaos, Greeks might elect a government that can put the country firmly on the path to prosperity. By then Syriza’s curiously anachronistic brand of socialism will hopefully have been once and for all consigned to the dustbin of history.
I reiterate my theoretical short stance on Greek equities expressed via the domestic banks. I would be an enthusiastic buyer of periphery equities in the event of a sell-off triggered by Grexit; the ability of the Eurozone to withstand this event is likely to be taken bullishly and further yield contraction vs bunds is ultimately likely, boosting the prices of risk assets. I would also go long Euro as a short term trade in the event that the currency sells off on Grexit, but believe that the existence of Euro QE will ultimately result in further weakening of Euro vs USD.
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