"The creation of the euro was a terrible mistake but breaking it up would be an even bigger mistake. Anything could happen," warns former IMF bail-out chief
By Ambrose Evans-Pritchard, International Business Editor
1:00PM GMT 31 Jan 2015
Berlin has warned of "fatal consequences" if Greece reneges on its bailout conditions Photo: Reuters
The North European power structure has issued stern and inflexible warnings to Greece. Syriza’s triumphant radicals must pay the country’s debts and stick to the letter of the hated `Memorandum’ imposed by creditors.
If premier Alexis Tsipras breaches the terms of Greece’s EU-IMF Troika bail-out – signed by earlier leaders under duress, and deemed unjust in Athens – Europe will cut off €54bn of support for the Greek banking system and force the country out of the euro in short order. Europe must not yield to “blackmail,” said Germany’s ZEW institute.
Wolfgang Schäuble, Germany’s finance minister, said the new Syriza government is bound by the contractual terms of Greece’s €245bn loan package from the Troika. “Elections change nothing. There are rules. We did whatever could be done to support Greece in difficult times, again and again," he said.
When the crisis first erupted in 2010, and re-erupted in 2012, Europe lacked a firewall. The conflagration threatened to spread instantly from Greece to Portugal, Ireland, and beyond.
This time Mr Schäuble thinks they are ready. “We face no risk of contagion, so nobody should think we can be put under pressure easily. We are relaxed,” he said.
In Frankfurt, the Bundesbank’s Joachim Nagel warned that there will be “fatal consequences” if Greece violates the terms of the rescue deal.
His words were echoed by the European Central Bank’s Benoît Cœuré, ubiquitous on the airways with hot admonitions. "Mr Tsipras must pay, those are the rules of the game, there is no room for unilateral behaviour in Europe,” he said.
The riposte from Athens has been tart. Greece will not have any further dealings with the Troika and will not ask for an extension of its bail-out at the end of February. “We will not accept the self-reinforcing crisis of deflation and debt,” said the new finance minister, Yanis Varoufakis.
Varoufakis: Troika are a "rottenly constructured commitee"
The creditors are treating the unfolding drama as if it were a local Balkan affair. If a country of eleven million chooses to commit economic suicide, it is free to do so. The broader consequences will be no greater than the fall-out from Argentina’s default in 2001. That is the message from Berlin.
Brussels is for now sticking to the tough line. “We expect them to fulfil everything that they have promised to fulfil,” said Jyrki Katainen, the EU’s economic enforcer.
Experts are deeply divided about the wisdom of this strategy, and the implications of Grexit.
Professor Luis Garicano from the London School of Economics says it is Syriza that has misjudged badly, both by teaming up in coalition with a virulently anti-German party, and by violating Troika terms across the board – halting privatisation, raising the minimum wage to €750 a month, re-hiring 10,000 civil servants, and blocking mortgage foreclosures.
“Tsipras is slapping the Germans in the face: it is almost as if he wishes to be thrown out of Europe. I can’t see any political support for Syriza from any government in southern Europe. They are all terrified of their own populist movements,” he says.
Prof Garicano thinks the eurozone can now withstand contagion from Grexit. The economy is on the mend. The ECB’s quantitative easing has covered the currency bloc in a protective blanket. By ejecting Greece – he argues - Chancellor Angela Merkel gains “political cover” to relax austerity and reward those countries that play by the rules. It is a net plus for Europe. “Sometimes you just have to drop off some baggage and move on,” he said.
The bond markets seem to agree. There has been no flicker of contagion to Italy and Spain, or even to Portugal, the country deemed most at risk.
SEE CHART
Yields on Portugal’s 10-year bonds have settled near record lows of 2.55pc, so low that the country is repaying loans to the International Monetary Fund to cut interest costs.
“This is nothing like 2012,” said David Owen from Jefferies. “We have the huge difference of open-ended QE. If there is contagion, the ECB will just buy the paper.
”
Yet there are darker signals in other markets. Paddy Power is offering 6/4 odds on Grexit by 2016, rising to 3/1 for Spain, 4/1 for Portugal, and 13/2 to two for Italy, a ranking that reflects politics as much as finance.
It is politics that now matter. EU veterans warn that any mishandling of the Greek drama could escalate into an existential threat to the European Project itself. They deplore the sabre-rattling in Brussels and Berlin, deeming it petulant, even bordering on idiocy at a time when the political centre is imploding in a string of countries, and not just in the South.
The Dutch Labour Party, the dominant force of Holland’s post-war `Polder’ era, collapsed to 9pc in the EU elections last year. It has immolated itself like so many of Europe’s once-great socialist parties by enforcing what amounts to reactionary 1930s policies in the name of EMU. “The centre-Left has lost all credibility,” said Simon Tilford from the Centre for European Reform.
Spain’s Podemos party – much in evidence at Syriza’s victory party in Athens, and even more mutinously radical – is leading national polls at 27pc. Marine Le Pen’s Front National won the EU elections in France with calls for a return to the franc and a return to sovereign borders. The three biggest opposition parties in Italy are now hostile to the euro. This is not contagion from Greece. It is running in parallel. Yet how it is handled will spill over with emotional force into the internal debates everywhere in Europe.
“Syriza has just won a landslide popular mandate from the Greek people to tell the Troika to go to Hell. It is ludicrous to shout at them and tell them they can’t wriggle out of agreements,” said Giles Merritt, head of the Brussels think-tank Friends of Europe.
Mr Merritt said the Syriza revolt has exposed the political failure of EMU crisis strategy with refreshing clarity. “People in Brussels are losing patience with Germany. The real issue at hand is how we are going to rescue the eurozone from economic depression caused by five years of misguided austerity. Tspiras may find that he has more friends in this city than he thinks,” he said.
“We cannot possibly risk Grexit at this stage and trigger a fresh eurozone crisis, so the Commission will soon waiver. Jyrki Katainen is towing the line for now but he is not a fool. It is Greece that really has the whip hand, and the task is to find a face-saving formula for Germany,” he said.
Prof Ashoka Mody, a former IMF bail-out chief in Europe and now at Princeton University, said hints by ECB members that they may pull the plug on Greek banks are “extremely irresponsible” and beyond the proper authority of these officials.
“They are supposed to be the guardians of financial stability. I have never heard of such outlandish threats before. The EU authorities have no idea what the consequences of Grexit might be, or what unknown tremors might hit the global payments system. They are playing with fire,” he said.
The creation of the euro was a terrible mistake but breaking it up would be an even bigger mistake.
We would be in a world where anything could happen. What they ignore at their peril is the huge political contagion. It would be slower-moving than a financial crisis but the effects on Europe would be devastating. I doubt whether the EU would be able to act in a meaningful way as a union after that” - Ashoka Mody
Marc Ostwald from Monument said Grexit would open a Pandora's Box. “They are all playing down the risk but once you throw Greece out, you are setting a precedent that nobody wanted to set. How could Cyprus stay in the euro given its dependence on Greek banks? As we have just seen with the Swiss franc, once the system buckles the markets will go after the next victim like a plague of locusts,” he said.
The ECB would shield Portugal from immediate Grexit fall-out, but corrosive doubts would be planted. As the Portuguese newspaper Publico wrote in an editorial entitled “Portugal is not Greece, but...”, the country has the same afflictions of crushing debt, low-growth, and lack of competitiveness within EMU.
Combined public and private (non-financial) debt is 380pc of GDP, the highest in Europe, making the country acutely vulnerable to debt-deflation dynamics. Nor is it still viewed as an austerity poster child by Berlin. “The reforms have stalled. Behind the scenes they have put a halt to cuts. It is surprising that people haven’t paid attention to this,” said Raoul Ruparel from Open Europe.
“We are ants; the Greeks are grass-hoppers,” protests Luís Marques Guedes, Portugal’s presidency minister.
But like Aesop’s fable, his own description is allegorical, and unlikely to count for much in a post-Grexit lightning storm.
“Portugal is in our view the one country at risk of contagion,” said Alberto Gallo from RBS. “Its debt is already borderline unsustainable. It has a weak banking system and highly leveraged corporates. Half of listed firms have debt more than five times EBITDA earnings.”
Mr Mody says EMU shock therapy has failed to put monetary union on a viable course. The deficits of the EMU crisis states may have fallen but the mix of perma-slump and “lowflation” - now deflation of minus 0.6pc – have by caused the debt stock to spiral upwards. This is a mathematical effect. The interest costs have been rising faster than nominal GDP. Italy’s public debt has jumped from 116pc to 133pc of GDP in three years despite a primary budget surplus.
SEE CHART
The hysteresis damage from youth unemployment – still 50pc in Spain and 44pc in Italy – has eroded job skills, and therefore reduced future economic growth needed to service the debt.
There has been no fundamental move to fiscal union. This month's compromise deal on QE means each national central bank will be responsible for 80pc of its own debt purchases, entrenching EMU fragmentation. The EU banking union belies its name. It is in fact a supervisory union. Leaders never delivered on their pledge to end the “vicious circle” in which bank crises and sovereign debt crises feed on each other.
“As long as funds for insolvent banks are to come from fiscally-distressed states, the death embrace will continue,” said Mr Varoufakis. He and Mr Tsipras think much of EMU crisis machinery is a Potemkin façade.
Rightly or wrongly, they conclude that Germany’s bluff can therefore be called.
Syriza supporters hold up banner for Germany's Chancellor
“Europe is sleepwalking into a very dangerous situation,” said Hans Redeker from Morgan Stanley.
“Diplomacy is breaking down and we are seeing same sort of emotional behaviour that led to the misjudgements of 1914.”
“The EU always said that the currency union is irrevocable. Once you destroy that faith, the eurozone becomes little more than a fixed-exchange system, an 'ERM3' with currency tail-risk always a nagging doubt. We think the euro would fall to $0.90 to the dollar very fast,” he said.
The stakes are high. Greece is a NATO member on the edges of Europe’s “arc of instability”, a string of conflicts, civil wars, and failed states that stretches from Ukraine, through the Levant to Libya.
Critics say it would be an act of strategic vandalism to push Greece over the abyss into this maelstrom.
“To believe that you can talk about Grexit and then contain the after-effects, takes a degree of unprecedented silliness,” said Mr Varoufakis.
Yet that is exactly where this spectacular game of chicken going to until one side or the other blinks.
In Frankfurt, the Bundesbank’s Joachim Nagel warned that there will be “fatal consequences” if Greece violates the terms of the rescue deal.
His words were echoed by the European Central Bank’s Benoît Cœuré, ubiquitous on the airways with hot admonitions. "Mr Tsipras must pay, those are the rules of the game, there is no room for unilateral behaviour in Europe,” he said.
The riposte from Athens has been tart. Greece will not have any further dealings with the Troika and will not ask for an extension of its bail-out at the end of February. “We will not accept the self-reinforcing crisis of deflation and debt,” said the new finance minister, Yanis Varoufakis.
Varoufakis: Troika are a "rottenly constructured commitee"
The creditors are treating the unfolding drama as if it were a local Balkan affair. If a country of eleven million chooses to commit economic suicide, it is free to do so. The broader consequences will be no greater than the fall-out from Argentina’s default in 2001. That is the message from Berlin.
Brussels is for now sticking to the tough line. “We expect them to fulfil everything that they have promised to fulfil,” said Jyrki Katainen, the EU’s economic enforcer.
Experts are deeply divided about the wisdom of this strategy, and the implications of Grexit.
Professor Luis Garicano from the London School of Economics says it is Syriza that has misjudged badly, both by teaming up in coalition with a virulently anti-German party, and by violating Troika terms across the board – halting privatisation, raising the minimum wage to €750 a month, re-hiring 10,000 civil servants, and blocking mortgage foreclosures.
“Tsipras is slapping the Germans in the face: it is almost as if he wishes to be thrown out of Europe. I can’t see any political support for Syriza from any government in southern Europe. They are all terrified of their own populist movements,” he says.
Prof Garicano thinks the eurozone can now withstand contagion from Grexit. The economy is on the mend. The ECB’s quantitative easing has covered the currency bloc in a protective blanket. By ejecting Greece – he argues - Chancellor Angela Merkel gains “political cover” to relax austerity and reward those countries that play by the rules. It is a net plus for Europe. “Sometimes you just have to drop off some baggage and move on,” he said.
The bond markets seem to agree. There has been no flicker of contagion to Italy and Spain, or even to Portugal, the country deemed most at risk.
SEE CHART
Yields on Portugal’s 10-year bonds have settled near record lows of 2.55pc, so low that the country is repaying loans to the International Monetary Fund to cut interest costs.
“This is nothing like 2012,” said David Owen from Jefferies. “We have the huge difference of open-ended QE. If there is contagion, the ECB will just buy the paper.
”
Yet there are darker signals in other markets. Paddy Power is offering 6/4 odds on Grexit by 2016, rising to 3/1 for Spain, 4/1 for Portugal, and 13/2 to two for Italy, a ranking that reflects politics as much as finance.
It is politics that now matter. EU veterans warn that any mishandling of the Greek drama could escalate into an existential threat to the European Project itself. They deplore the sabre-rattling in Brussels and Berlin, deeming it petulant, even bordering on idiocy at a time when the political centre is imploding in a string of countries, and not just in the South.
The Dutch Labour Party, the dominant force of Holland’s post-war `Polder’ era, collapsed to 9pc in the EU elections last year. It has immolated itself like so many of Europe’s once-great socialist parties by enforcing what amounts to reactionary 1930s policies in the name of EMU. “The centre-Left has lost all credibility,” said Simon Tilford from the Centre for European Reform.
Spain’s Podemos party – much in evidence at Syriza’s victory party in Athens, and even more mutinously radical – is leading national polls at 27pc. Marine Le Pen’s Front National won the EU elections in France with calls for a return to the franc and a return to sovereign borders. The three biggest opposition parties in Italy are now hostile to the euro. This is not contagion from Greece. It is running in parallel. Yet how it is handled will spill over with emotional force into the internal debates everywhere in Europe.
“Syriza has just won a landslide popular mandate from the Greek people to tell the Troika to go to Hell. It is ludicrous to shout at them and tell them they can’t wriggle out of agreements,” said Giles Merritt, head of the Brussels think-tank Friends of Europe.
Mr Merritt said the Syriza revolt has exposed the political failure of EMU crisis strategy with refreshing clarity. “People in Brussels are losing patience with Germany. The real issue at hand is how we are going to rescue the eurozone from economic depression caused by five years of misguided austerity. Tspiras may find that he has more friends in this city than he thinks,” he said.
“We cannot possibly risk Grexit at this stage and trigger a fresh eurozone crisis, so the Commission will soon waiver. Jyrki Katainen is towing the line for now but he is not a fool. It is Greece that really has the whip hand, and the task is to find a face-saving formula for Germany,” he said.
Prof Ashoka Mody, a former IMF bail-out chief in Europe and now at Princeton University, said hints by ECB members that they may pull the plug on Greek banks are “extremely irresponsible” and beyond the proper authority of these officials.
“They are supposed to be the guardians of financial stability. I have never heard of such outlandish threats before. The EU authorities have no idea what the consequences of Grexit might be, or what unknown tremors might hit the global payments system. They are playing with fire,” he said.
The creation of the euro was a terrible mistake but breaking it up would be an even bigger mistake. We would be in a world where anything could happen. What they ignore at their peril is the huge political contagion. It would be slower-moving than a financial crisis but the effects on Europe would be devastating. I doubt whether the EU would be able to act in a meaningful way as a union after that” - Ashoka Mody
Marc Ostwald from Monument said Grexit would open a Pandora's Box. “They are all playing down the risk but once you throw Greece out, you are setting a precedent that nobody wanted to set. How could Cyprus stay in the euro given its dependence on Greek banks? As we have just seen with the Swiss franc, once the system buckles the markets will go after the next victim like a plague of locusts,” he said.
The ECB would shield Portugal from immediate Grexit fall-out, but corrosive doubts would be planted. As the Portuguese newspaper Publico wrote in an editorial entitled “Portugal is not Greece, but...”, the country has the same afflictions of crushing debt, low-growth, and lack of competitiveness within EMU.
Combined public and private (non-financial) debt is 380pc of GDP, the highest in Europe, making the country acutely vulnerable to debt-deflation dynamics. Nor is it still viewed as an austerity poster child by Berlin. “The reforms have stalled. Behind the scenes they have put a halt to cuts. It is surprising that people haven’t paid attention to this,” said Raoul Ruparel from Open Europe.
“We are ants; the Greeks are grass-hoppers,” protests Luís Marques Guedes, Portugal’s presidency minister.
But like Aesop’s fable, his own description is allegorical, and unlikely to count for much in a post-Grexit lightning storm.
“Portugal is in our view the one country at risk of contagion,” said Alberto Gallo from RBS. “Its debt is already borderline unsustainable. It has a weak banking system and highly leveraged corporates. Half of listed firms have debt more than five times EBITDA earnings.”
Mr Mody says EMU shock therapy has failed to put monetary union on a viable course. The deficits of the EMU crisis states may have fallen but the mix of perma-slump and “lowflation” - now deflation of minus 0.6pc – have by caused the debt stock to spiral upwards. This is a mathematical effect. The interest costs have been rising faster than nominal GDP. Italy’s public debt has jumped from 116pc to 133pc of GDP in three years despite a primary budget surplus.
SEE CHART
The hysteresis damage from youth unemployment – still 50pc in Spain and 44pc in Italy – has eroded job skills, and therefore reduced future economic growth needed to service the debt.
There has been no fundamental move to fiscal union. This month's compromise deal on QE means each national central bank will be responsible for 80pc of its own debt purchases, entrenching EMU fragmentation. The EU banking union belies its name. It is in fact a supervisory union. Leaders never delivered on their pledge to end the “vicious circle” in which bank crises and sovereign debt crises feed on each other.
“As long as funds for insolvent banks are to come from fiscally-distressed states, the death embrace will continue,” said Mr Varoufakis. He and Mr Tsipras think much of EMU crisis machinery is a Potemkin façade.
Rightly or wrongly, they conclude that Germany’s bluff can therefore be called.
Syriza supporters hold up banner for Germany's Chancellor
“Europe is sleepwalking into a very dangerous situation,” said Hans Redeker from Morgan Stanley.
“Diplomacy is breaking down and we are seeing same sort of emotional behaviour that led to the misjudgements of 1914.”
“The EU always said that the currency union is irrevocable. Once you destroy that faith, the eurozone becomes little more than a fixed-exchange system, an 'ERM3' with currency tail-risk always a nagging doubt. We think the euro would fall to $0.90 to the dollar very fast,” he said.
The stakes are high. Greece is a NATO member on the edges of Europe’s “arc of instability”, a string of conflicts, civil wars, and failed states that stretches from Ukraine, through the Levant to Libya.
Critics say it would be an act of strategic vandalism to push Greece over the abyss into this maelstrom.
“To believe that you can talk about Grexit and then contain the after-effects, takes a degree of unprecedented silliness,” said Mr Varoufakis.
Yet that is exactly where this spectacular game of chicken going to until one side or the other blinks.
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