Every one is talking about European finance ministers failing to reach an agreement on Greek funding. There is another meeting scheduled for Monday. It is clear that a Greek exit, which many observers had thought was inevitable in six months ago, is not in the cards.
Instead, what is being debated is how to fund Greece, which we continue to note is not really about aiding Greece as much as ensuring the country's ability to service its debt, which is primarily in official hands. Still that does not stop some officials from proposing to give the private sector another haircut through the buy back of government bonds at a 50 cents of so on the euro. Anticipation of some buy back may be helping to drive Greek bonds higher today.
However, perhaps the most important take away from the failed talks was that it appears to have spurred a tactical shift by Germany. Shortly after talks ended, Germany indicated that it is open to providing new financing for the eurozone's EFSF lending capacity and accept lower interest rates on existing loans. It seems more determined than it has been in making sure that the Athens' program remains intact. The new funds would ostensibly be used by buy back Greek bonds.
To be sure though, increasing the EFSF lending capacity does not necessarily cost Germany a single cent. Despite cries from some quarters about German reluctance to give more funds to Greece, the fact of the matter is that the EFSF works on the basis of guarantees not money from the creditor nations. The EFSF funds are raised by the sale of bonds to investors, not by transfers from German tax payers.
While there may be opposition to new guarantees, most recognize it is preferable to the alternative that the IMF is pushing for which is an official sector haircut.
The media continues to report that a key remaining hurdle is debt sustainability. The issue is whether Greece should have another two years, to 2022 to bring its debt/GDP ratio down to 120%. That is what the European finance minister seem to favor. The IMF insists on 2020.
These numbers are arbitrary. Why is 120% debt to GDP sustainable, but not 125%? Moreover, the debt/GDP ratio is just as much about the denominator as the numerator. The IMF has done a spectacularly poor job in forecasting Greek GDP. Given the margin of error, there is, statistically speaking, no real difference between the IMF and European finance ministers positions. To be filed under "the hubris of small differences".
Germany's tactical shift underscores another point we have made. Some observers have argued that Germany should consider leaving the monetary union. There is no sign that this is being considered and quite to the contrary, Germany is willing to make some concessions to ensure that monetary union is sustained. Simply put, EMU is in Germany's interest. Leaving EMU would cost Germany. The hard won competitive gains of German producers would be quickly eroded by competitive devaluations. It would leave Germany isolated, which is abhors and it would be blamed for wrecking Europe... again.