There Will Be No "Grexit"
Greece’s headline drama will unfold the same way it has for the last five years. There will be a lot of turmoil. I’m not saying there aren’t problems in Greece; there are big problems there. But what I’ve said all along going back to 2010 is that Greece isn’t leaving the euro; there will be no Grexit.
Nobody’s going to get kicked out or quit.
Now that doesn’t mean everything’s fine in Greece. They could have bail-ins, nationalizations, bond defaults and a lot of economic disruption around the country. None of that is the same as Greece leaving the euro, however. I’m confident in my assessment because this isn’t solely an economic issue; it’s also political.
I’ve often referred to Europe today as the Fourth Reich. Go back to 1991; Margaret Thatcher was opposed to German reunification because she said every time the Germans get back together they take over Europe. They’re doing it again today, except economically and politically.
There’s a political will to keep Greece in the euro. If you look at Greek polls the Greek people overwhelmingly favor the euro. They don’t like the austerity that goes with it, but they favor the euro.
Germany wants Greece in the euro, too. The political will is there and they will stay — everything else is just a detail.
But before we get too far, a little background might be helpful to you. As I say, this issue is political, economic and theatrical at times with a lot of moving parts.
Greece is part of the European Union (EU), obviously. But the EU is a larger economic group. Within the EU you have what’s called the “eurozone.” Those are 19 countries that issue the euro and use the euro as their currency and Greece is one of them.
Today, Greece is in an awful debt crisis. A few years ago there was even a partial default where they restructured some bonds.
Since then, they’ve been getting bailouts from something called the “Institutions.” Interestingly, it used to be called the “Troika,” but I think the Greeks were a little bit offended by that, so the Germans changed the name.
But the Troika or Institutions are three entities: The European Central Bank, the European Union itself operating through special purpose entities, and the International Monetary Fund (IMF). These are the three places that Greece has received its bailout money from.
As always there’s what the Institutions call “conditionalities.” For example, they might tell Greece, “OK. We’ll give you the money you need. But you have to agree to certain conditions. And if you don’t abide by the conditions, we won’t give you the money.”
It’s a forcing mechanism to get Greece to change its political and economic arrangements. That’s been going on for a few years.
The money’s also disbursed in tranches meaning they’ll give Greece some of the money but not all of it. The Institutions will check the conditions set before releasing subsequent tranches. That’s the basic background for where we are now.
Today, Greece’s Syriza party — a more socialist, left-leaning party — has said to the Institutions “We’re not going to agree to the conditions anymore. They’re too harsh. We’re cutting pensions. We’re cutting government spending. We’re running a primary surplus. Unemployment is over 25 percent. We’re not getting the growth that was promised. This whole thing doesn’t work. So we want to, in effect, tear up the deal and start over. We’re not saying we won’t do a deal, but we’re saying we want new terms and conditions.”
Syriza was elected on that platform and, of course, Greece is a democracy. They have to respect the will of their voters.
That’s why we have today’s train wreck.
On the one hand, the EU and the so-called Institutions — the old Troika — are insisting that they will not give Greece any more money unless they meet certain conditions.
Meanwhile, Greece is saying, “We’d like some more money, thank you very much. But we’re not going to meet the conditions. We want a new deal.” All the while, the clock is ticking and Greece has major bond payments and interest payments due. This is why analysts are talking about Greece exiting the euro — the “Grexit.”
There’s no precedent for such a course. No member of the eurozone has ever quit or been forced out. The expectation then is that Greece would go back to the drachma. The drachma was their old currency before they joined the euro.
Of course, when a country has its own currency, it can print as much as they want. So the theory goes, they could exit the euro, go back to the drachma, their central bank could print drachma and pay their bills. But of course they would default on all the euro-denominated debt.
Let me spend a minute on what I call the game theoretic approach. It will show why this scenario is unlikely.
Europe would like to tell Greece to just put up or shut up. And Greece would like to tell Europe that they’re not going to put up with any more austerity.
But what you have to do is you have to think two or three moves ahead.
You have to say, “What would that actually mean? How will that actually play out? If one side acts that way, what does it mean for their constituency? Or other people — will the rest of the European Union or, for that matter, Austrian, Dutch, or German citizens be on the receiving end of any bad consequences?”
Some analysts claim “Greece leaving the euro is no big deal.” I couldn’t disagree more. Think of such a situation three steps ahead from the Institutions’ perspective.
It is true that Greece is not a big part of the world economy. It is true that if Greece’s GDP disappeared, that, by itself, it wouldn’t make that large of an impact on the world. But that’s not the danger. The danger is contagion. The danger is that dominos that start falling.
Going back to 2007, 2008, I remember when JPMorgan rescued Bear Stearns in March 2008. Everyone said, “The crisis is over.” Then Fannie and Freddie were rescued in July of 2008, and everybody said, “The crisis is over.”
And I kept looking at the situation and saying, “This crisis is not over. These are dominoes that are falling. Each one’s hitting the next one and taking the crisis further. We don’t have resolution.”
As I expected, Lehman Brothers was next, and then AIG behind that. Then we saw how bad things got between October of 2008 and the stock market bottom in March 2009 when investors lost 30 to 50 percent of their net worth on that market decline. Not just stocks, but real estate and other assets across the board.
So I see these dominos falling if Greece goes. It’s not about Greece — it’s about Spain, Italy, Portugal, Ireland. It’s about the whole eurozone. It’s about confidence.
That doesn’t mean that if Greece quits the euro, that the next day Italy says, “Oh, we’re quitting too.” I’m not saying that. What I’m saying is that markets will do the job for them.
You don’t need Italy and Spain and Portugal to quit. You just need investors to say, “Well, wait a second. Nobody thought Greece would quit. But they did. And now nobody thought these bonds would default, but they did. So maybe these other things can happen too.”
As investor, if an event happens once, you’re going to give it a different probability in the future and dump other countries’ bonds. That’s going to raise interest costs. That’s going to make those countries’ deficits worse. And it feeds on itself.
People would lose confidence in the euro itself. That’s would raise costs. That’s the danger. It’s the contagion and what happens in investors’ minds.
Europe’s leaders understand that. That’s the motivation for both sides to come to the table.
Why is Greece making such a big deal out of this?
Well, one of the things they’re saying is: “This austerity is causing us to cut pensions. We have Greek workers who had worked for 20 or 30 years. And, as part of the conditionality of the European loans,” which I explained above, “we’re required to cut those pension benefits. And we don’t like hurting the pensioners. That’s not fair.”
Going back to game theory, assume Greece quits the euro. The country defaults on its debts. That means they go back to the drachma. What happens then?
Nobody in the world wants drachma so their foreign direct investment’s going to dry up too. They’re not going to be able to finance anything. They will be able to print money. That’s all they’ll be able to do. That means hyperinflation, which destroys Greek pensions.
So, when the Greek government says they’ll play hardball with Europe to preserve Greek pensions, remember their alternative is: go back to the drachma and destroy the pensions anyway.
Greece wants to play hardball, but it knows if it leaves the euro it’s a disaster. Europe knows it will also be a disaster if the kick Greece out of the euro. It’s not that Europe cares about Greece or vice versa, but that they each care about themselves. That’s what drives a negotiation forward.
In a game theoretic space, this is what’s called a two party prisoner’s dilemma. A prisoner’s dilemma is a game theory approach where you have two people under interrogation.
If you rat out the other guy, you win. But if he rats you out, he wins. And if you both rat each other out, you both lose. But if you both keep your mouth shut, you both win. The caveat is, you don’t know what the other guy’s doing.
So, in a prisoner’s dilemma, you have to not only think about what you want to do, but about what is the other player is going to do. The way out of the dilemma is to assume that everybody’s rational.
Both sides respectively understand that a Grexit will cost them. It will cost them more if this doesn’t work out than if they go forward.
This will get resolved, in my view. But six months from now or a year from now, we could be at it again. I could be writing to you about the same dynamics at work. Any resolution is just buying time in hopes the economy grows. That’s a separate, bigger-term, structural issue that’s not going away.
But, in the short run, I do expect Greece and Europe to reach an agreement.
I imagine they’re meeting behind closed doors in non-public ways right now. That’s opposed to posing for the cameras and walking into a meeting and throwing up your hands and throwing up your hands, all of which is perfectly normal negotiating posturing, if I may say so.
Probably a core group that would involve Germany, the Netherlands, the ECB, and Greece, and probably someone from the IMF — a small group of five or six people meeting, who knows?
You know, at a restaurant or some out of the way place with no press involved, no posturing, and a bunch of lawyers waiting outside the room, wordsmithing, trying to come up with the right presentation. That’s where we are right now. There will be no Grexit.
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