By Frances Coppola, Forbes
The Greek government has refused to accept any more loans to meet future debt obligations, claiming that as Greece is insolvent, lending it more money simply makes matters worse.
This move seems to have caught everyone by surprise, but in fact it was clearly signalled by the leader of Syriza before its election victory. In an “open letter to the people of Germany” published in Handelsblatt on January 13, Alexis Tsipras explained why Germany should support debt reduction for Greece (my emphasis):
In 2010, the Greek state ceased to be able to service its debt. Unfortunately, European officials decided to pretend that this problem could be overcome by means of the largest loan in history on condition of fiscal austerity that would, with mathematical precision, shrink the national income from which both new and old loans must be paid. An insolvency problem was thus dealt with as if it were a case of illiquidity.
In other words, Europe adopted the tactics of the least reputable bankers who refuse to acknowledge bad loans, preferring to grant new ones to the insolvent entity so as to pretend that the original loan is performing while extending the bankruptcy into the future. Nothing more than common sense was required to see that the application of the ‘extend and pretend’ tactic would lead my country to a tragic state. That instead of Greece’s stabilization, Europe was creating the circumstances for a self-reinforcing crisis that undermines the foundations of Europe itself.
My party, and I personally, disagreed fiercely with the May 2010 loan agreement not because you, the citizens of Germany, did not give us enough money but because you gave us much, much more than you should have and our government accepted far, far more than it had a right to. Money that would, in any case, neither help the people of Greece (as it was being thrown into the black hole of an unsustainable debt) nor prevent the ballooning of Greek government debt, at great expense to the Greek and German taxpayer.
Tsipras has been proved correct on both counts. As this graphic from the FT shows, all but about 11% of the bailout money went straight back to the holders of Greek debt by one route or another:
And Greek debt has ballooned to 175% of GDP – a level which could force the IMF to reconsider any further lending. Under its own rules, the IMF is not allowed to lend unless the debt is sustainable.
But the actual cost of debt service for Greece is well below market rates, and much of it does not have to be repaid for a very long time. Greece also benefits from a concession that means it does not have to make principal repayments on EFSF loans until 2022. Greece’s debt service costs do not appear unaffordable, at an estimated 2.6% of GDP. On the face of it, therefore, Greece’s debt should be sustainable. Indeed, other highly-indebted Eurozone countries could rightly feel aggrieved if Greece receives further debt relief. So what is the justification for writing down Greece’s debt?
Syriza now wants to negotiate a haircut of the loans from eurozone governments. Mr Dixon argues that this would bring little immediate relief because the (nominal) interest rates on the loans are low and no principal is due until 2022. But he ignores the costs of requiring Greece to run a huge primary surplus of 4.5 per cent of GDP from next year on and the strictures of the EU fiscal compact, which requires governments with debts of more than 60 per cent of GDP to reduce the excess by one twentieth a year — a tall order with debts of more than 175 per cent of GDP.
What is really needed is less restrictive bailout conditions and relaxation of the fiscal compact rules. But the Greek government’s opening move was to risk default by refusing further bailouts and demanding debt relief. In my view this was for dramatic effect. The Finance Minister’s refusal to accept any more bailout money got the world’s attention, whereas a simple request for easier terms would have barely raised an eyebrow – and would therefore have been easily rebuffed by the Troika. Threatening to default is playing hardball.
And it got a hardball response. Germany’s Chancellor Merkel refused outright to consider further debt relief. And the ECB’s Liikainen warned that if the Greek government failed to secure a deal by the end of February, the ECB would pull the plug on funding for Greek banks.
As my colleague Tim Worstall explains, such an action by the ECB would force Greece’s immediate exit from the Euro:
Greece can only stay in if the ECB continues to provide liquidity to the banking system. Syriza insists that the Greeks want to stay in. But ECB liquidity will only be provided on the basis of two points. Either that the troika folds and agrees to the reduction in the debt that must be repaid. Or that Syriza negotiates with the troika and agrees that the current contract must be upheld. Which means that we’re in a game of chicken here. Who folds? Syriza or the troika?
As the economist Diane Coyle put it on twitter, this is “game theorists at dawn”. How the game will unfold is hard to predict. Worstall assumes that the game must be zero-sum – that it is “a question of who blinks first”. But as Steve Keen explains, the fact that this is a “prisoner’s dilemma” does not rule out the possibility of the participants cooperating. Yanis Varoufakis, the new Greek finance minister (and a game theory expert), clearly intends to push for a negotiated solution.
And his hand is much stronger than many people think. Germans may fantasise that Greece is no longer “systemically important”, but the reality is that forcing out a Euro member would signal the end of the single currency. Even admitting the possibility of exit (as has arguably already been done in the design of QE) undermines it, as Mario Draghi explained in a speech given in Helsinki in November 2014 (emphasis in final sentence mine):
…if there are parts of the euro area that are worse off inside the Union, doubts may grow about whether they might ultimately have to leave. And if one country can potentially leave the monetary union, then this creates a replicable precedent for all countries. This in turn would undermine the fungibility of money, as bank deposits and other financial contracts in any country would bear a redenomination risk…..
…So it should be clear that the success of monetary union anywheredepends on its success everywhere. The euro is – and has to be – irrevocable in all its member states, not just because the Treaties say so, but because without this there cannot be a truly single money.
Grexit would be an unmitigated disaster not just for Greece, but for the whole Eurozone. And Varoufakis knows this perfectly well. Threatening to default is a powerful strategic move to which the Troika has so far found no satisfactory response. Withdrawing ELA from Greek banks would simply precipitate disorderly unwinding of the Euro. The ECB can no more follow through on this threat than it could when it threatened to do the same to the Irish banks in 2010. But Varoufakis is not Enda Kenny. The ECB may well find its bluff called this time.
Greek debt is everyone’s problem. It is in everyone’s interests to work together to find a solution.