Archive for the 'default' Category

optimism

November 1, 2011

The Greek Prime Minister wants to hold a referendum on the new bailout deal to be signed with the Europeans. It appears that this was an unexpected move which has caused anger throughout the Eurozone (also here). The details are not yet available, but it seems that Greece will negotiate the rescue plan first, and then will put the proposal to a vote. The Greek people will decide if they agree or not.

To be honest, I thought that this was the best piece of news (for Greece) to come out recently. Negotiations thus far were a two-party game, which has now been forcibly turned into a three-part asymmetric game:

  1. The Greek Government who are on one side of the negotiating table,
  2. The EU, ECB, bankers, IMF, etc. who are on the other side of the negotiating table, and
  3. The Greek people who are voting on the outcome when negotiations are complete.

Now one has to only think: whose negotiating power increased immensely and whose negotiating power took a dive, when the third party entered the game. Yes, it is the Greek government who now drive the process.

Also, it is worth remembering that what Eurocrats fear most is democracy. The history of referenda on EU policies is not stellar, and I suspect that they really don’t want to lose this one. It will not surprise me if Greeks get away with an 80% uniform haircut including the ECB, and bank recapitalisation for free.

Unlike what Greek commentators keep repeating, Greeks have the option to say No: a standard EU policy is to keep having referenda until a Yes vote is won, giving more and more sweeteners in the process.

PS: All is not clear sailing though. A requirement is that the Greek government will maintain its slim majority until January, which is not certain. Another Greek MP resigned today, most probably because of the referendum proposal itself. The opposition leader does not want to hold a trump in his hands, and promises to stop the referendum at all costs.

The chance of Greece descending into a chaotic horde of witch hunters has gone up by another notch.

if I stay it will be trouble

September 26, 2011

… but if I go it will be double

Chancellor Merkel made the point today that if Greece were to leave [the Eurozone], others would swiftly follow. This is at the core of the problem, and it seems to be overlooked by the hawkish commentators and politicians, who seem to be gaining traction in Greece. As Willem Buiter points out, there are genuine commentators who believe that such an exit will be positive not only for the remaining Eurozone members, but also for Greece herself.

The story is a simple implementation of a beggar-thy-neighbor policy: Greece leaves the Euro, returns to the new Drachma and pulls herself out of the mess with competitive devaluations. What these commentators seem to forget, is that this is a multi-round game. And in repeated games the tit for tat strategy is the winner.

A healthy restructuring of the Greek debt is all but a certainty, so let’s make the working assumption that greek debt is reduced to ‘sustainable levels’. The question is what to do the morning after; and there are three major alternatives:
(1) Stay in the Eurozone and the EU, or
(2) Return to Drachma and exit the EU, or
(3) Return to Drachma but stay in the EU.

Of these three options I believe that only (1) and (2) offer some sense of long-run equilibrium. The punters in Greece and abroad that offer (3) as a viable option overlook the retaliation potential from existing Eurozone members, which will eventually lead to a Euro break up. Here I try to take a look at the three options, and take them to their logical conclusions.

In (1) the internal devaluation continues, and Greece finds herself in a new equilibrium where every Greek is substantially poorer but more competitive (the unit labour costs has dropped to more sustainable levels). En route to this equilibrium, house prices have collapsed and unemployment is persistently high. There has been a massive delevariging exercise, and Greek banks are nationalised with their shareholders wiped out. Throughout this transition Greece finances her deficits through European funds. There is the risk that at some point Greeks declare that they have had enough, and decide to take a gamble with the other two options (2) and (3). This depends on the speed of convergence, and on whether a Greek politician is able to sell these options as viable. “Austerity fatigue” is clearly visible already in Greece, and “bailout fatigue” is visible amongst the creditor countries.

In (2) Greece tries to take advantage of lower exchange rates. She moves out of the EU, and returns to the Drachma. In order to protect against capital leaving en masse, capital controls have to be imposed. The new currency is automatically devalued, and Greece is outside international capital markets for a prolonged period. In order to finance her deficits, Greece has to rely on internal borrowing and extract substantial seignorage. Therefore one should expect inflation to be rampant, and real wages to decline rapidly.

Will the lower exchange rates give a boost to the economy? This depends on the response of the remaining EU countries. Most periphery and some non-periphery countries are direct competitors for Greek goods and services. Portugal, Spain. Italy and France spring to mind as countries that Greece has been competing against for the agricultural and tourist Euro. An exit of Greece from the EU and subsequent competitive devaluations will cause direct losses, and some of them will declare that either (i) tariffs and other restrictions are introduced on imports from Greece, (ii) their products are supported to remain competitive, or (iii) they will also exit the EU. If the common currency (and equlibrium) is to be maintained, then a combination of (i) and (ii) will be implemented; (iii) results into a Euro break up. Nevertheless, this second-round breakup in (iii) can be carried out by the remaining nations in an orderly fashion (without leaving the EU); therefore Greece is left substantially worse off, withought any currency advantage and without access to European markets.

No equilibrium can be sustained in (3) as it will degenerate into scenario (2) if Greece proposes to exit the Eurozone but remain within the EU. There are legal reasons that postulate that if a member country wants to leave the monetary union, she will also have to leave the EU as well. Obviously these problems can be bypassed if the other EU members accept Greece to remain in the EU having left the Eurozone, for example by using the trick of exit and instantaneous re-entry. But such tricks require universal consensus, and I argue that this cannot happen. The competing nations will not agree to give Greece all the benefits of flexible exchange rates and free trade, while they are stuck with an overvalued (as far as they are concerned) Euro. If such a strategy becomes an option, then they too will opt for a new currency and Euro breaks up. Remember, when the Euro was introduced all these competing nations entered simultaneously, in order to maintain some element of status quo. For these reasons I think that option (3) is a non-starter, and should be put to bed.

If I had to choose from the above three options, then (1) looks like a no-brainer. I would not take a gamble and risk being excluded from a European trade zone, without any tangible benefits. The main risk in (1) is that the process can take too long, and Greeks might give up before the devaluation is complete. There could be variations that potentially speed up the adjustment process, for example introduce a quasi-currency that will be used in parallel to the Euro for internal purposes.

But the main problem as it stands is that Greeks, unlike the Irish, have not made the problem ‘their own’. They are still suspicious of a worldwide conspiracy, a ploy to deprive them of their assets. Many still believe that a painless way out exists, but they are not presented with it. And this is why I am worried that at some point a populist politician will raise option (2) and Greeks will say ‘why not try’.