Keeping Greece on the Bus

For all the doomsayers predicting an imminent ‘Grexit’ from the Eurozone, the latest EU deal to ease their debt burden to 124% of GDP by 2020 should surely give pause for thought… at least on timing, if not necessarily on the eventuality.

In observing the interminable crisis response efforts of Europe’s leaders, it is easy to confuse a lack of haste for a lack of resolve or a lack of understanding.

Certainly, the process may be frustratingly slow. This is particularly the case for financial markets with ADD and journalists with deadlines and a need for a simple narrative.

Quite clearly – and quite rightly – European leaders are not marching to the tune of bond traders (despite appearances to the contrary!), newspaper editors or economics professors with textbook answers. While economics may be a driving force, the Eurozone crisis is a political problem that requires a political solution.

As Chancellor Merkel would have learned from Bismarck – and as any politico-statesman worth their salt knows implicitly – politics is the art of the possible. In a democracy, this sometimes means, for better or for worse, that the economy becomes hostage to the electoral cycle.

The go-slow in solving the Eurozone crisis is not simply a function, however, of presidential elections in France, local elections in Finland, Bundestag elections in Germany or even riots in Greece.

What we learn in Macroeconomics or Corporate Finance 101 has to be reconciled with the European Union’s remarkably robust institutional set-up, high-level political resolve to holding the Union together at all costs, divergent interests and contrasting public opinions along the debtor-creditor axis  … not to mention, of course, the base instincts of politicians seeking re-election. This defines the parameters of what is possible, irrespective of what is preferable or what economics textbooks may dictate.

It’s not that Europe’s political elite don’t understand arithmetic or that they couldn’t see that Greek debt had become unsustainable. They may not admit it publicly, but the more astute will realize full well that the latest Greek deal simply buys more time to put together a comprehensive Euro-fix that reconciles divergent interests and broadly satisfies enlightened public opinion. Does anybody really believe that Greek sovereign debt will be 124% by 2020, or that the deal will not have to be re-opened long before then? Probably not.

What the latest deal does do is keep Greece on the bus for the immediate future and – importantly – lays down incentives for them to continue doing what is necessary to stay on the bus going forward. This satisfies German (and other creditors’) concerns about moral hazard: that writing down Greek debt now reduces pressure for future reform and budget consolidation. Debt relief will be staggered, dependent on Greece continuing to meet certain targets: notably hitting a primary surplus (i.e. before debt servicing costs are included) of 4.55% of GDP by 2016.

Of course, once a country has a primary surplus, their bargaining position is immeasurably stronger. Being able to finance day-to-day budget spending through tax revenues means that strategic default becomes a credible threat (NB: Greece is targeting a full-year primary surplus of 0.4% for 2013. Ireland is expected to be in primary surplus by 2014, i.e. after two more harsh budgets).

If a country does not need recourse to the bond market to finance budget deficits, but only to meet its obligations to the bond market itself… there is a shift in the balance of power. Of course, everybody playing the game knows this, which is why those with leverage continue to drive a hard bargain now in the hope that they can secure as much sacrifice and reform from Greece before the boot is on the other foot.

This does not mean that Greece will automatically default come 2013. The cost to the borrower of walking away from its debts is dramatically reduced once it is running a primary surplus, but that does not make default cost-free. Default may or may not inevitably lead to Greece’s exit from monetary union, but the cost-benefit calculus of default and ‘Grexit’ is something the Greeks will continue to evaluate.

The latest Greek deal is not a final solution, but a step in the right direction. Sure, the can is being kicked down the road – to use that well-worn cliché – but this time it’s been a good firm kick into the middle distance. It may be extend-and-pretend writ large but it is probably much as is politically possible at this point. Soon, however, the balance of power will shift from creditor to debtor.

Leave a Reply

Fill in your details below or click an icon to log in: Logo

You are commenting using your account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s