Sunday, July 12, 2015

Grexit Coming - How They Will Save Face

Where do we go from here? It is likely Greece will soon exit the Euro-zone, but do not be surprised if it is done under some new or politically correct moniker that puts the action under the most positive light possible. One way to re-frame this is not to view it as a bailout but as “humanitarian aid”. Two things are apparent, first this soap opera is far from over, and the other that Greece remains a money pit or "black-hole." This has generated suggestions that Greece take on a new "quasi membership" status of half in half out. This might give the country many of the benefits of being in the EU while giving it far more room and flexibility to put its house in order. Anyway you look at this it almost impossible for Greece to repay these euro-denominated debts, this not only applies to the government, but also to the private sector.  However, what is uncertain is the timetable over which all this will play out and what will bring down the final curtain.

Keep in mind the fact Greece is totally broke and that just because Greece defaults does not mean the debt suddenly vanishes. All dept is not created equally and lawsuits and disputes will rage on for years maybe even decades. The fact you cannot squeeze blood out of a turnip will not mean that those who are owed money will not pursue Greece into hell and back in an effort to recover at least a part of their money. Yes, write offs will be made and the balance sheets of those holding the debt will feel the blow, but the carnage will play out over time rather than be immediate. While people point out Greece is a small country and a small part of the Euro-zone GDP it has a massive amount of dept, and debt does matter! Greece cannot make this debt obligation vanish or go away by simply declaring it odious, as a parliamentary commission in Greece has recently done. The ECB, the IMF and every country in the EU that has contingent liabilities due to guaranteeing EFSF loans to Greece or has bilateral loans to Greece outstanding, would sue for repayment.

 Most of us forget the fact that 100 billion in Greek debt has already been forgiven in the “voluntary” private sector initiative in 2012. It is human nature to forget the details of things that are not in our face but if anything distant and a bit abstract. Below are a few key lines as to what Wikipedia says about this recent time in history;

In April 2010, adding to news of the adverse deficit and debt data for 2008 and 2009, the national account data revealed that the Greek economy had also been hit by three distinct recessions (Q3-Q4 2007, Q2-2008 until Q1-2009, and a third starting in Q3-2009),[76] which equaled an outlook for a further rise in the debt-to-GDP ratio from 109% in 2008 to 146% in 2010. Credit rating agencies responded by downgrading the Greek government debt to junk bond status (below investment grade), 
On 2 May 2010, the European Commission, European Central Bank (ECB) and International Monetary Fund (IMF), later nicknamed the Troika, responded by launching a €110 billion bailout loan to rescue Greece from sovereign default and cover its financial needs throughout May 2010 until June 2013, conditional on implementation of austerity measures, structural reforms, and privatization of government assets.
A year later, a worsened recession along with a delayed implementation by the Greek government of the agreed conditions in the bailout programme revealed the need for Greece to receive a second bailout worth €130 billion (including a bank recapitalization package worth €48bn), while all private creditors holding Greek government bonds were required at the same time to sign a deal accepting extended maturities, lower interest rates, and a 53.5% face value loss.[78]
The second bailout programme was finally ratified by all parties in February 2012, and by effect extending the first programme, meaning a total of €240 billion was to be transferred at regular tranches throughout the period of May 2010 to December 2014.

Fallout from the overwhelming 61% “No” vote taken by Greece has angered several members of the Euro-zone and reduced sympathy for them going forward. The latest ultimatums from both sides are leaving less wiggle room. Even before Greece’s referendum on a bailout plan in early July, EU decision makers, including Eurogroup Chairman Jeroen Dijsselbloem, warned a “no” vote might lead to Greece’s exit from the Euro. Greece is already in default to the IMF, on June 30, 2015 it failed to make an IMF loan repayment making it the first developed country in history to default on an IMF loan, at that time Greece's government had debts of 323 billion euro. Currently the the Greek banking system is dependent on the ECB. A scheme called Emergency Liquidity Assistance (ELA) that allows the Greek Central Bank to issue loans to banks with liquidity problems and in effect prop up insolvent banks. A two thirds majority is  needed within the ECB Governing Council to block the Greek Central Bank from creating euros to lend to Greek banks, this hasn’t been reached yet, but it appears the ECB is reaching its limit. 

If Greece would back down on its calls for debt restructuring it could enter a new European Stability Mechanism (ESM) program, but things do not seem to be moving in this direction, it is more likely that the EU Summit this Sunday will move towards excluding Greece from the Euro-zone and provide funds to make the transition to Drachma through the so-called “Balance of Payments” facility for non-euro states that has been used for Romania, Hungary and Latvia. The fact that EU Commission President Juncker declared that “We have a Grexit scenario, prepared in detail” indicates for the first time that adopting the euro as your currency is not irreversible. Now that the Greek people have sent a powerful signal by voting "No" they have given Euro-zone politicians the political cover they wanted and it will be much harder to blame them for refusing continued transfers and support.

Still we can expect the Euro-zone countries will most likely fly in occasional shipments of euro bank notes until the end of summer, in order to avoid a risk of social breakdown. This special “transition bailout” – possibly financed by future cuts to EU subsidies for Greece could be implemented as a way to raise hopes for an orderly transition to the Drachma. There is also an alternative scenario in which Greece after defaulting and restructuring its banks would continuing using the euro but it would no-longer enjoy the cheap money from the ECB. The Euro-zone could grant Greece a special status as an incentive to stay in both the EU and NATO. By shifting them into a status similar to that of Bulgaria, Sweden and Poland that will be seeking full membership down the road. German Finance Minister Schäuble alluded ahead of the referendum that a Greek “no” could lead to a “temporary” Grexit and opened a path to this potential scenario.

As to debt restructuring even Ms. Merkel has acknowledged that a restructuring will be required. However, she continues to dismiss an outright haircut as not viable and on her side is a history of Greece continually failing to honor agreements and their unsavory habit of returning to the table always asking for more. Make no doubt about the fact this makes no practical difference because a series of back-hand deals has already transferred the debt to all the people of Europe. A further stretching out of debt maturities will allow the real value of this debt to be eaten into by inflation, and if there is one thing we can be certain about, it is that the ECB will provide plenty of inflation. True money supply growth in the euro area has shot well above 13%. If Greece tries  to simply refuse paying any of this debt it will become shunned in the capital markets for years to come adding to its woes. Obviously, this makes it even more likely that Greece might eventually have to link up with Russia, which it is incidentally about to strike a deal with over a gas pipeline. The issue now before politicians and bankers is how to create the illusion this doesn't matter and minimize the fallout.

Footnote, July 15th-11pm; The problems with Greece are not resolved until the man on the street is on board with the agreement. This evening Greece voted to accept the harsh offer the Euro-zone has offered up over the cries of many of the Greek people. This is a bit of a surprise to some of us, but in many ways just another move in a long game that has yet to play out. The situation in the Euro-zone and its relationship with Greece just got more complicated and interesting. Do not be surprised if this all blows up in the faces of the politicians and ratchets up into massive civil unrest. It is apparent the Greek people feel the same kind of anger towards their lenders as the German people had following World War I and we would be wise to remember the  misery that fostered.

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