Greek Prime Minister George Papandreou has managed to put the European crisis game of financial fakery into turmoil. Pretty much no informed commentator expected the latest gimmick-larded rescue package to work; there were simply too many points of failure. And even if this program had miraculously come to fruition, a later train wreck was still inevitable, since Germany was persisting in wanting two contradictory outcomes: running trade surpluses in Europe, and not lending more to its trade parters.
But no one anticipated that a long suffering debtor would revolt, which is what Papandreou’s announcement of a referendum on the punitive bailout amounts to. He’s publicly coded it in securing Greek support for the deal, but this is actually a clever form of brinksmanship. As Marshall Auerback and Rob Parenteau foresaw, Greece is engaging in a Samson-like gesture of pulling down a much bigger structure to end its misery.
The creditors who pressed on relentlessly with austerity programs in the face of deteriorating results and visible opposition by the Greek public were unduly confident that they could grind down a subject state. Indeed, the New York Times reports that a more and more Greeks, including members of their elites, are contemplating what all orthodox Eurocrats and experts had heretofore considered unthinkable: leaving the Euro and restoring the drachma. That does not mean it will happen; indeed, nearly 70% of the public opposes the idea.
The goal of Papandreou’s move presumably is to renegotiate the terms of the deal imposed on Greece. To get the heretofore dictatorial Troika to take him seriously, he’s effectively threatened the nuclear option of blowing up the rescue package, which means default. And the disruption of a default suddenly changes the calculus of a Euro exit. The incremental short-term damage would not be that much worse, and the longer term benefit of regaining sovereignity, controlling its currency, and as a result, being able to depreciate the drachma would likely more than offset the costs. (Remember, the advantage of Greece staying in is to fund its budget deficit. But with the rescue packages so punitive that the Greek economy is shrinking faster than its debt levels are, the advantages of cooperation look to be illusory).
It is still possible that the Greeks will fall into line. Papandreou’s coalition has only a thin majority (5 as of the vote on the July package). Two have defected, and he faces a no-confidence vote on Friday. But the Matina Stevis of the Wall Street Journal tweeted (hat tip Clusterstock) that a referendum has 99.99% odds of taking place before Christmas. (Reports of a shake-up of its armed forces are a wild card. This move is presumably to prevent a military coup. However, so far, there is no further commentary from Greek sources).
But this gambit puts the plan announced last week in shambles. We’d said Chinese meaningful Chinese support was the ONLY way the bailout fund, the new super levered son of EFSF, might actually succeed. The Chinese were reportedly cool when Sarkozy made a sales pitch, and the Chinese went further, with a former member of its central bank, Yu Yongding, patiently explaining in a Financial Times comment why this was an obviously dopey deal from the Chinese vantage. That was before Papandreou’s coup de foudre, which means the Chinese now have even better reasons to keep their wallet closed. Not surprisingly (Kathimerini via Clusterstock), the IMF is considering withholding the next round of funding, which would assure a Greek default.
As Ambrose Evans-Pritchard reminds us, the next domino to fall is probably not Portugal or Ireland, but Italy, which has a refinancing coming in February 2012. The spread between German bunds and Italian government debt hit a life of Eurozone high today, and the absolute Italian borrowing costs at today’s yields would be unsustainable. From the Telegraph:
Unless the European Central Bank step in very soon and on a massive scale to shore up Italy, the game is up. We will have a spectacular smash-up.
If handled badly, the disorderly insolvency of the world’s third largest debtor with €1.9 trillion in public debt and nearer €3.5 trillion in total debt would be a much greater event than the fall of Credit Anstalt in 1931. (Let me add that Italy is not fundamentally insolvent. It is only in these straits because it does not have a lender of last resort, a sovereign central bank, or a sovereign currency. The euro structure itself has turned a solvent state into an insolvent state. It is reverse alchemy.)
The Anstalt debacle triggered the European banking collapse, set off tremors in London and New York, and turned recession into depression. Within four months the global financial order had essentially disintegrated.
Now in fact, this crisis may finally snap the Germans out of their unending hyperinflation fixation by making them realize that the looming disaster of cascading defaults is far more likely than a repeat of a very particular set of circumstances (including the stripping of German productive capacity) nearly 90 years ago. As we and numerous others have said, there is a simple solution here, which is for the ECB to expand its balance sheet (in crude terms, print). But we’ve been told by sources in contact with ECB staffers that Trichet and much of the ECB leadership is unwilling to leverage the bank’s “equity” beyond a certain point that is well below what would be required for a credible rescue (and we would assume its new head Draghi will not be able to change this view). So it is apparently not just the Germans who are opposed to the ECB acting as lender of the last resort, but the ECB itself.
As Martin Wolf wrote in today’s Financial Times:
Blessed are the creditors, for they shall inherit the earth. This is not in the Sermon on the Mount. Yet creditors believe it: if everybody were a creditor, we would have no unpaid debts and financial crises. That, creditors believe, is the way to behave. They are mistaken. Since the world cannot trade with Mars, creditors are joined at the hip to the debtors. The former must accumulate claims on the latter. This puts them in a trap of their own making.
And that trap is about to snap shut.