Pater Tenebrarum

About the Author Pater Tenebrarum

I'm an independent analyst and have been involved with financial markets for 31 years. I write economic and market analyses for independent research organizations and a European hedge fund consultancy. I'm the main author of the blog 'Acting Man', which presents articles on the markets and the economy, a mixture of commentary on current events as well as economic theory and history from an Austrian school of economics viewpoint.

Greece And The EU – Nothing But Political Theater?


Varoufakis’ Tour of Europe

Greece’s new finance minister Yanis Varoufakis has toured Europe, trying to drum up support for – actually, we’re not quite sure what for exactly, as the precise nature of the Greek government’s demands is currently in flux (this is a parallel to Syriza’s ever-changing pre-election statements). Essentially, he seems to be gauging what they can get away with.

Not surprisingly, France’s political leadership has announced its support for a “debt deal” in principle (whatever that means), as the spendthrift French government is so to speak an ideological partner-in-crime of Syriza. However, the French government stopped short of supporting a partial write-down of Greece’s debt (Michel Sapin: “No we will not annul, we can discuss, we can delay, we can reduce its weight, but not annul”). Similar noises have issued from Berlin and Madrid.

Yanis Varoufakis and French finance minister Michel Sapin. France’s socialists are actually split over the Syriza government – some are ecstatic over its election victory, but e.g. economy minister Emanuel Macron appears far less enthusiastic about Greece’s lurch to the left.

Photo credit: Jacques Demarthon / AFP

We have argued all along that no EU government can afford to accept such a write-down, as then the guarantees issued for Greek debt would come due and the losses would become “real” – and appear on everybody else’s budget. We imagine that every EU leader Mr. Varoufakis has spoken to so far has impressed the political necessity of “extend and pretend” on him in no uncertain terms; details may well be up for debate though.

UK Chancellor of the exchequer George Osborne urged Mr. Varoufakis to do a deal with Brussels asap and “be responsible”, undoubtedly fearing repercussions for the only just reanimated City of Zombie Banks.

Varoufakis continues to insist that the Greek government won’t take any more bailout money from the troika and that it won’t even talk to it, leaving Jeroen Dijsselbloem in Brussels in a somewhat miffed and flabbergasted state in the process (reportedly JD whispered apocalyptic assessments about the troika’s very existence into the Greek refusenik’s ears after their pow-wow). However, he also says that “Europe comes first” (whatever that means), seemingly in an attempt to placate the centralizers.

Dijsselbloem and Varoufakis in Brussels

Photo credit: Simela Pantzartzi / APA / EPA

Over the weekend, Alexis Tsipras and Yanis Varoufakis have announced a new plan of theirs that apparently no longer includes a debt write-off:

“Finance Minister Yanis Varoufakis is in London to reassure investors he is not seeking a Wild West-style showdown with Brussels over a new debt agreement.

He told the Financial Times that Athens would no longer call for a write-off of Greece’s €315bn of foreign debt. Instead it will seek a “menu of debt swaps” including two types of new bonds – one indexed to nominal economic growth and one he called “perpetual bonds” to replace European Central Bank (ECB)-owned Greek bonds, the newspaper reported.

“What I’ll say to our partners is that we are putting together a combination of a primary budget surplus and a reform agenda,” Mr Varoufakis told the FT.

“I’ll say, ‘Help us to reform our country and give us some fiscal space to do this, otherwise we shall continue to suffocate and become a deformed rather than a reformed Greece’.”

The bonds indexed to economic growth would replace Greece’s European rescue loans, Varoufakis said. Athens planned to target wealthy tax-evaders and post primary budget surpluses of 1% to 1.5% of gross domestic product, he told the paper, even if it meant his party, Syriza, could not fulfil all the spending promises on which it was elected.”

(emphasis added)

The idea to ditch Syriza’s spending promises this early in the game was received with cautious approval by EU government spokesmen, but the plan as a whole still meets with skepticism – especially in Germany (no wonder, as the Germans are essentially the EU’s designated paymasters and are already slightly paranoid over Mr. Draghi’s latest QE escapades – and rightly so).

All in all, it seems like a well-rehearsed piece of political theater, with the aim of letting everybody save face and then continue with “extend and pretend”, only in slightly altered packaging. After all, one thing is clear: there is no way the debt can be paid, at least not in any manner remotely approaching the terms of the contract. By extending it far into the future, it is mainly hoped that it will be slowly eroded by inflation.

The Bad Cops

We’re not sure what Syriza’s officials have discussed with various EU grand poobahs during their pre-election visits. As we have pointed out, Mr. Tsipras even met with Mario Draghi in November. We really wonder what was hatched out at that meeting. However, there are a few points worth considering. For one thing, the Greek government requires something like €20 billion in financing this year (an approximate estimate, the range is actually quite wide, depending on a few imponderables). Among the debts that are coming due are also a chunk of bonds held by the ECB under “SMP”.

The ECB has in the meantime picked a council member who has been given the role of “bad cop”, namely Finland’s Erkki Liikanen – who apparently has just rediscovered the ECB’s statute book under some sofa cushions in Frankfurt:

“A deal on extending Greece’s bailout deal must be found by the end of February or the European Central Bank will not be able to continue lending to its banks, ECB council member Erkki Liikanen said on Saturday.

Europe’s bailout programme for Greece, part of a 240-billion-euro ($270 billion) rescue package along with the International Monetary Fund, expires on Feb. 28 and a failure to renew it could leave Athens unable to meet its financing needs and cut its banks off from ECB liquidity support.

[…]

“We (ECB) have our own legislation and we will act according to that… Now, Greece’s program extension will expire in the end of February so some kind of solution must be found, otherwise we can’t continue lending,” Liikanen, also the governor of Finland’s central bank, told public broadcaster YLE.

“I don’t believe that one can hide from the realities in the economy,” he said in an interview. Asked about the possibility of a Greek debt haircut, Liikanen said: “A significant debt restructuring has been carried out with private investors. The ECB cannot fund a state directly, which is what it would mean in this case.”

(emphasis added)

While not explicitly mentioned on this occasion, the ECB has also extended rating exemptions to Greek securities so they can be pawned with it in repos. It could conceivably revoke those anytime. Here is a recent estimate of flows to and from the Greek banking system, as a percentage of GDP:

Outflows from Greek banks have resumed with some gusto, hence Greek banks require ELA in order to be able to pretend that they are solvent.

Obviously, this means Syriza is under some pressure, as any indication that it is about to break with the EU completely over its debt deal would undoubtedly hasten capital flight, before ECB support for Greece’s banks is actually dropped. The Greek government also frequently refinances itself through mechanisms evidently sanctioned by the ECB whenever there is a delay in troika approval of an aid tranche, by selling t-bills to the banks, which then pass them on to the national central bank. We actually believe that one could call this central bank financing of a government. Just saying.

We’re sure the ECB could be persuaded not to be too strict with its deadlines if a compromise between the Greek government and the EU appears to be taking shape, but for now it is pretending that it is politically independent so as to better fulfill its bad cop assignment. The noises coming from the ECB could well be part of the above mentioned political theater choreography though.

How Likely is a Greek Exit from the Euro?

There is certainly a possibility that the Greek government actually has different plans than those most recently announced. We imagine there will be discussions following the European tours of Mr. Varoufakis and Alexis Tsipras as to what was achieved (Tspiras is also about to visit various euro area governments, starting with Cyprus and Italy). Let us not forget, there are influential people in Syriza, who firmly believe that an exit from the euro is highly desirable. Such an exit would allow the decision over the debt/bailout deal to be made unilaterally. This could well be done by simply maneuvering the EU into an untenable position, so that it turns the spigot off. This in turn would make it possible for the government to shift blame for the default and its potential consequences.

We are bringing this up because absolutely nothing is certain yet, in spite of the more conciliatory noises currently emanating from all sides. As noted above, Mr. Varoufakis was likely busy gauging what the Greek government could get away with. Predictably, it didn’t seem to be a whole lot. Therefore, a post-EU tour internal discussion could well arrive at the conclusion that an exit from the euro and an outright debt default are to be preferred. Even in the event that such an exit has already been decided on, the new Greek government would still act precisely as it has done since coming into power.

This is for two reasons: 1. it would need to be able to say to Greek voters “we tried”, and 2. it would want to impose capital controls overnight without giving anyone advance warning. Otherwise the current still relatively low-intensity bank run would immediately turn into a veritable flood.

Conclusion

Looking at things superficially, it seems as if much of Syriza’s pre-election rhetoric is being shed quite quickly in favor of a face-saving deal that won’t be much different from the bail-out deal that is already in place. In fact, the whole show looks almost prearranged so far. However, this superficial impression may yet turn out to be wrong.

If an exit from the euro area is actually planned, the government would definitely be lying about its likelihood until the very last minute. It would still have to go through exactly the same motions it is currently going through. In light of this, there may actually not be as much information in what is currently being announced as it appears – even though the markets seem to be buying it, at least for one trading day:

Three-year Greek government bond yield, daily: down a hefty 2.83% after the most recent announcements by the government (but up 1.14% from the day’s lows).

Greece’s citizens would do well to remember Cyprus. Before access to the banks was shut down, the government swore up and down that a depositor haircut was completely out of the question. The public is never told the truth before bank holidays, sudden currency reforms, imposition of capital controls and similar measures.

In closing, we should point out that we believe it is actually more likely that some kind of cosmetically altered debt deal will eventually be struck. However, if a different course should indeed be on the menu, no-one would be told beforehand, and that is a significant caveat in this particular case.