Pablo Iglesias (C), leader of Spain’s party “Podemos” (We Can), raises his fist as he
Spaniards hold mass rally for leftist Podemos ahead of elections
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A man holds up a banner as people gather during a rally called by Spain’s anti-austerity xx
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Greek FinMin Warns "Euro Will Collapse If Greece Exits", Says Italy Is Next
The time for the final all-in bet has arrived.As we explained yesterday, when we wrote that "Greece Gambles On "Catastrophic Armageddon" For Europe, Warns It "Only Has Weeks Of Cash Left"", and as confirmed further by today's fire and brimstone speech by Greek PM Tsipras, in which he not only did not concede one millimeter to Europe but raised the stakes even higher, by promising among other things to raise the minimum wage and to halt foreclosures, Greece is now betting everything that Europe will not allow it to exit, hoping that "this time is not different", and the existential terror that would be heaped on the Eurozone as forecast in 2012 by the likes of Citi's Buiter and IIF's Charles Dallara, will still take place, and Europe will concede that spending a few more billion on Greece's bridge program is worth to avoid what could potentially spiral into an out of control collapse.
To be sure, that is precisely what Yanis Vaourfakis implied today when he said that "if Greece is forced out of the euro zone, other countries will inevitably follow and the currency bloc will collapse, Greek Finance Minister Yanis Varoufakis said on Sunday, in comments which drew a rebuke from Italy."
The comments emerged from an interview we commented on earlier with Italian state television network RAI, Varoufakis said Greece's debt problems must be solved as part of a rejection of austerity policies for the euro zone as a whole. He called for a massive "new deal" investment program funded by the European Investment Bank.
From Reuters:
So now that Greece is all in, the time for even more truth has emerged, and if Greece is finally being honest, it may as well spook Italy and drag it down - or rather up - with it."The euro is fragile, it's like building a castle of cards, if you take out the Greek card the others will collapse." Varoufakis said according to an Italian transcript of the interview released by RAI ahead of broadcast.
The euro zone faces a risk of fragmentation and "de-construction" unless it faces up to the fact that Greece, and not only Greece, is unable to pay back its debt under the current terms, Varoufakis said.
"I would warn anyone who is considering strategically amputating Greece from Europe because this is very dangerous," he said. "Who will be next after us? Portugal? What will happen when Italy discovers it is impossible to remain inside the straitjacket of austerity?"
And while the Greek "scorched earth" approach would have no doubt succeeded had it taken place three, two or even one year ago, when Europe still had some faint resemblance of an actual market, the difference this time is that by dint of its recently launched QE, which revealed that Germany's staunch "anti money printing " stance was nothing but melodramatic theater all along, it is the ECB that is in charge of every asset class in Europe: from the EUR, to the German Bund, to the Italian BTPs, to the DAX to, well, everything, and neither fundamentals nor non-central bank players matter any more."Italian officials, I can't tell you from which big institution, approached me to tell me they backed us but they can't tell the truth because Italy also risks bankruptcy and they are afraid of the reaction from Germany," he said.
"Let's face it, Italy's debt situation is unsustainable," he added, a comment that drew a sharp response from Italian Economy Minister Pier Carlo Padoan, who said in a tweet that Italy's debt was "solid and sustainable."
Varoufakis's remarks were "out of place", Padoan said, adding that Italy was working for a European solution to Greece's problems, which requires "mutual trust".
Italy's public debt is the largest in the euro zone after Greece's and Italian bond yields surged in 2011 at the height of the euro zone crisis. They have since fallen steeply and have so far come under little pressure from the renewed tensions in Greece.
Which is why Greece may have waited just three weeks to long with its final gambit, as Europe is confident that the ECB's interventions can offset the loss of faith in an already crashing Eurozone (if only for a short period of time, of course). Because the alternative, ceding to Greece, means that all other European peripheral states will demand the same treatment.
Which brings us back to Greece, for whom the moment has finally arrived: the moment which was so eloquently described by a Chuck Palahniuk character when he said that "it is only after we have lost everything, that we are free to do anything."
"We" in this case being Greece. The only question is whether the freedom from its final loss has arrived just a few weeks too late...
Europe Fractures: France Pivots To Putin, Cyprus Offers Moscow Military Base, Germany-US Splinter On Ukraine
German Foreign Minister Frank-Walter Steinmeier doubled down on Germany's rejection of weapons deliveries to Ukraine in a speech here Sunday...
But John Kerry says, everything's fine... as he denies any split between U.S. and Europe on Russia policy..."I see this, to say it openly, as not just for risky but for counter-productive," Mr. Steinmeier said at the Munich Security Conference. Mr. Steinmeier also hit back at open criticism of Germany's position on weapons deliveries from U.S. Senators and others here on Saturday. The White House is mulling delivering weapons to Ukraine to support the country's fight against pro-Russia separatists in the country's east.
- *GABRIEL SAYS GERMAN SPD WOULD NEVER BACK ARMS TO UKRAINE
- *EUROPE SEES U.S. ARMS DELIVERIES TO UKRAINE AS BAD IDEA: LAVROV
"Perhaps we are so insistent because we know the region a bit," Mr. Steinmeier said.
Secretary of State John Kerry on Sunday denied any divisions between the U.S. and Europe over how to handle Russia, as Germany announced another high-level summit aimed at stemming the crisis in Ukraine.But perhaps most significantly is France's continued apparent pivot towards Russia... Following Francois Hollande's calls for greater autonomy for Eastern Ukraine, former French President Nicolas Sarkozy has come out in apparent support of Russia (and specifically against the US).
Kerry told a security conference in Munich that he wanted to "assure everybody there is no division, there is no split" between Washington and its European allies amid the crisis in Ukraine.
"We are united, we are working closely together," he told the conference following meetings with his French and German counterparts. "We all agree that this challenge will not end through military force. We are united in our diplomacy."
“We are part of a common civilization with Russia,” said Sarkozy, speaking on Saturday at the congress of the Union for a Popular Movement Party (UMP), which the former president heads.And then Cyprus joins the fracture party, offering to sign a military cooperation agreement on Feb 25th offering Russia the use of military facilities on its soil...
“The interests of the Americans with the Russians are not the interests of Europe and Russia,” he said adding that “we do not want the revival of a Cold War between Europe and Russia.”
“Crimea has chosen Russia, and we cannot blame it [for doing so],” he said pointing out that “we must find the means to create a peacekeeping force to protect Russian speakers in Ukraine.”
The air force base at which Russian planes will use is about 40 kilometers from Britain's sovereign Air Force base at Akrotiri, on the south shores of Cyprus, which provides support to NATO operations in the Middle and Near East regionsEven NATO appears to know the "peace deal" is not coming...
- STOLTENBERG: 'IMPOSSIBLE TO SAY' IF MINSK PRODUCES CEASE-FIRE
- *GERMANY'S GABRIEL `CAUTIOUSLY OPTIMISTIC' ABOUT MINSK SUMMIT
- *PUTIN MUST TAKE EU'S `OUTSTRETCHED HAND,' GABRIEL SAYS
- *EU SEEKS POST-CRISIS PARTNERSHIP RENEWAL WITH RUSSIA: GABRIEL
- *RUSSIA SAYS FEB. 9-10 UKRAINE MEETINGS TO PREPARE MINSK SUMMIT
Talks in Moscow - a two-part analysis
Part one (On 6th February 2015)
They have apparently continued for 5 hours and are still not finished though it seems some sort of document is being prepared for tomorrow.
Three comments:
1. If negotiations go on for 5 hours that does not suggest a smooth and conflict free discussion.
2. One of the most interesting things about the Moscow talks is that they mainly happened without the presence of aides and officials i.e. Putin, Hollande and Merkel were by themselves save for interpreters and stenographers. Putin and Merkel are known to be masters of detail and given his background as an enarque I presume Hollande also is. However the German and French officials will be very unhappy about this. The Russians less so because since the meeting is taking place in the Kremlin they are listening in to the discussions via hidden microphones.
One wonders why this is happening? Even if the Russian officials are not listening in Merkel and Hollande will assume they are. The fact that Russian officials were not present is therefore less significant than that German and French officials have been barred from the meeting by their respective chiefs, suggesting that Merkel and Hollande do not entirely trust them.
There has been an extraordinary degree of secrecy about this whole episode and it rather looks as if Merkel and Hollande were anxious to stop leaks and to prevent information about the talks from getting out. Presumably this is why their officials were barred from the meeting. From whom one wonders do Merkel and Hollande want to keep details of the meeting secret? From the media? From other members of their own governments? From the Americans? What do they need to keep so secret? The frustration and worry on the part of all these groups must be intense.
3. The fact that the British are excluded from the talks is going down very badly with many people here in London. It has not escaped people's notice that this is the first major negotiation to settle a big crisis in Europe in which Britain is not involved since the one that ended the Franco-Prussian War in 1870. Of course it is largely the fault of the inept diplomacy of Cameron, who has taken such an extreme pro-Ukrainian position that Moscow simply doesn't see him as someone worth talking to. Also one suspects Merkel and Hollande do not trust Cameron not to leak the whole discussion to whomever they want to keep it from. Having said that it is difficult to see this as anything other than further evidence of Britain's decline into complete irrelevance. I cannot imagine Thatcher being excluded in this way. If the United Kingdom is indeed in the process of breaking up (and as I suspected the Scottish referendum settled nothing with polls indicating that the SNP may make an almost clean sweep of all the seats in Scotland in the election in May) then the slide into irrelevance still has a long way to go.
Part two (On 7th February 2015)
I am coming increasingly round to the view of Alastair Newman that Merkel and Hollande came with no plan to Moscow but with the purpose of having what diplomats call "a full and frank discussion" in private with Putin looking at all the issues in the one place in Europe - the Kremlin - where they can be confident the Americans are not spying on them. That must be why they sent their officials away.
It is also clear that Merkel's and Hollande's visit to Kiev before their flight to Moscow was just for show.
Poroshenko's officials are insisting that the question of federalisation was not discussed during Poroshenko's meeting with Hollande and Merkel. Hollande has however now come out publicly to support "autonomy" for the eastern regions i.e. federalisation, which makes it a virtual certainty that in the meeting in Moscow it was discussed. The point is that Merkel and Hollande did not want to discuss federalisation with Poroshenko because they know the junta adamantly opposes the idea and did not want him to veto it before the meeting in Moscow had even begun.
The problem is that since everyone pretends that federalisation is an internal Ukrainian issue to be agreed freely between the two Ukrainian sides, its terms will only be thrashed out once constitutional negotiations between the two Ukrainian sides begin. Since the junta will never willingly agree to federalisation, in reality its form will have to be hammered out in private by Moscow after consultations with the NAF and with Berlin and Paris and then imposed on the junta in the negotiations.
Saying this shows how fraught with difficulty this whole process is going to be.
Not only are there plenty of people in the Donbass who now oppose federalisation (and some in Moscow too I suspect) but this whole process if it is to work would somehow have to get round the roadblock of the Washington hardliners, who will undoubtedly give their full support to the junta as it tries to obstruct a process over which it has a theoretical veto. Frankly, I wonder whether it can be done.
If the process is to have any chance of success then Merkel and Hollande must screw up the courage to do what they failed to do last spring and summer, which is publicly stand up to the hardliners in Washington and Kiev and impose their will upon them. Are they really willing to do that? Given how entrenched attitudes have become over the last few months and given the false position Merkel and Hollande put themselves in by so strongly supporting Kiev, the chances of them pulling this off look much weaker than they did last spring.
I would add a few more points;
1. There is one major difference between the situation now and in the Spring, which might offer some hope of movement.
Anyone reading the Western media now cannot fail but see that there is a growing sense of defeat. Sanctions have failed to work, the Ukrainian economy is disintegrating and the junta's military is being defeated.
That was not the case last spring, when many in the West had convinced themselves that the junta would win the military struggle with the NAF. The confrontation strategy Merkel opted for in July based on that belief has totally and visibly failed. It is not therefore surprising if she is now looking for a way-out by reviving some of the ideas that were being floated by the Russians in the spring. She now has a political imperative to look for a solution in order to avoid the appearance of defeat, which would leave her position both in Germany and Europe badly weakened. That political imperative was not there in the spring. It is now. In a sense the pressure is now on her.
2. I should stress that it is Merkel who is Putin's key interlocutor. The reason Hollande is there and appears to be taking the lead is to provide Merkel with cover. The one thing Merkel cannot afford politically is the appearance of a Moscow-Berlin stitch-up that the hardliners in Washington, Kiev, London, Warsaw and the Baltic States will claim is a new Molotov-Ribbentrop Pact to divide Europe into German and Russian spheres of influence. Whether we like it or not in Germany the shadow of Hitler still hangs heavy and exposes Berlin to endless moral blackmail whenever it tries to pursue with Moscow an independent course. That is why Merkel needs Hollande present when she meets Putin for talks of the sort she's just had in Moscow.
3. One other possible sign of hope is that there is some evidence that a sea-change in European and especially German opinion may be underway.
Whatever the purpose of the ongoing debate in Washington about sending weapons to the junta, whether it is a serious proposal or an attempt to secure diplomatic leverage or a combination of the two, it has horrified opinion in Europe, bringing home to many people there how fundamentally nihilistic US policy has become.
All the talk in the Western media yesterday and this morning is of a split between Europe and the US. That is going much too far. However for the first time there is public disagreement in Europe with Washington on the Ukrainian question. Whether that crystallises into an actual break with Washington leading to a serious and sustained European attempt to reach a diplomatic solution to the Ukrainian crisis against Washington's wishes is an altogether different question. I have to say that for the moment I very much doubt it.
4. I remain deeply pessimistic about this whole process. The best opportunity to settle this conflict diplomatically was last spring. I cannot help but feel that as Peter Lavelle said on the Crosstalk in which I appeared yesterday, the train has now left the station.
A peaceful solution to the Ukrainian conflict ultimately depends on European resolve to face down the hardliners in Washington and Kiev. It is going to be much harder to do this now than it was last year.
Moreover, despite the bad news on the economy and on the front line in Debaltsevo, the hardliners in Kiev are bound to have been emboldened by all the talk in Washington about sending them arms, which is going to make the effort to bring them round even harder than it already is.
The besetting problem of this whole crisis is that the Europeans have never shown either the resolve or the realism to face the hardliners down though it is certainly within their power to do so. In Merkel's case one has to wonder whether her heart is in it anyway. My view remains that this situation will only be resolved by war, and that the negotiations in Moscow will prove just another footnote to that.
5. If I am wrong and some autonomy really is granted to the Donbass, then I make one confident prediction. This is that the Ukraine will in that case disintegrate even more rapidly than it would have done if federalisation had been agreed upon last spring or summer.
Following such a terrible war, I cannot see people in the Donbass accepting federalisation as anything other than a stepping stone to eventual secession and union with Russia. If the Donbass secures autonomy, I cannot see people in places like Odessa and Kharkov failing to press for an at least equivalent degree of autonomy to that granted to the Donbass. If the Europeans are prepared to see the Donbass achieve autonomy, by what logic can they deny it to the people of Odessa and Kharkov?
More to the point, the November elections showed the emergence of what looks like an increasingly strong potential autonomy or even independence movement in Galicia.
Given that a terrible war has been fought and lost in the east to defeat "separatism" in the Donbass, and given the widespread disillusion with the junta in Kiev, it is difficult to see how many people in Galicia will not feel betrayed if the grant of federalisation to the Donbass is now imposed on them after so many of their men died to prevent it. If in reaction Galicia presses for the same sort of autonomy as the Donbass - which it could well do - then the Ukraine is finished. I doubt it would hold together for more than a few months. If federalisation had been granted last spring or summer before the war began then it is possible - likely even - that the Ukraine could have been held together in a sort of state of suspended animation at least for a while. I don't think there's much chance of that now.
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If Greece Exits, Here Is What Happens (Redux)
Now that the possibility of a Greek exit from the euro is back to being topic #1 of discussion, just as it was back in the summer of 2012 and the fall of 2011, and investors are propagandized by groundless speculation posited by journalists who have never used excel in their lives and are merely paid mouthpieces of bigger bank interests, it is time to rewind to a step by step analysis of precisely what will happen in the moments before Greece announces the EMU exit, how the transition from pre- to post- occurs, and the aftermath of what said transition would entail, courtesy of one of the smarter minds out there at the time (before his transition to a more status quo supportive tone), Citi's Willem Buiter, who pontificated precisely on this topic previously. Three words: "not unequivocally good."
From Willem Buiter (2012)
What happens when Greece exits from the euro area?
Were Greece to be forced out of the euro area (say by the ECB refusing to continue lending to Greek banks through the regular channels at the Eurosystem and stopping Greece’s access to enhanced credit support (ELA) at the Greek central bank), there would be no reason for Greece not to repudiate completely all sovereign debt held by the private sector and by the ECB. Domestic political pressures might even drive the government of the day to repudiate the loans it had received from the Greek Loan Facility and from the EFSF, despite it having been issued under English law. Only the IMF would be likely to continue to be exempt from a default on its exposure, because a newly ex-euro area Greece would need all the friends it could get – outside the EU. In the case of a confrontation-driven Greek exit from the euro area, we would therefore expect to see around a 90 percent NPV cut in its sovereign debt, with 100 percent NPV losses on all debt issued under Greek law, including the debt held, directly or directly, by the ECB/Eurosystem. We would also expect 100 percent NPV losses on the loans by the Greek Loan Facility and the EFSF to the Greek sovereign.
Consequences for Greece
Costs of EA exit for Greece are very high, most notably the damage done to balance sheets of Greek banks and nonfinancial corporates in anticipation of EA exit.Monetising the deficit
We have recently discussed at length what we think would happen should Greece leave the euro area (Buiter and Rahbari (2011)), so we shall be brief here. Note that we assume that Greece exits the euro area and does not engage in the technical fudge discussed in Buiter and Rahbari (2011), under which it technically stays in the euro area but introduces a second, parallel or complementary currency.
The instant before Greece exits it (somehow) introduces a new currency (the New Drachma or ND, say). Assume for simplicity that at the moment of its introduction the exchange rate between the ND and the euro is 1 for 1. This currency then immediately depreciates sharply vis-à-vis the euro (by 40 percent seems a reasonable point estimate). All pre-existing financial instruments and contracts under Greek law are redenominated into ND at the 1 for 1 exchange rate.
What this means is that, as soon as the possibility of a Greek exit becomes known, there will be a bank run in Greece and denial of further funding to any and all entities, private or public, through instruments and contracts under Greek law. Holders of existing euro-denominated contracts under Greek law want to avoid their conversion into ND and the subsequent sharp depreciation of the ND. The Greek banking system would be destroyed even before Greece had left the euro area.
There would remain many contracts and financial instruments involving Greek private and public entities denominated in euro (or other currencies, like the US dollar) that are not under Greek law. These would not get redenominated into ND. With part of their balance sheet redenominated into ND which would depreciate sharply and the rest remaining denominated in euro and other currencies, any portfolio mismatch would cause disruptive capital gains and losses for what’s left of the Greek banking system, Greek non-bank financial institutions and any private or public entity with a (now) mismatched balance sheet. Widespread defaults seem certain.
As discussed in Buiter and Rahbari (2011), we believe that the improvement in Greek competitiveness that would result from the introduction of the ND and its sharp depreciation vis-à-vis the euro would be short-lived in the absence of meaningful further structural reform of labour markets, product markets and the public sector. Higher domestic Greek ND-denominated wage inflation and other domestic cost inflation would swiftly restore the old uncompetitive real equilibrium or a worse one, given the diminution of pressures for structural reform resulting from euro area exit.
In our view, the bottom line for Greece from an exit is therefore a financial collapse and an even deeper recession than the country is already experiencing - probably a depression.
A key difference between the ‘Greece stays in’ and the ‘Greece exits’ scenarios is that we believe/assume that if Greece remains a member of the euro area, there would be official funding for the Greek sovereign (from the Greek Loan Facility, the EFSF and the IMF), even after the inevitable deep coercive Greek sovereign debt restructuring, and even if NPV losses were imposed on the official creditors – the Greek Loan Facility, the EFSF and the ECB. The ECB probably would no longer engage in outright purchases of Greek sovereign debt through the SMP, but the EFSF would be able to take over that role following the enhancement and enlargement of the EFSF later in 2011.4 If Greece remains a member of the euro area, the ECB would likewise, in our view, continue to fund Greek banks (which would have to be recapitalised following the Greek sovereign debt restructuring), both through the regular liquidity facilities of the Eurosystem and through the ELA.Consequences for the remaining euro area and EU member states of a Greek exit
In the case of a (confrontational and bitter) departure of Greece from the euro area, it is likely that all official funding would vanish, at least for a while, even from the IMF (which would, under our most likely scenario, not have suffered any losses on its loans to the Greek sovereign). The ECB/Eurosystem would, of course, following a Greek exit, cease funding the Greek banks.
This means that the Greek sovereign would either have to close its budget gap through additional fiscal austerity, following its departure from the euro area, or find other means to finance it. The gap would be the primary (non-interest) general government deficit plus the interest due on the debt the Greek sovereign would continue to serve (the debt issued under foreign law other than the loans from the Greek Loan Facility and the EFSF, and the debt to the IMF), plus any refinancing of this remaining sovereign debt as it matured. We expect the Greek General Government deficit, including interest, to come out at around 10 percent of GDP for 2011, while the programme target is 7.6 percent. General government interest as a share of GDP is likely to be around 7.2 percent of GDP in 2011, which means that we expect the primary General Government deficit to be around 2.8 percent of GDP. We don’t know the interest bill in 2011 for the IMF loan and for the outstanding privately held debt issued under foreign law. If we assume that these account for 10 percent of the total interest bill on the general government debt – probably an overestimate as interest rates on the IMF loan are lower than on the rest of Troika funding – then we would have to add 0.72 percent to the primary deficit as a percentage of GDP to obtain an estimate of the budget deficit that would have to be funded by the Greek government, say 3.5 percent of GDP. We would have to add to that any maturing IMF loans and any maturing privately held sovereign debt not under Greek law. This is on the assumption that even those creditors under international law that continue to get serviced in full, would prefer not to renew their exposure to the Greek sovereign once they have been repaid. In addition, future disbursements by the IMF under the first Greek programme would be at risk following a Greek exit. This would create a further funding gap.
Assume the Greek authorities end up (very optimistically) having to find a further 5 percent of GDP worth of financing. This could be done by borrowing or by monetary financing. Borrowing in ND-denominated debt would likely be very costly. Nominal interest rates would be high because of high anticipated inflation – inflation that would indeed be likely to materialise. Real interest rates would also be high.
Although the Greek sovereign’s ability to service newly issued debt would be greatly enhanced following its repudiation of most of its outstanding debt, the default would raise doubts about its future willingness to service its debt. Default risk premia and liquidity premia (the market for ND-denominated Greek debt would be thin) would raise the cost of borrowing in ND-denominated debt. Even if the Greek authorities were to borrow under foreign law by issuing debt denominated in US dollars or euro, default risk premia and liquidity premia would likely be prohibitive for at least the first few quarters following the kind of confrontational or non-consensual debt default we would expect if Greece were pushed out of the euro area.
So the authorities might have to finance at least 5 percent worth of GDP through issuance of ND base money, under circumstances where the markets would inevitably expect a high rate of inflation. The demand for real ND base money would be very limited. The country would likely remain de-facto euroised to a significant extent, with euro notes constituting an attractive store of value and means of payment even for domestic transactions relative to New Drachma notes. We have few observations on post-currency union exit base money demand to tell us whether a 5 percent of GDP expected inflation tax could be extracted at all by the issuance of ND – that is, at any rate of inflation. If it is feasible at all, it would probably involve a very high rate of inflation. It is possible that we would end up with hyperinflation.
The obvious alternative to monetisation is a further tightening in the primary deficit through additional fiscal austerity (of something under 5 percent of GDP), allowing for some non-inflationary issuance of base money. Because Greek exit would be in part the result of austerity fatigue in Greece, this outcome does not seem likely.
A collapsed banking system, widespread default throughout the economy, a continuing non-competitive economy and high inflation with a material risk of hyperinflation would make for a deep and enduring recession/depression in Greece. Social and political dislocation would be certain. There would, in our view, be a material risk of a downward spiral of dysfunctional politics and economics.
For the world outside Greece, and especially for the remaining euro area member states following a Greek exit, the key insight would be that a taboo was broken with a euro area exit by Greece. The irrevocably fixed conversion rates at which the old Drachma was joined to the euro in 2001 would, de facto, have been revoked. The permanent currency union would have been revealed to be a snowball on a hot stove.***
Not only would Greek official credibility be shot, the same thing would happen for the rest of the EA member states in our view. First, monetary union is a two-sided binding commitment. Both sides renege if the accord is broken. Second, Greece would only exit from the euro area if it was driven out by the rest of the euro area member states, with the active cooperation of the ECB. Even though it would be Greece that cuts the umbilical cord, it would be clear for all the world to see that it was the remaining euro area member states and the ECB that forced them to wield the scalpel.
It does not help to say that Greece ought never to have been admitted to the euro area because the authorities during the years leading up to Greek membership in 2001, knowingly falsified the fiscal data to meet the Maastricht criteria for EMU admission, and continued doing so for long afterwards.6 After all, what Greece did was just an exaggerated version of the deliberate data manipulation, distortion and misrepresentation that allowed the vast majority of the euro area member states to join the EMU, including quite a few from what is now called the core euro area7. The preventive arm of the euro area, the Stability and Growth Pact (SGP) which, if it had been enforced would have prevented the Greek situation from arising, was emasculated by Germany and France in 2004, when these two countries were about to be at the receiving end of its enforcement.
Euro area membership is a two-sided commitment. If Greece fails to keep that commitment and exits, the remaining members also and equally fail to keep their commitment. This is not just a morality tale. It has highly practical implications. When Greece can exit, any country can exit. If we look at the austerity fatigue and resistance to structural reform in the rest of the periphery and in quite a few core euro area countries, it is not plausible to argue that the Greek case is completely unique and that its exit creates no precedent. Despite the fact that both Greece’s fiscal situation and its structural, supply-side economic problems are by some margin the most severe in the euro area, Greece’s exit would create a powerful and highly visible precedent.
As soon as Greece has exited, we expect the markets will focus on the country or countries most likely to exit next from the euro area. Any non-captive/financially sophisticated owner of a deposit account in that country (or in those countries) will withdraw his deposits from banks in countries deemed at risk - even a small risk - of exit. Any non-captive depositor who fears a non-zero risk of the future introduction of a New Escudo, a New Punt, a New Peseta or a New Lira (to name but the most obvious candidates) would withdraw his deposits from the countries involved at the drop of a hat and deposit them in the handful of countries likely to remain in the euro area no matter what - Germany, Luxembourg, the Netherlands, Austria and Finland. The ‘broad periphery’ and ‘soft core’ countries deemed at any risk of exit could of course start issuing deposits under English or New York law in an attempt to stop a deposit run, but even that might not be sufficient. Who wants to have their deposit tied up in litigation for months or years?
Apart from bank runs in every country deemed, by markets and investors, to be even remotely at risk of exit from the euro area, there would be de facto funding strikes by external investors and lenders for borrowers from these countries. Again, putting under foreign law (most likely English or New York) all cross-border (or perhaps even all domestic) financial contracts and instruments could at most mitigate this but would not cure it.
The funding strike and deposit run out of the periphery euro area member states (defined very broadly), would create financial havoc and mostly like cause a financial crisis followed by a deep recession in the euro area broad periphery. The counterparty inflow of deposits and diversion of funding to the ‘hard core’ euro area and the removal (or at least substantial reduction) of the risk of ECB monetisation of EA sovereign and bank debt would drive up the euro exchange rate. So the remaining euro area members would suffer (at least temporarily) from an uncompetitive exchange rate as well from the spillovers of the financial and economic crises in the broad periphery.
As noted by the new IMF Managing Director, Christine Lagarde (Lagarde (2011) and confirmed by Josef Ackerman (Ackermann (2011, p.14)), the European banking sector is seriously undercapitalised. It would not be well-positioned, in our view, to cope with the spillovers and contagion caused by a Greek exit and the fear of further exits. Ms Lagarde was arm-twisted by the EU political leadership, the ECB and the European regulators into a partial retraction of her EU banking sector capital inadequacy alarm call.10 However, this only served to draw attention to the obvious truth that despite the three bank stress tests in the EU since October 2009 and despite the capital raising that has gone on since then both to address any weaknesses revealed by these tests and to anticipate the Basel III capital requirements, the EU banking sector as a whole remains significantly undercapitalised even if sovereign debt is carried at face value. In addition, the warning by Ackermann that “… many European banks would not be able to handle writing down the sovereign bonds they hold on their banking books to market levels…” (Ackermann (2011), see also IMF (2011, pp. 12 -20)) serves as a reminder of the fact that Europe is faced with a combined sovereign debt crisis in the euro area periphery and a potential banking sector insolvency crisis throughout the EU.
A banking crisis in the euro area and in the EU would most likely result from an exit by Greece from the euro area. The fundamental financial and real economy linkages from the rest of the world to the euro area and the rest of the EU are strong enough to make this a global concern.
Ok, now we get it... all the worst bits of the bible...
But, of course, we will be told how it's all so different now just 3 years on. How it will be "contained" and managable... so rest assured and listen to Jean-Claude Juncker.
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