16 February 2015

Time for Greece to take the olive branches

The Eurogroup meeting today is likely to be a crucial stage in the run–up to the expiration of Greece’s programme at the end of February. Recent rhetoric suggests Greece wants to arrive at an agreement - but on Greek terms. Some commentators liken this to a game of chicken to see who gives way driving along the middle of the road, who blinks first etc. However, the balance of forces is actually rather different.

The right analogy is a game of chicken between a Fiat 500 and a 50-ton `main battle tank’ - the relative weights are roughly comparable to the economic weights. The drivers of the Fiat may be concerned that they will run out of fuel even if they get past the tank. But they should discover soon – perhaps even this week – that the designers of the tank hard-wired in a very big bazooka and have pre-programmed it with an automatic firing sequence that the current crew members cannot change easily or quickly.

Greece is not without attractive bargaining chips such as improved relations with Turkey and thus solutions to the problems of Cyprus; genuinely tackling the problem of tax payments in Greece. Both should warrant support – especially from the whole of the European Union for improved relations with Turkey. In return, the [EFSF/ESM] programme could be enlarged to buy out the ECB’s Greek bond holdings and then apply the same generous 10-year grace period on interest and capital that has been given to the EFSF’s existing loans. 

TINA – There is no alternative

The phrase “TINA” was immortalised by UK Prime Minister Thatcher in the early 1980’s as part of her uncompromising advocacy of market economics. After an uncomfortably long period of great social turmoil, the UK experienced a productivity boom (for the UK) of about 3% annually. Correspondingly, GDP grew for several years at rates averaging nearly 4%. For Greece (and the other programme countries), the downswing seems to be drawing to a close and a period of rapid growth is at hand – unless disrupted by an unnecessary crisis.  

The Big Bazooka

The risk of the Greek Government running out of cash within a few months is well-known. But `the bazooka’ is pre-programmed to fire two rounds in the fullness of time – of which the first is likely to be decisive:

• Round 1: The solvency of the Greek banking system may come into question very quickly if the current `run’ accelerates. The main Greek banks reported very high capital positions at the ECB’s Asset Quality Review (AQR) so the immediate risk is one of liquidity, but inevitably that would morph into capital adequacy problems if this political drama triggered a new downturn in the economy and thus higher loan losses. The supervisor of the four largest Greek banks is the Single Supervisory Mechanism (SSM) of the ECB. It may soon undergo a baptism of fire.

This new drama may also illustrate that Banking Union really was a major extension of Political Union. `Europe’ is the direct supervisor so will have intimate knowledge of the banks’ liquidity condition and solvency. The ECB can only lend to `solvent banks’ – as reported by its independent arm, the SSM. If the situation deteriorates, then Europe’s new Single Resolution Authority (SRA) would have to put the relevant banks into resolution. What will be the attitude of non-EU supervisors of branches/subsidiaries e.g. in the US? The crew of the `main battle tank’ will be unable to interfere in the decisions of the independent ECB and its supervisory arms. If the bazooka automatically fires this first round, a liquidation of any major Greek bank may create the classic domino effect – leaving banknotes as the only effective means of payment. 

• Round 2: In the months ahead, the euro area will have to pass judgement on Greece’s compliance with both the Stability and Growth Pact (SGP) and the Fiscal Compact if Greek policy moves towards breaches of these. The outcome of a fierce debate (as a direct result of Greece’s flouting of the rules in 2010) was to introduce a regime of sanctions so that “a fine, as a rule, be required” for breaches. The fines could run up to €4 billion annually. Moreover, the argument might be re-opened that a state in flagrant breach of its Treaty commitments should not be eligible for transfer payments from the EU and disbursements from the EIB. For the euro area to back down on these issues would be to dismember the economic governance processes created in recent years. Would the pressure arise to exclude Greek votes in non-economic areas? That would be tantamount to Greece being excluded from the EU itself. The near automatic application of these rules may be very difficult to stop as any Commission recommendation can only be over-turned by a reverse Qualified Majority Vote.  If the Commission fails to propose proper application of the Treaty-specified rules, then it will be perceived to have failed in its first duty as custodian of the Treaties.

The drivers of the Fiat 500 need to consider their tactics very carefully as the votes of 10 million cannot bind the other 400 million in the euro area – especially if it amounts to a challenge to the entire political construction of the euro area. In the end, a de facto Greek exit from the European Union itself may become the more likely result.

© Graham Bishop