By Marshall Auerback, a portfolio strategist and hedge fund manager
News stories continue to suggest that Greece once again appears on the verge of reaching a deal with its private sector creditors on how much of a loss they would be willing to accept on their bond holdings. The latest numbers suggest a 70% write-down. A pretty striking comedown for what is supposed to be a “voluntary default” and, hence, not subject to the triggers of a credit default swap on Greek debt.
Naturally, the spin surrounding the proposed agreement is that this is a “one-off” and that other troubled periphery nations shouldn’t even begin to think of securing a comparable deal. But the inherent tension between securing a write-down on Greek debt which more closely mirrors the disaster which is now the Greek economy, and the desire to minimise the potential contagion effect is rearing its ugly head already, and may help to explain some of Germany’s recent machinations.
Peter Spiegel of the Financial Times published the German government’s proposal for Greece’s “improvement of compliance” with the terms of the bailout, and all of a sudden Greek PSI positively pales in comparison. According to Germany’s proposal, whatever the result of the PSI deal, Greece would need to “legally commit itself to giving absolute priority to future debt service” and “accept shifting budgetary sovereignty to the European level”. If the Greek government is not willing to do this, the troika would presumably turn off the taps of bailout money and Greece would default. With no access to market or official financing, Greece would be forced to exit the eurozone.
Now, polls appear to indicate that a bunch of the Greek middle classes might actually welcome EU control over their finances, as opposed to a bunch of corrupt Greek politicians, but overall, it’s almost certainly guaranteed to trigger a violent reaction. In any case, given that a deal with Athens is seemingly so close, why did Berlin choose this particular moment to make this demand, and place the entire deal potentially at risk?
I think we have to look beyond Greece for the answer to that question.
One suggestion is that Berlin’s proposal is a by-product of the unintended consequences of the ECB’s three year long term refinancing operation (LTRO):
If eurozone banks have as much access to cheap, three-year ECB funding as their collateral allows, perhaps Germany and the troika have decided that eurozone banks can survive a Greek default.
In the absence of the ECB hoovering up all of Greece’s debt via its Securities Market Programme (“Not gonna happen; wouldn’t be prudent,” as George Bush the Elder/Dana Carvey might have said), Greece is, as Greene argues, clearly insolvent and would likely have to leave the eurozone to eventually return to growth. The German proposal, argues Greene, may have accelerated the inevitable.
But there’s another, more sinister interpretation. The question which has been persistently asked since the debt renegotiations started with Greece is: what will stop Portugal, Ireland, or indeed Spain from demanding the same deal? And I continue to believe that Spain is the domino which is too big to fail. Its liabilities are too big to be covered by the existing firewall established by the EFSF and ESM. An expansion of the LTRO might address the solvency/banking crisis, but not the broader problem of deficient aggregate demand, high unemployment, and rising social turmoil.
So to repeat the question: how do you preclude Portugal, Ireland and, indeed, Spain from asking for the same deal as Greece, if the negotiations succeed?
Answer; you can’t. So the Germans throw a politically impossible demand in front of the Greeks, in effect saying, “No more money unless you effectively surrender your national sovereignty.” And that’s the implied warning ahead for the other periphery countries which look to secure the deal currently on the table for Greece.
In effect, the Germans (behind the auspices of the troika) are saying, “It’s fiscal austerity on our terms. You try to renegotiate like the Greeks and we take you over. The other alternative is that you leave.”
Anschluss economics, plain and simple.
Is this too harsh an assessment? Well, when their national interests are at stake, the Germans are perfectly prepared to shed the “good European” persona and play hardball. Think back to how the Bundesbank engineered the departure of Britain from the ERM back in the early 1990s, and you’ve got the template for today. By publicly suggesting that sterling was overvalued and refusing to offer support to the British pound (in contrast to its subsequent defence of the French franc), then BUBA President Helmut Schlesinger virtually assured the UK’s ejection from the Exchange Rate Mechanism. Let’s face it: history shows that Germany doesn’t do “subtle” very well. This looks like a blitzkrieg, plain and simple. Spain, Ireland, Portugal and Italy – you have been warned.