Remember the battle cries before the Greek referendum? The Greek government has let the last
opportunity for a final deal go by, and a “no” on Sunday, July 5th,
will invariably mean a “Grexit”, an exit of Greece from the Euro currency
zone. It will mean that the world for
Greece will come crashing down and that excruciating disaster will strike.
Well, the Greeks voted “no” anyhow. Now, there is yet another deadline on Sunday,
July 12th, for a final, final deal, or else a “Grexit” will
invariably follow. Or perhaps the
endgame truly arrives on July 20th, when Greece has to repay 3.5
billion Euros to the ECB. Yes, this is getting tiresome.
Now, granted, it is possible that the exit scenario will finally
come to pass on July 21st, if no deal is struck on Sunday, July 12 and Greece then
defaults on the ECB on July 20th. This
is what most observers predict, this is what the threatening voices from the
ECB suggest. So let me raise another possibility.
I will argue that there may be no Grexit
at all. Yes, there will be
haggling. Yes, there will be chaos in
Greece (no kidding, things haven’t been great there as of late). Eventually, in a few years, everything will
be humming along ok. Indeed, if the cooler heads prevail, on both sides and in
particular at the ECB, this scenario looks to me more likely. How so?
Let me start with a hypothetical scenario. Suppose, Merkel and Co. would have offered in
June that all Greek sovereign debt is going to be wiped out and forgiven, at
the price of no further lending to Greece by other governments or European
funds in the future. No other
conditions: no “austerity”, no demands of cuts in pension, nothing else. What would Tsipras have done? He would have driven home to a victory
parade. He and his government would have
been celebrated through the night by huge cheering crowds for this major
triumph. They would have considered
building him a huge statue on the Parthenon.
And all talk of a Grexit would have stopped.
Take the current situation.
And suppose, the Greek government simply does not make any further
payments on its old debt. Suppose that
otherwise, everybody carries on with whatever they would have done in that
hypothetical scenario above. Sure: the
IMF, the ECB and the other European governments will not be happy. But if they, essentially, act rather
similarly as if the debt had been forgiven in that scenario above, the
difference to that scenario will be small indeed. And: no Grexit.
But, you may say, why should the IMF, the ECB, the other
European governments act the same way? So, let’s ask, what can they do about the
Greek default? What are they prepared to
do? And: what is it, that they really want?
There is a lot of noise by many that Greece should be
punished for its intransigence by kicking it out of the Eurozone. But there really is no procedure for doing
that. The Maastricht treaty does not
say, that the ECB and the other European governments can liberally bail out
each other, against the promise of debt repayment and the threat of having to
leave the Eurozone otherwise. On the contrary: the whole legal framework had
been designed explicitly with the stipulation of “no bailout” and no financing
of governments by the ECB. It takes two
to Tango. You lent money to Greece? You shouldn’t have. You are mad that you are not getting your
money back? I get that. But, unfortunately, there is no legal basis
for you to somehow now punish Greece by kicking it out of the Eurozone. Sorry.
The somewhat more elegant version is the argument that
Greece should finally, really decide whether they want to be part of the
European Monetary Union and play by its rules, or not. The mischievous hope here somehow seems to be
that Greece throws in the towel on its own.
It probably could indeed somehow exit the European Union, and thereby
exit the EMU as well. And there are even
a number of economists who argue, that the introduction of a Drachma and a
subsequent devaluation would revive the situation in Greece and restore order
to its banking system. But guess
what! The Greeks like the Euro. So far, they have no intention of leaving the
EMU on their own. They probably think
that a Grexit and the reintroduction of a Drachma would do more harm than good:
incidentally, so do I. It seems
unlikely, therefore, that the Greeks will leave on their own: certainly, for a
while.
The key issue to all this is the ECB and the Greek
banks. We have all seen the dramatic
pictures of people in Greece lining up at banks, trying to withdraw cash, of
which the Greek banks now have very little.
But as in any bank run, banks run out of liquidity pretty quickly. It is then the task of the lender of last
resort to step in and lend to solvent, but illiquid banks against good
collateral at penalty rates, as Bagehot has taught us. And that is exactly what the ECB claims it
has done. It has provided emergency
liquidity assistance or ELA, via the Bank of Greece to Greek banks to the tune
of nearly 90 billion Euro, vastly exceeding the --- by comparison --- rather
minor amounts that were the subject of negotiation between the Greek government
and the other European countries in June.
What happened to those 90 billion? They are no longer in the banks. If they are not abroad, they are now in
circulation in Greece. They are under
mattresses. They are in envelopes and
suitcases, which get handed over, whenever a large transaction needs to take
place. The next plot by Barclay’s
research puts it into a nice perspective: Greece is increasingly becoming a
cash economy. For every Euro withdrawn from Greek banks, about 40 cent increase
domestic cash circulating.
How much, really, could the Greek depositors still withdraw,
if the ECB would be so generous and lift the limit entirely? It turns out: a lot less than it used to be. Check the plot of the private sector deposits
in Greece. They once stood at 240 billion
Euro at the end of 2009. They fell
dramatically: the latest number from the Bank of Greece for May states it as
130 billion. Surely, it is even lower
now. So, one half or more of what has
been on the bank accounts has been withdrawn already. There is lots of cash in Greece. It just isn’t in the cash machines or at the
banks. Good luck with converting all
that cash into Drachma.
The ECB has felt increasingly uncomfortable with extending
so much ELA. There are increasingly
stronger voices which argue that the ECB has gone too far already and should
withdraw this support. ELA was meant for
the plain-vanilla bank-run: for solvent, but illiquid banks, the national
central bank provides cash against collateral, at a haircut, unless the ECB
vetoes that. Should any losses occur,
the national government will have to pony up.
But this here is a system-wide run on the Greek banks. And the Greek government does not seem
inclined to pay for any losses to any non-Greek entity. With the deep recession in Greece, the ECB
may finally judge that the collateral isn’t worth the cash lent against it and
may judge the banks to be insolvent, rather than illiquid, and stop the ELA
entirely, rather than just keeping it at the current 90 billion Euros. Many think that a default by Greece on the ECB
on July 20th will trigger that, though there is really no logical
reason to link the two. This is all
about a judgement call, how much the collateral is worth, how solvent the banks
are, and how much one should value the fiscal backstop for those losses that
result.
So let us examine the scenario of ELA withdrawal. At that point, the ECB could ask for the ELA
to be repaid --- an impossibility at this point --- or seize the collateral,
pushing the banks into bankruptcy. Does
that now automatically mean a Grexit, because somehow the Greek government
would be pushed into printing Drachma to repay the remaining depositors? There are lots of other possibilities. One is: split the banks into a part that has
liabilities vis-a-vis the Bank of Greece and the other parts, which have a
viable network of branches, cash machines and customer base. Sell the latter to the foreign banks: they
will be valuable; they will be open for business as soon as the deal gets done.
What about the former? For that, gradually sell the assets that have
been pledged as collateral: perhaps, they were really worth as much as has been
claimed all along and the banks were really solvent, in which case these parts
will be profitable too and the remaining deposits can be paid off. Or perhaps losses occur, which need to be covered
somehow, perhaps with a mix of haircuts on the remaining deposits, government
IOUs and a reinjection of capital by the Greek government. The Syriza government, after all, is not
averse against making payments to its own citizens, and there would be
considerable national pressure to solve this issue. Does it beat receiving Drachmas instead? I think so.
It probably beats it by a mile.
Moreover, a number of Greek banks are already part of the single
resolution mechanism of the European Monetary Union, which guarantees European
funds as a backstop, should national backstops fail. It is entirely possible that the end of ELA
and an inability or unwillingness by the Greek government to pay triggers
European clauses, providing considerable payouts and deposit guarantees to
Greek depositors. That will be
fascinating to watch.
Finally, it is interesting, what Merkel, what Hollande, what
Draghi are saying. They claim that their
objective is to keep Greece in the Eurozone.
They really do not hope for a Grexit.
Not only would it be a huge black spot on their record, it also would
make any repayment of existing Greek debt even less likely. The Greeks do not want out either. So, the wisest course of action may be for
the ECB to simply sit really still on its ELA claim on the Greek
national bank. Some of the Greek banks
will have to be broken up, as described above, to get the functionality of the
financial system back on track. The Greek
government will need to make sure to keep collecting taxes from the now
somewhat further reduced activity at home.
It is close to a zero primary deficit, and should be able to keep making
payments at home with the taxes it collects.
There will be occasional financial flow mismatches or perhaps there will
be a bit of a primary deficit: perhaps then, the Greek government will pay a
small portion of its salaries, pensions or obligations with IOUs. These may then circulate: perhaps at a
discount or perhaps not (for example, if they can be used for paying taxes). Is
this a Grexit? If the majority of the
transactions happen in Euros, if all the accounting is still done in Euros, we
shouldn’t call it that. IOUs are used
elsewhere too.
So, perhaps the best thing for everyone is to table the
whole issue of debt repayments for now.
We really do not need more final, final, final, final deadlines and
hectic negotiations. There are more
important things to do. Let’s put these
issues and the outstanding ELA amounts on ice for a while, and let the Greeks
struggle along, on their own. In a year
or two, let’s calmly restart the discussion on what to do about it all. With that, things may turn out to be much
more benign, than the doomsday sayers have been preaching. Indeed, this may not be a disastrous “Grimbo”,
as some have argued, but a new beginning.
After a somewhat painful adjustment phase, which Greece is in the middle
of already, there will be a return to some reasonable normality. Things will be ok. And Greece may even be
willing to repay a good portion of its debt, at that point.
So, just keep calm and carry on and keep Greece in the
Eurozone.
