Greece Moves to Become a Banana Republic

Here is a picture of what a real European leader looks like (Associated Press):

Greek politicians have overplayed their hand. "Give me more money, or I'll shoot myself!"  Let's say, in the eternal Euro-Optimist view, French mathematics are applied to Greek sovereign debt, i.e. stretched out to 40 years, with rates and face values TBD.  It is guaranteed that there will never be any meaningful economic reform in Greece, other than maintaining the current government employment/pension mess and taxing a small private sector into oblivion.  The European Union itself is the big loser, but Chancellor Merkel will earn the devil's horns, while the French and the French-led IMF will proclaim victory.  The ECB will live to waste capital another day.  Other peripheral countries, and perhaps some core members, will realize that there are no teeth in the rules of the EU.

We hear from private economists and a few think tanks that Greek sovereign debt risk has been "ring fenced."  If that is true, then the only real impact of Greece's ill conceived intransigence will fall on their own people, which may be appropriate and the best thing for their democracy in the long run. What comes after the debacle will bear watching, but the economic risk to the EU can be absorbed

Greek PM Tsipras has 61% of his electorate behind him.  If he really is leading his country down this path, he needs to accept the consequences, get driven from office eventually, and the body politic can repair itself.

The only European politician who has stubbornly and effectively tried to show leadership on key bilateral and multilateral issues, like Ruusian sanctions,  has been Chancellor Merkel.   Strong and effective leadership in Europe is something at which elitists crinkle their noses.

If Greece defaults, it is their medicine of choice, and a convulsive purging is much better than a 40 year, slow bloodletting, where spending trajectories don't change and economic growth will be minimal.

A Greek Exit May Be the Lesser of Two Evils

One of my favorite financial commentators, Professor John Cochrane of Chicago Booth pooh-poohs talk about a Greek exit from the euro, saying essentially that we are used to sovereign defaults and this issue is separate and distinct from a decision by Greece to exit the euro.  He writes,

"Greece no more needs to leave the euro zone than it needs to leave the meter zone and recalibrate all its rulers, or than it needs to leave the UTC+2 zone and reset all its clocks to Athens time. When large companies default, they do not need to leave the dollar zone. When cities and even US states default they do not need to leave the dollar zone. A common currency means that sovereigns default just like large financial companies."

But, unlike the U.S. dollar which gained wide acceptance after the detailed architecture of the United States of America had been put in place and operating, the euro was created as a common currency without a political union in place, so I would argue that John's comment misses an essential political difference. Finance, more often than not, turns on politics, which is logical since markets are themselves social constructs in which the rulers of the nation-state have an intense interest.

Going back to 2011, we wrote, "...a paralyzed Europe has to come to terms with the failure of the notion of their common currency union."  

In 2012, we wrote, "Meanwhile, the economic and social  costs of the adjustment to the weaker EU members will be genuinely painful."

I can't believe that it's taken four years for the financial press to wake up to the realities as opposed to covering EU press conferences. The Greek government played chicken with Germany, and Greece blinked. Cash was found, debt repayments were made, but they were made with prior loaned amounts found laying around, lent by the IMF/ECB. This was a cruel joke, and the charade continues, but at what cost?

Greece is a sovereign state, and it should have the freedom to make its own foolish economic decisions and to run itself into the ground, if there is no domestic political will.  Instead, its economy is chronically mismanaged, but more so than Italy or France?  And, though its electorate expressed revulsion at the euro scenario by bringing in a reform party, the people's will continues not to be carried out because of the eurozone's fiscal and economic reform requirements.  Sooner or later, this lack of political freedom is a genuine cost of belonging to the euro zone.  

The contagion issue is a technical red herring, in my opinion.  Policy pundits have argued about this before, to no real conclusion or benefit.  Greece needs to confront its own economic and social mismanagement and deal with monetary issues through its own elected representative government.  If Greece were to reissue the drachma, try to prohibit capital flight, and the drachma rose to 500 drachma/euro, then a rather painful adjustment process would begin and a new equilibrium found. But this process might be less destructive to the Greek polity than the slow bloodletting under the ECB/IMF/ESM, Whatever path chosen, it would be chosen by the Greek voters, without outside pressures, other than by market price signals. 

Greece would also being doing a favor for the rest of Europe by exposing the economic fraud which is the EU, that shouldn't have allowed most of the periphery to join the eurozone had it enforced its own rules.  

One Way Out for the Eurozone?

The capital markets have Eurozone fatigue.  Day after day, hour after hour, we await the same news: an answer is forthcoming from the next meeting of EU finance ministers.  There's a Monty Python sketch in which the characters play around with an innocent question, "How big is it?"  Well pundits at the IMF conference have suggested a rescue/bailout/fiscal equalization fund of 1.4-4.0 TRILLON euros would solve the problem.  There is no answer to "How big?"

A facility of that size is out of the realm of possibility, for a union in which the strongest member has a GDP of 2.5 trillion euros.  Eventually, Germany will have to deal with the reality that its interests diverge not only from the weaker members of the union, but from those of France as well.  Then, Merkel and Sarkozy will no longer be able to pose as figurative, "Brothers in Arms." 

Greece has announced that its austerity measures will not enable it to meet its budget targets in today's WSJ. So, really we are moving, like a slow motion train wreck, towards a default of some kind, semantically within or outside the euro.  We wrote way back in June about the likely fate of the euro and about the attractiveness of Treasuries despite all of our fiscal management issues. 

A country's exchange rate is the most effective market price for adjusting imbalances in merchandise trade and external capital  accounts.  With the euro, Greece or Italy don't  have an exchange rate for the market to devalue until their economises  adjust to a new equilibrium.  Playing with tax and fiscal policies are not primary tools for these adjustments, as Greece is finding out.  Italy is waiting in the wings, and I don't believe that the Berlusconi government would have any inclination to drive itself down a path as Greeece has done. 

Thinking back to the Lehman crisis, one of the justifications for the absurd bailout concocted by Treasury was the fact that nobody could really map out the complete counter party network for Lehman/AIG/Bear Stearns and the other SIFI's, along with the amounts at risk.  Nobody knew how bad it would get and whose hands would get blown off. So we implemented a really bad deal.

Likewise, the structure of the EU and the obligations of its members were built without contemplating the alternatives we're now facing, namely an exit from the euro.  However, if one member exits, the utility of the entire common currency mechanism is mortally wounded as an economic construct. I'm not sure anyone really knows how the default//exit scenario would play out in practice.  Markets need to adjust and move one, but that means a paralyzed Europe has to come to terms with the failure of the notion of their common currency union. 

It doesn't matter how many times the finance ministers meet and where they meet, there may only be "One Way Out."

"Ain't but one way out, baby,
  Lord, I just can't go out that door.
  Ain't but one way out baby,
  Lord, I just can't go out that door.
  'Cause there's a man down there,
  Might be your man, I just don't know."
 
  (Holland/Dozier/Holland) EMI