Swallowing The Poison Pill

                              Voters in Greece rejected further EU-led austerity today (Photo: AFP)

The stage for a confrontation years in the making was finally set last week, when the Greek government failed to repay a $1.7 billion USD instalment and announced its intention to hold a referendum on whether or not to accept a bailout package which Eurogroup creditors insist be contingent on further austerity measures the leftist government there was loathe to implement.  While some likened the latest twist in the ongoing crisis as a game of chicken to see which side blinks first, it increasingly looks like the rest of the currency union's patience is beginning to wear thin.  Eurozone leaders last week warned that a "no" vote would only serve to isolate Greece and drive it further into insolvency.  Evidently it wasn't enough to convince Greeks however, who have grappled with levels of unemployment which now see 1 in 4 people jobless, as well as youth unemployment just shy of 50%, for they voted overwhelmingly in favour of rejecting the deal as is.  A significant reason why was the successful narrative painting the referendum as the reassertion of the democratic process in negotiations, which many in the country view as the realm of European technocrats and politicians more interested in their European Union pet project than the plight of the average Greek.  When the results were announced, Prime Minister Alexis Tsipras was jubilant, and for good reason; a "yes" vote would have been disastrous for his vehemently anti-austerity party, who were key in spinning the ultimately winning narrative.  To illustrate, the Minister of Labour later said "I believe there is no Greek today who is not proud, because regardless of what he voted he showed that this country above all respects democracy."

But what of the already dire situation which is now only set to become worse?  After the ECB cut emergency liquidity in response to Greece defaulting, the government was forced to implement capital controls, something which should have been done months earlier while the banking system was still receiving regular injections of liquidity.  While tightly controlling the flow of money out of the system has bought Greece some time, it has done little to stave off a potential banking collapse, with most estimates forecasting that the banks will run out of cash on Monday.  Some have suggested that the use of "scrips", or IOUs presents a potential way forward in the event of a now inevitable liquidity crunch, pointing out that such a system was successful in 2009 when California was undergoing significant economic turmoil.  Ignoring the fact that the system was only in place for two months (even then banks had ceased purchasing scrips in exchange for USD, fearing potential overexposure) and that Californians were okay receiving incomes, pensions and benefits in IOUs was in part because of 3.75% annual interest to be paid upon maturity, the fact of the matter is that Greece's creditworthiness is such that borrowing on such a scale is virtually impossible.  July 13th is when the government must pay salaries, benefits and other liabilities, a de facto deadline which will certainly test the mettle of Tsipras's government, whose officials have repeatedly insisted they can get a new deal done within a 24-48 hour time frame.

And that claim raises yet another issue.  The government got a favourable result in the referendum by promising to extract greater concessions from the Eurogroup, something which it must now do.  It wants budgetary restraint on its terms, favouring an increased tax net rather than further cuts to social programs that will only be more necessary as the economy's plunge accelerates.  While austerity failed to cut into Greece's debt at the anticipated rate, European leaders would likely lay the blame for that at the feet of successive Greek governments which failed to improve competition, fight corruption and combat rampant tax evasion, all of which played a role in turning the aftershocks of the 2008 global financial crisis into a six year recession.  As such, it is hard to imagine any of the involved parties being in a charitable mood come Monday.  The initial responses to the referendum and Greek entreaties for continued talks only confirm this grim assessment.  Eurozone finance ministers shot down the idea of emergency meetings Monday, point blank saying they "would not know what to discuss".  The ECB reluctance to agree carte blanche to continue providing emergency funds to Greek banks, despite the potential for such a move to cause the country to collapse, speaks volumes to the fact that the Greek debt crisis has reached uncharted territory; and the rest of Europe isn't ruling out anything.

"You have to do things that are going to be fundamentally impossible to explain to people" - Former U.S Treasury Secretary Tim Geithner 

Taken alone, the jubilation in Athens today could have made one forget about how Greece currently sits at the precipice of total economic collapse.  Retailers in the city go sometimes days without a single customer, and even butchers and grocers who still do brisk business are feeling the pinch from their suppliers abroad, who are beginning to demand payment upfront.  The now uncertain future of the country's economy has rendered Greeks unable to import everything from simple foodstuffs to desperately needed medical supplies.  The fact that many in the country didn't know what exactly they were being asked to vote "yes" or "no" to, or that the government there won by appealing to Greeks' wounded pride, all signal a dark future ahead for Greece.  Tsipras's referendum might have been a win for democracy, but it carries with it a significant price;  the rest of Europe is now reconsidering its support for the Greek economy, and behind the government's hopelessly optimistic assessment that it can get a deal done in a matter of days, as opposed to weeks, complete silence about the coming unravelling of the country's economy makes the "democracy at work" narrative being peddled ring hallow.  Successful bailout programs, such as TARP in the United States as well as Sweden's rescue of its banking sector in the 90s, were both reviled by the public when they were first unveiled.  And yet the architects of such programs are now lauded for their work, and the model of isolating toxic assets in "bad banks" first pioneered by Bo Lundgren in Sweden has been emulated in several debt crises since.  

Antagonizing your creditors is never a good idea, (something Argentina knows very well) even when their methodology isn't working as intended.  Should a productive relationship be reestablished however, there may be hope yet for Greece.  Recently the IMF released a white paper containing its latest analysis of Greek debt, and came to the conclusion that given the sheer heft of Greece's debt load, its unlikely Greece's creditors will ever be repaid the entirety of the sum they are owed.  Among some of the figures thrown out, perhaps the most interesting was the fund's assessment of Greece's ability to both service and pay down its considerable debt.  In the IMF's estimation, the country not only requires a third bailout to the tune of $67 billion USD, but that the maturities on its debt obligations be doubled to 40 years.  The hope for Greece however, lays in what was said next; it is vital that a significant portion of Greece's debt be written off, to the tune of $59 billion USD.  This makes sense, given that the economy will continue to suffer for the foreseeable future.  A restructuring of the country's debt would allow the Greek government, which has drained funds from areas such as healthcare and education in order to make repayments, to further stabilize the economy without having to resort to further cuts to important social programs.  Surprisingly, it was the Eurozone which first proposed such a move three years prior, in exchange for reforms.  Should such terms be reintroduced, the EU will get the fundamental changes to the Greek economy it wanted, and Greece gets more favourable terms in the form of long term debt relief.  While by no means sufficient, such a deal would firstly put Greece on a path to recovery, and provide a roadmap for the Greek economy going forward.  But it simply cannot happen if the current admittedly rather frosty state of affairs between involved parties persists.

The current austerity regime is far from perfect, having misjudged the impact of cuts and overestimated the Greek economy's capacity to grow in order to compensate.  And yet the wholesale rejection of austerity, combined with a seeming abdication of responsibility on the part of the Greek government for the role of its fiscal policies in initiating this crisis reflect a seeming dissonance between Greece and its fellow EU confederates.  One argues that a messy and fraught economic issue should be placed in the hands of those who simply cannot hope to understand it, while the other believes that such problems best be left to the brightest minds.  Greece has no clear path forward, but a messy divorce from the eurozone, now a real possibility, certainly will not help matters.  Sensible solutions have been put forward for years, now both sides simply need to listen.    
     

Cyprus And Its Own "Grexit": A Roadmap for Greece?

Greek deputy finance minister Dimitris Mardas reassured the finance world last week that Greece would in fact meet an April 9th deadline to repay a 450 million euro IMF loan instalment on time, after comments his superior had made on television were construed by many to suggest that the country was actively considering renegading on its debt.  It did little to help already skittish investor confidence, and reignited speculation amongst many financial journalism outlets on a potential "Grexit" that is now to be expected whenever the newly installed anti-austerity government in Greece pokes its creditors in Brussels and Berlin in the eye.  But while the fracas unfolded in Athens, across the Mediterranean an unlikely and largely unheralded success story quietly wound down Monday.

in late 2012, the Cypriot government was in trouble.  Facing an over leveraged banking system exposed to (perhaps ironically) the stumbling Greek economy and an overheated real estate market, the subsequent downgrade to "junk" status of the country's debt meant that Cyprus was suddenly unable to turn to global equity markets in order to finance the stimulus and rescue packages needed to save its faltering economy.  Facing a looming default, in March of 2013 the Cypriot government agreed to a rescue package with the "troika" (the IMF, ECB, as well as the European Commission and Eurogroup representing the EU) consisting of a 10 billion euro bailout as well as strict reforms meant to forcibly instill confidence in the Cypriot banking system as well as the creditworthiness of the government.  The portion of reforms aimed at preventing a large scale exodus of money from Cyprus's banks are known as "capital controls", and were implemented in the hopes of buying more time for efforts to recapitalize the country's banking system and prevent panicked runs on the banks, which would most likely have resulted in a collapse of the system.  Initially quite strict (withdrawals from personal accounts were limited to 300 euros per day, and transfers to foreign banks were severely limited as well), the restrictions on the Cypriot euro were gradually lifted as the banks were further stabilized and confidence was slowly restored.

The measures were never popular, with leftist parties opposed to the package floating alternatives ranging from a reduction in the size of the military, a corporate income tax increase, and even outright nationalization of the banking sector.  A common theme among many opponents was resistance to what many believed amounted to EU-imposed austerity, championed by technocrats in Brussels who were only interested in preserving their economic and political union and cared little for the average Cypriot.  A blog attached to The Economist even went so far as to call the package "unfair" and "self defeating", arguing that the high political cost of such austerity preconditions for bailouts made them impractical if the EU hoped to maintain the goodwill of its constituent states.  Others worried that the implementation of such harsh measures would push Cyprus into the arms of Russia, from whom it had already received substantial financial aid.  Ultimately, it was not an easy road to recovery in Cyprus; the country's significant community of wealthy Russians who had stashed their wealth there had to be placated, and the first parliamentary vote on an assistance package failed amidst widespread protests.  And yet last month, two years removed from the bailout, a Bank of Cyprus official referred to the capital controls as "irrelevant", suggesting that the country's top economists were now confident enough in the state of the recovery that they were considering doing away with the last of the monetary restrictions first put in place two years ago, a milestone they quietly fulfilled earlier this week.

Cypriot president Nicos Anistasiades heralded that admittedly largely symbolic day as indicative of "the full restoration of confidence in our banking system and the stabilization of the economy of Cyprus."  And he's not wrong in asserting that significant progress has been made.  The flow of money within the country is now unhindered, the country has resumed borrowing (paywall) and the economy is finally expected to return to growth in 2015 after three years of recession.  While decisive action on the part of the ECB and Cypriot lawmakers no doubt played an important role in staving off a default and subsequent exit from the Eurozone, capital controls were imperative in allowing the structural issues within the economy (the banking sector's debt obligations at one point were nine times greater than the size of the Cypriot economy) to be resolved.  Despite initial public backlash, Cyprus today is in markedly better condition than Greece.  While the full extent of Greece's sovereign debt issues mean that capital controls, should they be implemented, would be in place for potentially much longer than they were in place in Cyprus, they present a more desirable alternative to the "Grexit" as a means of quarantining the country's financial troubles until a deal finally resolving the crisis is struck (or the ruling Syriza party in Greece is voted out), as opposed to continuing to simply bankroll the Greek government while subjecting it to austerity measures which are doing little to improve the long term viability of the country's economy.  But given how the Bank of England has all but thrown in the towel when it comes to Greece, it remains to see how much appetite remains amongst the EU's other core economies, especially Germany, for continued support in order to stave off a Greek default, especially given the latter's penchant for creative schemes aimed at alleviating its strict bailout conditions.  Barring a significant change in tune from the government in Athens however, its looking highly unlikely that a currency quarantine will be given a chance to help rectify the country's long running debt issues.