Greece and the Return of the Repressed

Freud warned that unresolved psychological conflicts might be
repressed but they keep returning. 
So too with Greece’s debt problems.  A new
crisis is at hand.  Investor nervousness is evident in the surge in the
two-year yield this week, up nearly 100 bp.  The fact that the 10-year
yield is up a more modest 10 bp, and minor
losses in Greek stocks this week, suggest the investors may be more sanguine.
  


In 2010 and
again in 2015 many thought Greece was going to be forced out of the monetary
union, and both times the many observers and investors underestimated the political will to preserve the union. 
    Some have begun talking about Grexit again,
but this is very premature.   The pressure now will likely ease, even
without a near-term solution as Greece’s roughly seven bln euro payment is not due until July.   Given the cast
of characters and the political calendar,
 there is no reason to expect that this time will be different and it to
go to the very brink.  

There are no reasons to expect an early resolution.  The key issue is not about this year’s budget.
 It is about the commitment to a 3.5% primary budget surplus starting next
year that was agreed upon in the 2015
deal.  That agreement called for Greece to run a primary surplus of 3.5%
for the medium term beginning in 2018.  Germany argues that medium-term
means a decade, while the European Commission says it mean 1-2 years. 
Last year
Greece recorded a 2% primary budget surplus. 
 The initial target was a deficit of
0.5%. The results gave the government the wherewithal to offer some tax relief
for some of the islands and some pension relief to the dismay of the official
creditors.  The problem is that last year’s achievement is not a recurring
process.  The IMF says that the primary surplus was the result of one-off
factors and that the Greece needs to take additional belt-tightening measures
to the tune of about 2% of GDP. 
The Greek
government is reluctant to impose more any more austerity. 
  The kind of fiscal adjustment that has been foisted
on Greece, in part because the official sector refuses to accept debt relief,
typically is counterproductive.  Because of the impact on the denominator,
debt-to-GDP ratios worsen.  This was
also the case in the large fiscal adjustments pre-2008 in Denmark, Sweden, and Finland, for example, and they had
the benefit of currency depreciation and a domestically-run monetary
policy. 
There is a
European finance ministers’ meeting on
Feb 20.  
It was hoped an
agreement would be reached by that meeting.  Such an agreement
would be new Greek austerity measures for
payment from the 86 bln euro 2015 package to ensure that government can
make the seven bln euro payment due in
July. If the agreement is elusive, which seems
highly probable, then the situation looks frozen for at least three months.
 The Dutch parliamentary approval is necessary,
and it will be dissolved ahead of the
March election. The French election in April (and a likely second round
in May) will also likely deter an agreement.  
The underlying
issue is the sustainability of Greece’s debt. 
 In an unusual development, the IMF
executive board was split on the issue earlier this week.  The European
contingent argued that Greece’s debt is sustainable and that the European
commitment to Greece is what makes it a unique case.  Other board members,
including the US, China, Brazil, India and South Africa questioned the
sustainability of Greece’s debt and did not accept that a 3.5% primary budget
surplus for years was realistic.  
The IMF’s
position is important even though when the crisis first broke the ECB and
Germany were not particularly keen for the involvement of the multilateral
lender. 
 Now Germany (and the Netherlands)
insist on the IMF’s participation as a condition for their continued support.
 At the same time, the IMF’s assessment has increasing diverged from
Germany’s and the European Commission’s (self-serving) assessment more broadly.
 
The European
creditors are expected to make a specific proposal for a contingency policies
that will automatically kick in if the primary budget target is missed. 
  Most likely, Greece’s Prime
Minister Tsipras will reject the proposal.  As we have seen, the more
austerity, the weaker the economy. The economy shrinks faster that spending can
be cut,  which results in an
increase in the debt-to-GDP ratios, which forces more austerity, and so on and
so forth.  
The Greek
economy is showing some green shoots. 
 More austerity could easily kill the
traumatized patient.  The economy expanded by 0.4% in Q2 and 0.8% in Q3.
 The initial estimate for Q4 will be
reported next week (February 14).  A 0.4% expansion in Q4, would be
the longest expansion streak in a decade.  It would put 2016
year-over-year growth around 0.4% after a 0.2% contraction in 2015.
If pushed hard,
Tsipras could call early elections. 
 Syriza may not win the election, but
imposing a new round of austerity would erode its support in any event.  A
new government, perhaps led by New Democracy might see the European creditors
offer a slightly better deal.  However, recall that Syriza came to power
primarily because of the loss of credibility of the mainstream parties.
 Although Tsiprias equivocates and offers strong rhetoric, he has largely
implemented demands of the creditors. Almost 99 years ago, Keynes warned, and
history has shown, that there are indeed limits on a country’s willingness to
service foreign creditors with current output. That means that nearly any
elected government in Greece is going to resist the never-ending demands of the
creditors.  

It is the
European countries, not Greece, that put other tax payers money on the line. 
 How did the official sector become Greece’s largest
creditor?  Greek bonds were in the private sector hands, but the ECB
(under Trichet, not Draghi) bought them
from the banks.  European governments wanted to avoid a Greed default, so
they loaned the Greek government money so Greece can repay its lenders.   

The IMF,
seemingly belatedly, is pushing for debt relief. 
 The previous US government argued for debt relief.
 Given Trump’s experience with renegotiating debt and bankruptcy, the US
position may not change.  However, given the elections in the Netherlands,
France, and Germany this year, debt
forgiveness of any kind will most likely not be agreed upon this year.  

Investors should be prepared for new brinkmanship.  A deal is not likely this month or
much before the July.  Talk of Grexit will increase again.  However,
the larger political context, including Brexit, Trump and a more aggressive
Russia, the political will to keep Greece in the EU and EMU has likely
strengthened rather than slackened.  Still, until Greece’s debt is on a
clearly sustainable path, it will be a recurring issue.  Other countries with large debt-to-GDP burdens, like Japan and Italy, have greater capacity to service it than Greece.  

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