25 February 2012

Why Should Greeks Play Chicken with Germany

Did you see this picture on the right?

This is IMF Managing Director talking to Greek Prime Minister Lucas Papademos.

Doesn't her body language summarize succintly the entire freak show?

I know I just posted a nice piece about her but in this case, I am afraid she is with the powerful austerity boys.

Not that it matters but she probably doesn't even have a choice in this matter. The decision to feed Greece to the lions was made elsewhere and regardless of the foolishness of the proposed solution, Very Serious People (VSP) will continue with the game plan.

The Plan

The plan Eurozone ministers agreed upon calls for further austerity measures, budget cuts, salary reductions, slashing benefits and pensions to...wait for it... reduce Greek debt to 120 percent of the country's GDP by 2020.

Really? Seriously?

And the ironic part, almost all the reports I have seen about the plan caution immediately that there is chance this target might not be achieved. Including an internal report from Morgan Stanley that I have seen this morning (no link as it is not a public document) that flatly states that achieving this goal is very improbable. More to the point, Reuter's Felix Salmon and New York Times' Paul Krugman demonstrate that it is pretty much impossible (Salmon finds 159 percent of GP by 2020).

In other words, they are telling that Greek people should accept a decade of hardship, chronic high unemployment and extreme poverty and at the end there is a very good chance that all of this will be for nothing.

Moreover, these high priests of democracy are asking Greece to postpone elections as a condition for further help, because they believe that, if given the choice, Greek people might get rid of this technocratic government and vote against their generous package.
When Wolfgang Schäuble proposed that Greece should postpone its elections as a condition for further help, I knew that the game would soon be up. We are at the point where success is no longer compatible with democracy. The German finance minister wants to prevent a “wrong” democratic choice. Similar to this is the suggestion to let the elections go ahead, but to have a grand coalition irrespective of the outcome. The eurozone wants to impose its choice of government on Greece – the eurozone’s first colony.
Remember also that they first wanted to establish a Kommissar to actually run the Greek economy. Then came the escrow account idea though which all spending was going to be channelled (and stopped if and when Eurozone ministers did not wish to allow and expenditure).

They also kept asking that salaries and wages be reduced to ridiculous levels even though, not being an export-oriented economy, such cuts would hardly make Greece more competitive.
The latest German hysteria is the demand that the private sector minimum wage in Greece be cut from €750 a month to €550. As the leader of the Laos party in the Greek parliament put it: ‘They’ve put a gun to our head and said they will shoot us.’
These cuts would just depress aggregate demand further and contract the economy. Economically, they make zero sense.

Now, they have come to the point of imposing "let's just postpone elections" as a condition to provide some relief.

Can you honestly tell me that this does not remind you of Structural Adjustment Programs of previous decades?

Given my hypothesis on Structural Adjustment (see the previous link for details), that is, the goal to create perpetually struggling dependent economies with broken underclasses willing to do anything just to survive, the outrageous demands of the Troika do not surprise me.

But I fail to understand how Greek politicians bought into this disastrous course of action.

Greek Politicians Are Guilty of Malpractice

But not for the reasons you might think.

Sure, they are guilty of taking the easy money when it was offered. Guilty of using it for nepotism, for filling up state owned enterprises with their cronies and for distributing easy money and easy benefits to their supporters and others to be re-elected.

But show me a politician who doesn’t do these things. Look at American politicians. Earmarks galore. Usually with a direct correlation to campaign contributions. All military projects are divided up to as many states as humanly possible to ensure that every single one of them survive all budget cuts. And they do. These paragons of virtue pretend to never give in to nepotism but when you look at dynasties being formed in real time you know that it is all a chimera (sorry, I couldn't resist that one).

Greek politicians are also guilty of hiding the size of the debt from the EU. But we know that it was Germany and France who first contravened Maastricht rules, not Greece. If the pastor sins openly can you expect the congregation to be saintly? 

We also know that it was Goldman Sachs who told them they could hide it all and taught them how to do it. How hard is it to convince yourself that if there was a way to do it, i.e. a loophole, it must have been legal?

No. Greek people should punish them for the malpractice of keeping the process going for too long and at the end choosing the wrong solution.

Greece should have defaulted and left the Euro last year as I argued at the time. By the way I mention my past statements for continuity and not as I-told-you-so-statements, as I know that my humble soap box is more or less invisible. But Krugman, Stergios Skaperdas and a bunch of others made the same point from their much more public platforms.

That full year of haggling gave Germany and France to shore up their banks as they were very dangerously exposed to Southern debt (and especially Greek sovereign debt) and a default at the time would have been very damaging to them:
Germany and France have suggested in recent days that rescuing Greece may be necessary to safeguard the euro zone, but both countries may have a more pressing motivation in the move—protecting their own banks.

German and French banks carry a combined $119 billion in exposure to Greek borrowers alone and more than $900 billion to Greece and other countries on the euro-zone's vulnerable periphery: Portugal, Ireland and Spain.Together, France and Germany's banking sectors account for roughly half of all European banks' exposure to those countries
It also gave time to wealthy Greeks to move their euros out of the country.

At the time, a swift default and exit from Euro could have been handled reasonably well. Now, it will almost certainly be a colossal disaster.

The single most important thing their indecision did was to remove Greece's leverage about the effects of its default. At the time nobody cared about Greece defaulting, they just represent 2 percent of the EU economy. What everyone was worried about was the contagion effect that could engulf the other members of GIIPS and beyond.

In the intervening months, Germans had time to create new European mechanisms and they believe that a Greek default and exit will not trigger a run on the banks in other countries. That is why they are now playing hardball. In other words, Greece lost its primary leverage thanks to its politicians who went along with such a long process.

They also accepted a terrible deal. There is nothing in it that gives Greeks hope for the future. It destroys the economy, tears up the social fabric and turns the country into a ward of European Union. As Felix Salmon put it:
Greece is now officially a ward of the international community. It has no real independence when it comes to fiscal policy any more, and if everything goes according to plan, it’s not going to have any independence for many, many years to come.
The sad thing is, if the deal goes through, "The Plan" could become a blueprint for the rest of the GIIPS group. As Krugman has been saying, Germany's inflation expectations translate into severe deflation in the south. Now HSBC's chief economist Stephen King joined the same chorus. In other words, keeping Eurozone intact and compliant with Germany's priorities may now mean Structural Adjustment Programs being implemented all over the periphery.

What Would I do if I were the Greek Prime Minister?

If I were the Greek Prime Minister, the first thing I would do would be to reclaim my trump card, my only leverage: the contagion effect.

I would calmly tell the EU Finance Ministers and members of the Troika that my country did not intend to make its 20 March payment and would default on that day unless all its debt is forgiven and some fresh loans are given to get the economy going.

From everything you read in the media you would think that they would have a laughter fit and kick me out of the room.

Well, they wouldn't.

That's because of a ticking time bomb called Credit Default Swaps (CDS). I am sure you heard of them during the 2008 crisis. CDS are basically some form of insurance instruments, a contract that investors buy when they make an investment. If the recipient of the funds defaults, the issuer of the CDS will pay the investor.

However, unlike regular insurance these instruments are unregulated and are issued by banks without a minimum fund requirement to cover potential losses. As of June 2011, the total value of outstanding (pdf) CDS was $32,409 billion. That's 32 trillion dollars. Trillion with a "T" or more than twice the GDP of the US.

And 95 percent of these contracts were held (pdf) by five banks, JP Morgan Chase, Citigroup, Bank of America, HSBC and of course, Goldman Sachs.

In other words, if Greece, Ireland, Italy, Portugal and Spain said today "excuse us, we decided not to pay our debt, you are knowledgeable investors, you knew the risks, we paid high premiums accordingly but we can no longer put our people through this austerity rubbish, we are defaulting" these five institutions would most certainly collapse. They do not have the funds to cover even a portion of these contracts.

You can just barely imagine the implications and repercussions of such a massive financial collapse.

Actually, hedge funds have been buying up Greek debt in recent months betting on the likelihood of a default. In fact, MF Global, the fund managed by former Goldman Sachs CEO and former New Jersey governor Jon Corzine, bought a lot of Greek debt with CDS attached to them, assuming that a 50 percent "haircut" would be considered a default and therefore his fund would get paid the full amount by the issuer of CDS. But the International Swaps and Derivatives Association (ISDA) claimed that a 50 percent haircut does not constitute a default and MF Global went under.

That's because ISDA represents the interests of the issuers of CDS (i.e these five banks and some hedge funds). But if a country simply defaults, there is nothing they can do to stop the contracts from coming into effect.

An outright Greek default would very likely trigger the contagion effect because it would turn the default from being just a scary prospect into an immediate reality. As such, it would become an example for the Irish, the Italians, the Portuguese, the Spanish and would take away the scare tactics and horrible predictions associated with default. Argentine and Russia did it and they were back in the game in no time. Tiny Iceland told the banksters to take a hike and a year later they were knocking on its door to offer more credit.

Knowing this, as soon as Greece defaults unconditionally, most investors would try to get their money out of GIIPS. As you can guess, such a run on the banks and the example set by Greece would convince these countries to default as well. This domino effect would have repercussions beyond breaking up the Eurozone and shattering the EU project. It could threaten the global financial system and capitalism as we know it.

In short, if I were the Greek Prime Minister I would play chicken with Merkel and the Troika and I think they would capitulate if they believed I was serious. And faced with the kind of terrible deal they offered me I would certainly be very serious.

But if I was Lucas Papademos and I was the Governor of Greek Central Bank who collaborated with Goldman Sachs to cook the books, I would take the current deal and turn Greece into a dependent, impoverished and hopeless country.

No wonder they want to postpone elections and keep him as the Prime Minister.

People of Greece, rise up. Get rid of your politicians. And play chicken with the Masters of the Universe.

You have nothing to lose and everything to gain.

UPDATE:  Greece's bond exchange is now more or less official as Felix Salmon reports:
If you go to the official website for the Greek bond exchange, greekbonds.gr, you can now find an actual official document! The rest of the website, it says, “will be available shortly”, whatever that’s supposed to mean.
UPDATE 2: If you are curious about the Goldman Sachs shenanigans on debt hiding and how much Eurostat knew about the whole situation at the time, watch this report by BBC Newsnight's Nick Dunbar.

I always thought that it was impossible for the European Union not to know (and that is probably how the Greek politicians cooking the books convinced themselves that it was all a legal loophole). It looks like they knew and said absolutely nothing even when explicitly question about the legality of the arrangement.

Talk about hypocrisy.

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