Many have been looking for economic volatility and drama at the incoming Trump government, but what if we're looking at the wrong place? There are some lurking traditional drama's that, while masked by a period of relative calm, haven't really been solved on a fundamental level.
Almost two years ago we predicted Grexit and in the time since it looked like we were wrong. We still could be wrong, as there are still ways to carry on as before. But things haven't really gotten any better in the meantime and that's where we were right.
And this should alarm basically everybody. Why? Simple, if things don't improve during supposedly good times, it doesn't take much imagination what will happen during bad times.
What are those good times? Well, the eurozone has experienced a period of relative calm. This has been the result of (in no particular order):
- A (fairly modest) upturn in growth, which is in itself the result of:
- The ECB embarking on a once unthinkable program of monetary stimulus.
- Which contributed to a decline in the value of the euro, boosting exports.
- Low oil prices acting as a further stimulus.
- The moderation, or even end of austerity policies in many eurozone countries.
This might very well be about to change. For instance, inflation is rising in the eurozone, in Germany especially. The Germans are complaining monetary policy is too loose for them. Now, that's basically what they always say, but this time they actually have a point.
And indeed that's what the new Trump government also claims, and they argue it unfairly favors German exports. They do have a point.
While it's unlikely the ECB will tighten in the immediate future, an extension of the current QE program beyond this year looks increasingly unlikely. And we know from experience that currencies turn on expectations, so the euro could actually start rising way before that happens.
The Greek condition
Some facts for the reader to ponder on:
- Since the Greek debt saga exploded seven years ago the Greek economy has shrunk by more than a quarter.
- This economic slump is mainly the result of savage austerity measures. Big tax increases and public spending cuts
- This economic slump hasn't made public finances more sustainable, in fact it has blown up the public debt/GDP through the denominator effect and plunging tax receipts.
- Greek unemployment is 23% and one in three Greek lives below the poverty line
There is a modicum of good news though, from Ekathimerini:
After meeting his euro zone counterparts in Brussels, Finance Minister Euclid Tsakalotos said that last year's primary surplus - which excludes debt servicing costs - reached 2 percent of gross domestic product, beating a target of 0.5 percent of GDP set in its bailout plan. A Greek government official said earlier that due to this over-performance Athens was "making a much better start in 2017" in terms of state revenues.
If the Greek economy ever returns to anywhere near normal, that is, more or less full employment, it's budget surplus would skyrocket. It's remarkable enough that they can manage a 2% primary surplus in such a depressed economy, and this testifies to the austerity efforts already consumed.
While the economy still contracted in 2016, the EU commission expects a revival of growth in 2017 to no less than 2.7%. Not everybody is that optimistic, and rising uncertainty over the next tranche of the bailout could very well dampen business and consumer sentiment, this has happened before.
The bailout ends in 2018 and with a public debt level of 175% of GDP and rates of 10 year bonds at 7%+ it's hard to see how Greece will go back to the markets to finance itself. Especially with the IMF arguing that its debt situation will become highly explosive.
Given the above facts, you don't need to be the IMF to arrive at that conclusion, but this is a problem for later. We have a more immediate problem at hand, which are the conditions for releasing the next tranche of the existing bailout.
All this has translated into a little bit of a spike in Greek bond yields, although still not anywhere near the dramatic scale of earlier crisis.
The main negotiators are locked into their position:
- The Greek (formerly radical left wing) government under Tsipras is deeply unpopular because of the endless austerity, if they want any chance of reelection, they can't cave.
- The Germans think they have already provided enough money for Greed and face their own election this year (September), they can't be seen to be 'soft' on Greece, for instance by engaging in debt forgiveness. Being 'soft' means opening itself up to the right wing populist Alternatieve für Deutschland party. Even if a deal is struck for the next tranche of the present bailout, it's difficult to see any German appetite for a fourth one after this one expires in 2018.
- The IMF (rightly) argues that the Greek debt is unsustainable and this prevents it from participating in any new bailout. They want debt restructuring to make the debt sustainable. They also argue that Greece is unable to achieve the 3.5% budget surplus required by the third bailout program in 2018, when that bailout program ends.
There are further complications:
- The Germans won't commit more funds to Greece without the IMF participating but the IMF won't participate without Greek debt relief, something which is anathema to the Germans.
- The IMF might further change now that there is a new US government. Trump has already argued that the Greeks have no business within the euro.
Here is the IMF's assessment (from The Guardian):
"Greece cannot grow out of its debt problem," the Washington-based body wrote in a confidential report leaked to the media last week. "Greece requires substantial debt relief from its European partners to restore debt sustainability."
And from Reuters:
The head of the European Department Poul Thomsen and chief economist Maury Obstfeld wrote in an article the Fund believed that euro zone insistence on a Greek primary surplus of 3.5 percent in 2018 was wrong and 1.5 percent would be enough. "We warned that this would generate a degree of austerity that could prevent the nascent recovery from taking hold," the two senior IMF officials wrote of the higher euro zone target.
And Germany's position, from the same source:
Some euro zone countries like Germany believe that not only should Greece reach a primary surplus of 3.5 percent of GDP in 2018 but it should keep it at that level for the next 10 years. The IMF believes this would be counterproductive... Germany insists on the higher primary surplus target because it means lower, or even no need for debt relief for Athens -- an important factor in an election year in Germany where public opinion is suffering from bailout fatigue.
So the IMF's position is basically one of:
- Less, not more austerity, a permanent 3.5% structural surplus of 2018 and beyond will hamper growth.
- Substantial debt relief.
- Pro-growth reforms, like broadening the tax base, spending on infrastructure and basic social services (like unemployment benefits, the lack of which make collective dismissals extremely awkward) and cutting pensions further.
The normal way out
These positions aren't really new (apart from a new US government). We have been here before and the usual way out is simply for the Greeks to cave and embark on yet more budget and pension cuts, tax hikes, and economic reforms.
It should come as no surprise that this doesn't improve the situation. Can anyone doubt that? After all, this is the experience of the last seven years. The normal way out would be Greece caving in and embark on yet more dramatic cuts, reforms and tax hikes.
This wasn't more apparent, and more dramatic as in the previous run-in with the creditors. The Greeks voted no to austerity in a referendum and elected a radical left party to government, which caved and subscribed to even more drastic austerity.
This time might be different though. There is increasing realization in Greece that life might actually be better outside the euro.
What happens next?
Ideally, things will be resolved by, or during the meeting of Finance Ministers on the 20th of February, but given the digging that has been done in the positions, it requires a miracle. Then we have several elections in European countries (the Netherlands, France, Germany) where the center is trying to hold against a rising tide of populist right.
Then there are debt payments (7.4B euros) Greece has to make in July this year, for which it needs bailout money. Greece economic foundations, despite the recent slight improvement, are still very shaky, as is its political situation. The government has a majority of just two seats in parliament.
The impasse in the present bailout (the review of the creditors which is supposed to lead them to approve the release of the next tranche of bailout money) is also preventing the ECB from buying Greek bonds.
It was exactly on that perspective that Greek bonds rallied last year, but without creditor approval the ECB's hands are tied. In any case, ECB bond buying isn't going to last forever.
Even if the deadlock about the present bailout can be solved, it's only kicking the can, or in this case, kicking the bomb forward.
It is simply inconceivable that Greece, without really substantial debt relief, can return to the markets at the end of the present bailout in 2018.
The Greek economy has been improving, but not nearly enough for it to give it a shot at debt sustainability without substantial debt relief and ECB bond buying (which ends at the end of this year), as even the IMF argues.
There is already deadlock over the present bailout between all parties. Greece doesn't want more austerity, which could well sap the economy yet again from recovering, the Germans don't want debt relief, without the latter the IMF won't participate.
It is difficult to see how these parties would be able to agree on a new bailout, which even under the most rosy scenarios will be needed when the present one expires.
Yes, there is stuff the country could still do, like cutting pensions further and broadening its tax base
A country, especially one having gone through seven years of depression, isn't likely to be able to deal with a public debt load of 175% of GDP, especially when that debt is denominated in a currency over which it has no control.
While growth was actually returning, the fact that this sword of Damocles is hanging over the economy and solutions are not readily at hand makes it near impossible for Greece to the markets to fund its own debt again.
It would need a stunning reversal of economic fortunes, lasting for a decade or more to be able to pull this off. This is simply not realistic. Investors know this, which is simply the reason they will require steep risk premium before they step into Greek bonds, which makes the public finance dynamics simply unsustainable.
Only a really substantial debt cut, in exchange for implementing the more sensible IMF reform program can really alter the picture, but this isn't forthcoming before the German election, and one can have substantial doubts whether it will be after that.
Greece doesn't stand in a vacuum, Italy and Portugal are also on the brink and there is the threat of a lot of political volatility and discord within the ECB about the stimulus policies. It is an explosive mix.
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