It is increasingly difficult to find metaphors adequate to describe the pathological dysfunction among European leaders as their rigidities and biases make a full blown crisis look inevitable. While there was never going to be an easy path out of the linked sovereign debt/banking crisis, since lasting solutions would require fundamental changes in institutional arrangements, short term expediencies and pandering to national prejudices were one of the worst choices on offer. So the surplus countries, unwilling to see that rescues of periphery countries are rescues of their banks and export markets, continue to punish the supposed wastrels, unable to see that their economic morality play will visit retribution on all the actors.
The discussions in some European papers, and even in this blog’s comment section, have a fundamentalist “burn them if they don’t repent” zeal. Yet even thought the rolling crisis has inflamed national passions and stereotypes, from an economic perspective, the periphery countries are no longer Other. It’s as if the northern countries have a case of body integrity identity disorder, when individuals believe they’d be better off if they were an amputee and keenly want to have healthy limbs cut off. This condition does not respond to drugs or psychotherapy and is not well understood. One theory is that these individuals have faulty sensory mechanisms, and don’t experience the limb they want to be rid of as part of their body.
Japanese stock markets are down nearly 2%, the Hang Seng over 3%, the FTSE is off just shy of 1.5% and the Dax 1.3% as of this writing as investors watch Eurozone leaders blame the victims rather than devise solutions, or even longer-lasting patch-ups. Last week the focus was Spain as the supposed bank rescue was more a bank liquidity facility that adds to Spanish debt. As soon as the government passed yet another austerity package (a condition of the rescue) which included a rescue facility for stressed regions, Valencia immediately put up its hand and said it wanted some. Spanish bond yields jumped and international markets swooned.
The focus this week is Greece. Germany looks determined to break Greece via insistence on continued austerity, even though it is clearly a massive fail. Prime Minister Anotonis Samaris said over the weekend that his country is a depression on a scale of the US Great Depression, and he wants relief from the conditions imposed in a €130 billion rescue package in March. Analysts overwhelmingly forecast that Greece will fail to meet its fiscal targets and will need even more relief before year end. This is exactly what you expect to see in a deflationary spiral: budget cuts shrink the economy, lowering tax receipts and making deficits even worse.
But as conditions in Greece become even more desperate (reader nathan found that the national railway company has suspended all international trains, for instance), German threats are becoming more dire:
“If Greece doesn’t fulfill those conditions, then there can be no more payments,” German Vice Chancellor Philipp Roesler told broadcaster ARD yesterday, adding that he is “very skeptical” Greece can be rescued and that the prospect of its exit from the monetary union “has long ago lost its terror.”
The immediate trigger is inspectors from the Troika are due back in Greece this week to “assess” progress towards meeting targets. Since there is no way for a patient in an intensive care ward to stave himself back to health, it is not at all obvious how Greek leaders can convince their new economic lords and masters that they can do the impossible. The Wall Street Journal sets forth the critical dates over the coming months:
But without a green light from the troika, Athens risks being cut off from badly needed aid and could run out of cash as early as August. It has sought emergency funding from Europe to cover a looming bond redemption in late August.
Greece faces a much more important deadline in September, when international creditors are due to make their next aid payment, which they delayed in June as the elections played out. Extending the deadline could require even more aid to support Greece while it delays more cuts.
An unnamed EU source told Der Spiegel won’t reach its goal of lowering government debt to 120% of GDP by 2020 (quelle surprise!). The article states that falling short means Greece would need €10 billion to €50 billion more in funding, which the IMF and certain Eurozone governments (read Germany) will nix.
So how does this play out? John Dizard foretold this all in mid June:
The IMF-ECB-EU troika comes next month to perform its review of Greece’s progress under the memorandum. Progress is at a halt, of course, and discussions on minor or major modifications are set to continue with the new government. In the meantime, Greece finances itself through its banking system with, effectively, drawings on the ECB’s Emergency Liquidity Assistance lines via the National Bank of Greece. That is good for some single-digit billions of euros. That can handle the government’s cash shortfall until September, supplemented by strategic non-payment of bills.
It might not be enough to handle both the government’s cash shortfall and an accelerated deposit drain for even that long. At some point, probably by September (when the next instalment payment to Greece under the memorandum is due), the ECB cuts further advances under the ELA. Then Greece imposes its Article 65 controls on transfers out of Greece, and a deeper involuntary austerity begins.
That program includes capital controls, by the way, which might be partly circumvented by over-invoicing imports and under invoicing exports. But the bigger point is that a program for intensifying Greece’s misery is already queued up. And the Germans officials are increasingly saying that Greece exiting the euro might be for the best. Even Mario Draghi signaled that a Grexit was an acceptable option:
Is a Greek exit from the euro area still a leading concern?
Our unequivocal preference is for Greece to remain in the euro area. But that is a matter for the Greek government. It has stated its commitment, now it must deliver results. Regarding the renegotiation of the memorandum [to ease the austerity measures and reforms imposed on the country, I will not take any stance before seeing the Troika’s report.
German Finance Minister Wolfgang Schäuble is taking a similar line.
That talk may have started out as a way to undermine Greece's negotiating position (the only card it has to play is its threat to leave) but the Germans seem to believe it. They fail to get that the problem isn't Greece per se but that their policies simply won't work. And if they'll push their test to destruction with Greece, they'll do it with Spain, which is decaying at an astonishing rate. But as Delusional Economics points out, Eurozone leaders are in denial. Draghi predicts a recovery in the next year and said "the country [Spain] will get back on its feet quickly.” That may prove to be his “subprime is contained” quote.
Ambrose Evan-Prichard argues there is a way to break the stranglehold of the Troika:
…the ECB is currently in breach of Article 127 (clause 5) of the Lisbon Treaty obliging it to contribute to “the stability of the financial system”. The first duty of every central bank is to avert disaster.
It is time for Spain and the victim states to seize the initiative. They cannot force Germany, Holland, Finland, and Austria to swallow eurobonds, debt-pooling and fiscal union, and nor should they try since such a move implies the evisceration of their own democracies.
What they can to do is use their majority votes on the ECB’s Governing Council to force a change in monetary policy. Germany has two votes out of 23, with a hardcore of seven or eight at most. The Greco-Latin bloc can force a showdown. If Germany storms out of monetary union in protest, that would be an excellent solution.
The Latins would keep the euro – until the storm had passed – allowing them to uphold their euro debt contracts. There would be less risk of sovereign defaults since these countries would enjoy a pro-growth shock from monetary stimulus and a weaker Latin euro against the Chinese yuan, the D-Mark, and the Guilder.
The currency misalignment eating away at EMU would be cured instantly. There might even be a stock market rally once the boil was lanced. It would certainly be a better outcome than the current course of deflationary Troika regimes and loan packages for economies trapped with the wrong exchange rate, destined to end with one country after another being thrown out of EMU in a chain reaction.
For Germany it would entail a revaluation shock and stiff losses for German banks and insurers with large holdings of Club Med debt.
It’s hard to foresee how this ends, but if the powers that be are balking at another €10 billion to €50 billion for Greece, they will not pony up the hundreds of billions that many analysts see as necessary for Spain. The Eurocrats are running out of runway, and there’s no sign of a Plan B. If we didn’t all have a stake in the outcome, this would make for great theater.