So you thought that Euro-Crisis had gone away. Well guess what, it is back baby, in bourses near you!!!
It has been something people have been predicting with the Troika (EC+ECB+IMF) designed austerity program that was imposed on the country where democracy originated. Those people tended to be economists of largely the Keynesian variety and many of them predicted that it will result in an extreme party coming into power rallying around people's misgivings with the brutal austerity measures. Well, it has happened and Syriza, a coalition of left wing parties, has come to power indeed. Its finance minister, Yanis Varoufakis, whom I have been following for some time on twitter is now on a road show advocating the restructuring of Greek debt with a possibility of linking it to GDP. What is now happening is a question of Who Blinks First and it seems both sides are unwilling to do so. So the odds for a Grexit (Greece Exit) have increased and the attitude that the union can survive the exit is also contributing to it.
How We Got Here
The narrative that has been built during the euro-crisis was that it a case of Creditor countries from Northern Europe (Germany primarily) getting screwed up by profligate peripheral countries like Greece, Spain and Portugal. The current mindset is that debt is sinful and it is debtors that got to pay when things go tits up. Michael Pettis examines how wrongheaded and dangerous it is to think of this case as one country against the other in his excellent blog: Syriza and the French indemnity of 1871-73 . It is a very long read indeed touching upon economic history and drawing parallels with the current situation. After the Franco-Prussian war in the 19th century in which Prussia emerged victorious, they extracted war reparations in the form of indemnity from France. Pettis looks at how it impacted both countries and finds that France didn't suffer much since it was a time of credit boom and the bonds that they issued were oversubscribed with a major portion by German investors. But for Prussia, recipient of the fiscal transfer, much of it was squandered which always tend to be the case when there is a sudden such windfall. This is so even after having the money routed through a centralized body like the government. Pettis compares this to what happened in euro-zone after the currency union citing the experience of Spain, an economy he is very familiar with. When you have a currency union of various countries with varying inflation rates like Euro-Zone is, then it is inevitable that the monetary policy won't work as desired for all the countries. The Germans started running a current account surplus after 2000 aided by keeping the wage growth of German workers in check and curtailing investments in their economy. The consumption was also very low compared to what it should be and in effect they had a lot of money sitting their waiting for higher yields. A major portion of this money went to peripheral economies like Greece and Spain and most of this were absorbed by the private sector and households. The interest rates in those countries were lower than what it should have been considering their inflation rates since they didn't have control over the monetary policy because of the union. Like Prussia with the French Indemnity that it received in 19th century, most of the money was squandered and in Spain's case it sustained a real estate bubble. It was inevitable and you can find the same thing happening in plenty of other instances from history when cheap credit was made available. It is not a case of one country's people having the propensity to behave in such a manner and if Germany was in a similar position, the same thing would have happened. And moreover in the case of peripheral countries-it was the private sector that built up this debt and it became sovereign debt when its banks were bailed out by the government. That is why it is so wrong to pit this as Germany on one side and Greece/Spain the other.
The Austerity Solution
When the euro-crisis began to rear its head a few years back, the Troika consisting of European Commission, ECB and the IMF started dictating terms to these countries. They worked largely in the interests of Germany, whose private investors had maximum claim over most of these sovereign debts. After some hair-cuts to the debt, which was not enough, troika designed austerity was imposed on the peripheral countries with tales of debtor's morality put into the forefront. They waxed lyrical about the Moral Hazard that would entail if the debtors were given too much leeway. What about the moral hazard for creditors? It takes two to tango and it is as much a fault of creditors as it is of debtors. Both sides have to suffer looses. As Pettis points out, it is always the people that will ultimately suffer since banks will be always bailed out. It is the German workforce that relatively suffered when Germany started running this surplus and it is Greece people that is suffering now due to austerity. You don't need to be a rocket scientist/economist to figure out that this is gonna end in tears. Suppose GDP of a country is 100 and its debt to GDP ratio is 100% now. If austerity is being imposed in a very depression like scenario, it is inevitable that the GDP will contract like it did in Greece. This is only going to help in its debt to spiral out of control. Forget about GDP contracting, even if the GDP is growing but at a rate less than the rate of growth in debt, then also Debt/GDP is going to worsen. People are suffering for no good reason and the backlash against austerity was inevitable and considering all this, it is a positive that Greece is still a democracy. Before the austerity and restructuring, Greek Debt/GDP was 170% and 157% immediately after the hair-cut. At the end of 2013 after austerity took its effect it again went back up to 175%
What Now?
As described in this FT article: All Grexit needs is a few more disastrous weeks like this, following are the ways Yanis can proceed:
1) Extension of existing program- This is not Syriza's mandate and even if Yanis Varousfakis accepts it after inventing more cuddly names and measures, the Greek parliament is not going to pass it.
2) He might ask ECB to release interest payments and profits from purchases of Greek debt during the crisis, He can also ask the troika to lift the ceiling of treasury bills that Greece can issue, which was imposed so that Athens cannot issue too much debt during the bailout. Troika might not accept this unless he agrees to their austerity program.
3) Find money elsewhere like from Russia and it is not gonna be easy politically.
4) Issue a parallel currency, which is more or less what Grexit is.
Conclusion
The probability for a Greek Exit have increased with Syriza coming to power. Even Alan Greenspan has come out with a statement recently that a currency union without political union is not going to sustain and Eurozone is on the path towards a breakup. Many of the decision makers in Troika seems to think that the Union can withstand a Grexit, but I suspect it will be a Lehman moment for the markets. Then also the Fed underestimated the impact of letting Lehman go under and the same is going to happen if Greece makes an exit-it will be a clusterfuck. I have been looking for a trigger for the markets to collapse and this may very well be it, with the other possible triggers being China or a geo-political event like Ukraine war.
