Options after the Greek vote: choosing the finger to bite

Greek voters may have though that they were voting on an immediate ending of the austerity. But that never was on offer, and difficult choices are just beginning with the vote.

What does the Greek “Oxi” vote mean? No to one version of the creditor’s offer, obviously. But can the government accept a slightly better deal? That is unlikely – the government needs to show large concessions from creditors so that the referendum was worth it. Creditors are unlikely to offer a much better deal, because their voters are against it. So the most likely outcome is no deal for at least several months.

Lost in translation. Image: ncr.nl

What happens if there is no deal? The Greek government needs to reduce its primary budget deficit, because no one is financing it – and that involves, ironically, larger fiscal restrictions than would have been the case had it accepted a deal. Many people are under the impression that the debate is about paying back debt and paying interest. But in recent months the situation worsened in Greece, and the government is running a (probably large) budget deficit even before interest or debt repayment comes into the picture – a primary deficit. The economy is collapsing as confidence has evaporated. Tax payments (and most other payments too) seized up – why pay now when you may be able to pay in devalued drachma, if there is any government left to collect taxes due?

Anti-austerity commentators imagine a world where someone pays for Greece to loosen fiscal policies and run primary deficits for several years. I seriously would love to see how that experiment would go. Maybe there is a Keynes Fairy, and after an increase of Greek government spending, strong growth would re-start and Greece would be willing to run a primary surplus. I doubt it, but unfortunately we can never be sure as no one is going to finance such an experiment.

So the Greek government will tighten fiscal policies because it has no other choice. But probably it will try to blame creditors for this. It can do it in an orderly fashion, reducing wages and pensions for example. Or it can do it in an ad-hoc fashion, by rationing, not paying wages, VAT refunds and the like. The latter may be politically better, but more damaging for the economy, increasing uncertainty and reducing economic activity even further.

The banking sector is insolvent as well. That leaves the ECB with a difficult dilemma. If it continues to finance banks, that is a quasi-fiscal transfer to their share- and bondholders and depositors. If it cuts them off, it may be seen as not fulfilling its monetary mandate of being the lender of last resort and making a political decision. I think the ECB will nevertheless choose the latter. Otherwise we would get a German referendum about leaving the Euro in no time, with predictable results.

Creditor governments may decide to finance Greek banks while not financing the government. That separation would be tricky, but may work. But creditors would need to effectively take over the management of the banks, otherwise the incentives for the bank management would be perverse. Uncle Jorgos would get that loan, and unfortunately his company would default on it. We have seen it many times over in Central Europe what it is like when there is no effective shareholder control on bank management and lending decisions. The fact that they would be stealing foreign colonizer’s money would be an added bonus. And it is far from certain that it is politically feasible to hand over effective management control of banks to foreign lenders.

There is a lot of talk about whether the Greek debt is sustainable and what should be the size of the write-off. Sustainability is always a political question, as we wrote earlier. If Greece is not able politically to run a primary surplus, as seems to be the case right now, then its sustainable debt is zero, unless interest rates are negative. There is no clear guideline how much the debt write-down should be. 50%? 80%? 100%? What message that sends to other debtor countries? That you can just vote for a debt reduction? Because of these considerations, and their voters’ resistance, creditors will be very reluctant to offer debt write-downs. It is more likely that Greece will unilaterally not pay the debt and interest, as it is doing now.

With the acrimony between Greece and its creditors intensifying, we can get to the point where someone (maybe a new political movement or a trigger-happy general?) in Greece lobbies for total debt repudiation. It is odious, it is the fault of creditors, why should we pay a penny? It is always a bit of a mystery why countries pay their creditors after the age of gunboats. It has to do with hopes about future credit lines and the pain of currently being shut out of capital markets. But if you are already shut out of the markets, and everyone will lose their office or bank job who lends you in the next 10 years, maybe it is time to test new grounds here too…

All this makes it very likely that creditor governments and the ECB will lose a lot of money in Greece, whether the country remains in the Euro or not. That will make politically very difficult to help any other Eurozone country next time it is in trouble. And sooner or later another recession will come…

Can there be a deal between Greece and the creditor governments? Possibly still yes, but it would be a difficult sell on both sides. Can Greece stay in the Eurozone without a deal? Possibly yes, if it is ready to effectively wipe out its banking sector…but it goes without saying that the chances of an exit from the Eurozone have increased a lot in recent days.

Tough choices are just beginning with the referendum….

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Tags: Euro, Eurozone, Greece