The new populist Greek government reached a creditor “transitional agreement” two months ago to avoid a “Grexit,” in which Greece would have reneged on its $350 billion in debt and left the European Union.
The populists are screening a modern Greek Tragedy wherein the noble Greek people are forced to suffer deprivations in return for the villainous German-controlled creditors pretend to loan Greece money that mostly repay existing EU loans used to buy German imports. But with Greece on the brink of running out of cash, and Greece’s creditors running out of patience, a compromise may be coming together to avoid an overt ‘Grexit’ by allowing for a devalued “Greek euro.”
The Greek Tragedies consist of 207 serious dramas in which a central character, the protagonist–usually an important, heroic person–meets with disaster, either through some personal fault or through unavoidable circumstances. In most cases, the protagonist’s downfall conveys a sense of human dignity in the face of great conflict.
The first Greek tragic debt default occurred in the fourth century B.C., when 13 Greek city states borrowed funds from the Temple of Delos. Most of the borrowers never paid back the loans and the Temple took an 80% loss on its principal. Greece also defaulted on its external sovereign debt in 1826, 1843, 1860, 1894 and 1932. In addition, the nation has devalued its currency an estimated 174 times to become more competitive.
Since the 2008 Global Financial Crisis, Greek domestic demand has fallen by 25 percent, about the same as Germany from World War I to the “hyperinflation” of the Weimar Republic.
After a series of creditor bail-out loans tied to austerity spending limits, Greece now has a debt of about $360 billion. The tragic pain at the individual level, the Economist notes, has included house prices falling by around 40% and “median incomes falling by 22%; for 18- to 24-year-old Greeks they were down by 38%.”
According to Lombard Street Research (LSR), the Greek populist government’s “overarching objective is to get an agreement with its EU creditors on a medium-term ‘social contract’ by summer that would include elements of debt relief that required only paying creditors with some percentage of the nation’s balance of payments surplus.
As a result of the creditor-imposed budget consolidation and depression since 2009, Greek labor cost competitiveness has largely been restored. The current account has swung back into a positive balance of payments surplus, due to an almost doubling of exports. The Greek banking system has been largely recapitalized, with substantial progress made in dealing with its impaired loans.
To the populist Athens government, the February 20 transition agreement negotiated with the “troika“–composed of the European Commission, International Monetary Fund and European Central Bank, who in turn represent Greece’s international creditors–was a procedural bridge to delay a final creditor showdown until a bigger crisis this summer.
LSR believes that Greek populists accept the need for deep labor market and pension structural reforms, but do not want to be “climbing back from initial pledges in sensitive policy areas would come at an unbearably high political cost” with a domestic audience.
“Seen under this prism,” veering closer to the brink of a catastrophic default is part of the Greek government’s tactics. The populists believe that forcing Greece’s 8 major political parties to vote for a painful final deal with creditors “will (ironically) prove easier to gather when things turn binary.” The Greek populists also hope that when the imminent ‘Grexit’ scenario materializes that it might also cause creditors to blink, “conceding enough ground to prevent an accident.”
LSR calls this brinksmanship a “very dangerous game to play.” Greek leaders have “added a liquidity crisis to a solvency problem.” State coffers are now dry and sustained capital flight has pushed the level of domestic bank deposits under the 2012 crisis lows:
“Elevated uncertainty has brought economic activity to a standstill, amplifying the risk of budgetary target derailment and preserving the large risk premium built into Greek financial assets. Crucially, business confidence indicators have decoupled from the improving climate in the euro area, suggesting that the quarterly GDP contraction in Q4 of last year will continue well into 2015.”
The risks to the rest of the euro area from outright “Grexit” remain underappreciated, according to LSR. Even if it is economically manageable, “any country-member’s departure would introduce a permanent convertibility risk premium into the sovereign yields” for the peripheral euro area countries. “Grexit” could quickly cause Spain to exit the Euro, for example.
LSR believes that policymakers are already discussing a compromise to avoid an overt “Grexit.” The deal would keep Greece in the euro, but with currency exchange controls and a floating “Greek euro.”
Given the painful economic adjustments that have made labor costs competitive, LSR believes a compromise offers the best ‘middle way’ between the need for continuing deflationary reforms that are the key to sustained competitiveness.
Greek Tragedy is designed for the audience to feel an emotional purge that swings from pity and fear to cathartic relief and exhilaration. By pushing “Grexit” to the brink, both creditor and debtor would enjoy a little relief and exhilaration.