Pushback on the imminent Grexit meme

I still find it hard to believe a Greek exit from the euro zone is imminent. So it’s good to see someone push back on the concept that a Greek exit from the euro zone is imminent. John Dizard at the FT does just this in a piece out today entitled "Everybody chill – Grexit is not really imminent".

When I wrote more on the political economy of the coming Grexit last Monday, I said "I still think the bar is very high here" and outlined three high hurdles a Grexit would have to clear. I followed this up with a non-member post that mirrors Dizard’s language: "Although my post at US News makes it seem like a Greek exit is imminent, I still believe that we are going to see more ways of extending this because the euro zone is not ready politically for what the consequences of a Greek exit entails (bailouts, bank recaps, massive ECB intervention and a lot more)."

Let me dissect what Dizard is saying in this post and why I still think Greece will not exit the euro zone in the immediate future.

Here are the crucial parts. I will underline the bits I think most important.

The reason for the panic among selling bondholders and euro-punditry was the ascent of Alex Tsipras and the Syriza coalition of the left. Syriza rejects the conditionality, or “memorandum”, of the bailout deal. What the sellers and opinion leaders miss is that the memorandum was a dead letter anyway. There never was any possibility that any Greek government could comply with its terms. If, after the June elections, Syriza and the other anti-memorandum parties make it impossible for any governing coalition to even pretend to comply with the troika’s terms, then the troika can cut off direct payments to the Greek government without taking the blame for initiating the divorce, or, rather, temporary separation.

Even if the pro-memorandum parties put together a coalition government, they would face a determined, motivated opposition and an obdurate civil service blocking its moves. The “internationals” loathe the two mainstream parties, and their dead weight of “clientism” and corruption, even more than they do the left.

Remember that the troika could make payments for the PSI bonds through an escrow account that is not under the control of the Greeks. So when the memorandum terms (civil service layoffs, pay cuts, etc.) are rejected, probably in the second half of July, the troika could cut payments to the Greek government, yet still make the PSI bond interest payments that start in September.

Then the Greek government, now even shorter of cash, will have to impose deeper, swifter cuts than the memorandum’s. Greece will have to rapidly balance its current account and primary government budget, with the populace and Syriza hurling blame and those imaginative Greek curses at the troika.

This does not require departure from the euro, which would have huge logistic costs and delays. The Greek government can make payments in its internal debts, including civil service pay, pensions, suppliers, and so on, partly with the euros it collects in taxes, and partly with IOUs. Those IOUs would immediately trade at a discount.

After months, or even a year, of self-imposed austerity and morally satisfying defiance of multilateral imperialism, the Greek government strikes a new deal. The IOUs are formally devalued in euros, or, alternatively, at that time, turned into drachma. The official creditors recognise their losses. Greece gets some transfers/loans/ growth aid.

This still requires keeping the insolvent banking system liquid and capable of doing the day-to-day business of the payments system. That can be handled with a pre-election recapitalisation, along with limits on withdrawals and intra-euro area and international transfers, justified under Article 65 of the Treaty on European Union. (Loan books and assets would be valued forgivingly.)

This arguably allows for those restrictions “in the field of taxation and the prudential supervision of financial institutions …”. You want “transferable” euros? Let’s see your tax returns or audited invoices for necessary imports. Maybe that would be an abuse of Article 65; the courts would tell us in a few years.

But Greece can continue to use its capital-controlled euros in the meantime. PSI bonds gradually trade up. Grexit cannot be done by a temporary caretaker government. Chill.

The important points Dizard makes are as follows:

1. Greece was never going to hit its austerity targets to begin with. Syriza’s rejection of the targets might be politically difficult to finesses since it would be Greece not even trying, but the reality is even if they tried they would fail. And then we would be in nearly the same situation.
2. Who says an anti-austerity Greek government could be elected and reject austerity? The polls are now moving against Syriza, something Dizard doesn’t mention. However, Dizard does mention the fact that getting the Syriza agenda through would be difficult even so.
3. Eurozone default is not synonymous with breakup. That’s the title of a post I wrote from last September. Dizard makes this point too. He points to Greece’s being able to do at a minimum what the US state of California had done with issuing IOUs when they were on the verge of default. In my September post I wrote at the very outset: "Implicit in my post explaining that Germany is preparing for Greek bankruptcy is the view amongst European policy makers that default does not equal euro zone exit. I think I should reiterate this because a lot of people are acting like an imminent Greece exit from the euro zone is likely."
4. Logistically, an imminent Greek departure would be difficult. Dizard in effect notes that European policy makers are not crazy enough to push this through on a temporary care taker government. I think, more likely, they will set in process the framework for exit as the new fiscal and growth compact come to take form. This is what I have been saying for six months ever since the Italian crisis.

Yes, the euro zone has become a political economy black hole and anything could happen. However, most of the events on the ground speak against an imminent breakup just as they did in September when we last heard cries of this sort.

1. You would need a huge infusion of liquidity right around the European economies – one that Europe is not prepared to make.
2. And as I wrote last Monday, you need to clear three separate hurdles: 
• You have to get Greek politicians voting to renege on their austerity pledges.
• Then you have to see this move met by a cut off of aid from the EU.
• Then you have to see the resulting default lead to a movement within the EU to exclude Greece from the euro zone altogether.
3. A Greek default means a huge writedown at the ECB. ECB capital is a political issue Europe is not prepared to handle.

I think the Europeans are now actively preparing for a Grexit because to not do so would be folly. However, Europe wants Greece to stay in for now because the EU is not yet prepared for a Greek euro zone exit. Instead, we are more likely to see the Greek memorandum renegotiated, get a Spanish bank recap and see a push toward tighter fiscal integration with penalties for ‘free riders’ including explicit mechanisms for euro zone exit.