Grexit is much closer than we think

The Greek government has now been boxed in by the “no” referendum vote and is unable to make the kinds of concessions a “yes” vote would have allowed. Meanwhile, the Eurogroup’s thinking about the manageability of Grexit is coalescing around letting Greece go unless it makes major concessions. With only a few days left to come to an agreement before bank nationalization and IOUs are necessary, a deal looks less likely to me. Grexit has become the default scenario. The ECB’s decisive move has transformed what was an untenable negotiating position for the Institutions into an untenable position for Greece and its government.

Looking at the Greek side’s negotiating position, let’s remember that they received an overwhelming vote of support in the referendum by a 22% margin even though less than 40% of the electorate voted for Syriza in general elections in January. Ambrose Evans-Pritchard thinks this is a surprise for the government. Whether it is a surprise or not, it effectively gives the Greek government a mandate only to negotiate terms that limit the concessions Syriza makes. To hold a referendum, have the electorate and your party back your position and then to turn your back on that position is not a tenable policy position for Prime Minister Alexis Tsipras if he wants to remain in office. He could capitulate and call for a unity government, but I believe he would be done as Prime Minister.

If one looks at his speech before the European parliament earlier today, he does not seem ready to capitulate. Tsipras said things like, “I take full responsibility for what’s happened over last 5 months but Greece’s problems have evolved over last 5 years”. He said, “It wouldn’t be an exaggeration to say Greece became an experiment lab for austerity over the last years.” And he also said, “Nobody denies that reforms, measures are needed but the burden has to fall on those who can pay, not those who have paid already”. And finally, he insists that talks on debt relief begin as a condition for a deal. While it does seem Tsipras recognizes writedowns or even maturity extensions and interest payment halts may be a non-starter, none of this looks to be a politician who is ready to capitulate. The only deal that has a chance of threading the needle is one that delays interest payments and lengthens maturities. Would the Eurogroup go for it? I doubt it, especially if there is wrangling over other issues like pensions.

Meanwhile the Eurogroup and the ECB are making noises as if they are ready to accept Greece’s departure from the eurozone and then take extraordinary measures to maintain stability for all the other members. For example, the ECB’s Christian Noyer was quoted today as saying ‘we are starting to get very worried’ because if no perspective for a deal is evident come Sunday, the ECB will be obliged to end the Emergency Liquidity Assistance program to Greek banks, cutting them off and forcing the system into collapse. Noyer said that this would effectively mean Grexit and that the ECB would take measures to boost eurozone credibility, essentially a commitment to whatever it takes for the remaining countries in the eurozone.

At the same time, an article in the Guardian gives voice to what I believe is the thinking now within the Eurogroup. The article reads Grexit would strengthen, not weaken, the eurozone. Here are some highlights:

Since coming into office, the Athens government has relentlessly argued that Greek expulsion would inevitably trigger an unravelling of the monetary union, and ultimately deal a fatal blow to the European project itself.

[…]

It may be true that Grexit would be an unprecedented event in the history of European integration and raise a host of difficult legal questions. But the fears for the political sustainability of the euro are vastly overblown. In the short term Grexit would pose no existential threat to the eurozone, especially if it is done in a coordinated fashion.

…The economies of Ireland, Spain and Portugal are in a much better shape as a result of structural reforms and fiscal consolidation.

Moreover, the European Central Bank has become de facto lender of last resort with its OMT – outright monetary transactions – programme, flanked by new institutions and mechanisms such as the European stability mechanism and the banking union…

The second reason lies in the need for trust. Economists have torn out their hair over why the creditors have not been able to reach a deal, given the alleged failure of the programme, the certain financial losses to creditors, and the small differences in fiscal terms. What they failed to appreciate is that the governance of the eurozone, as indeed of European integration more broadly, is not a succession of single bargains but a compromise-making machine held together by law, informal rules and trust among democratically elected participants.

[…]

Grexit would increase the chances of further eurozone deepening through stronger institutions and fiscal policy, necessary to make monetary union sustainable in the long run. Before this happens many eurozone governments, including Germany, will need to spell out the full implications of economic and monetary union membership to their citizens and make an enlightened case for greater fiscal solidarity and deeper integration. However, making this case will be easier when the representatives of the recipient states don’t accuse those who provide bailouts and debt relief of “fiscal waterboarding” or financial “terrorism”.

Finally, Grexit would make it more likely that the eurozone will adopt a mechanism for planned exit from the euro. Plans for this have already been drawn up in Brussels and some national capitals to forestall any future danger of countries blackmailing their partners with the threat of irregular exit. Instead of engineering an exit through the back door of a misleading referendum question, governments that feel their electoral mandates are incompatible with eurozone membership can ask their populations in a transparent and informed way about leaving.

Make no mistake; the Eurogroup is prepared for Greece to be forced to exit the eurozone unless Greece presents a deal that is agreeable to all members of the Eurogroup. Ambrose Evans-Pritchard quotes former Greek Finance Minister Yanis Varoufakis as saying, “They just didn’t want us to sign. They had already decided to push us out”. So perhaps the Greek government understand how the Eurogroup is thinking already – and will just negotiate to the end on a deal that hews closely to the one that they presented pre-referendum. If so, it won’t be enough. It will be rejected and ELA will end, forcing further capital controls, bank nationalization, IOUs, and almost certain Grexit.

Grexit has to be a base case scenario now. We have already seen a default within the eurozone. And the Greeks want to leave it at that. But now I believe, with no deal on the table, the ECB is ready to cut Greece off and that is the beginning of the end for Greece as a member of the eurozone. While stocks and bonds would sell off violently in the initial days if this shock takes place, I believe Europe has enough firepower to contain the mess in the immediate days afterwards. It is the longer term consequences we should fear.