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Marcuard's Market update by GaveKal Dragonomics
Greece has reopened its banks, paid its dues to the European Central Bank and cleared its arrears with the International Monetary Fund. After five years of pan-European economic depression and the near-death experience in Greece this month, can we finally say that the euro crisis is over? The conventional answer is definitely not.
According to the vast majority of political commentators and economists, ranging from left-wing Keynesians such as Joseph Stiglitz and Paul Krugman, to conservative monetarists like Wolfgang Schauble in Germany and Charles Gave here at Gavekal, the Greek bailout was little more than an analgesic. It may dull the pain for a short period, but the deep-seated malignancies of the single currency project will continue to spread like cancer, with a dismal prognosis for the euro and perhaps even for the EU as a whole.
Luckily for Europe, and for risk assets around the world, these prophecies of doom are likely to prove wrong. In the end, the painful and chaotic negotiations of recent weeks may actually have produced a tolerable deal for both Greece and the rest of the eurozone. Far from marking the beginning of a new phase of the crisis, this settlement may go down in history as the end of a long series of desperate political gambles that ultimately created the conditions for economic recovery across Europe by correcting some of the worst design flaws introduced into the single currency by the Maastricht Treaty’s misguided monetary and fiscal rules.
To express guarded optimism about the Greek deal is not to condone either the provocative arrogance of former Greek finance minister Yanis Varoufakis, or the pointless vindictiveness of Schauble, his German opposite number. Their unnecessary feud, fuelled by personal vanity, inflicted enormous costs on both countries. Nor is it to deny economic criticisms of the bailout provisions levelled both by progressive Keynesians like Stiglitz and by conservative monetarists like Hans-Werner Sinn.
The arguments against creating a European single currency in the first place, and then against allowing Greece to cheat its way into membership, were absolutely valid back in the 1990s, and in theory they still are. But this does not mean that breaking up the euro would be desirable, or even tolerable, in practice today. Joining the euro was certainly ruinous for Greece, but there is always “a great deal of ruin in a nation,” as Adam Smith remarked almost 250 years ago, when the loss of its American colonies appeared to threaten Britain with financial ruin.
The great virtue of capitalism is that it adapts to ruinous conditions and even finds ways of turning them to advantage. The US in the mid-19th century was very badly suited to a single currency and a single economic structure, as demonstrated by the civil war, which was provoked as much by single currency tensions as by moral abhorrence of slavery. Italy would probably be better off today if Giuseppe Garibaldi had never unified it into a single economy. But once unification has happened, the pain of dismantling the political and economic settlement usually overwhelms the apparent gains from a break-up, at least in the eyes of the citizens and political leaders of the time. This seems to be the case in Europe today, as clear majorities of voters are saying in all euro countries, including Germany and Greece.
Thus the question that should have been asked throughout the euro crisis was not whether the single currency would break up, but rather what political reversals, economic sacrifices and legal subterfuges would be needed to prevent a break-up.
The good news is that Europe now has some persuasive answers. The bad news is that the Greek government, in its flirtations with academic game theory, completely misjudged its negotiating strategy. Instead of taking the deal on offer last January—an exchange of symbolic political concessions by Greece for debt relief by Europe on terms very similar to those now accepted by prime minister Alexis Tsipras—Athens completely misjudged the four pre-conditions necessary for a successful bailout; conditions which now promise to stabilise the Greek economy and the euro, despite last week’s widespread scepticism.
1) First and foremost, Europe has overcome what could be described as the “original sin” of the single currency project. This was the Maastricht Treaty’s prohibition against “monetary financing” of government deficits by the ECB and the related ban on national governments mutually supporting each other’s debt burdens. In January, ECB president Mario Draghi effectively side-stepped both these obstacles by announcing a quantitative easing programme so enormous that it will finance the entire deficits of all eurozone governments (in theory now including Greece) and that will, in addition, mutualise a significant proportion of their outstanding stock of government bonds.
2) Secondly, European governments have belatedly understood the most basic principle of public finance. Government debts never have to be repaid, provided they can be rolled over in an orderly manner or monetised by a credible central bank. But for this to be possible, interest payments must always be made on time and the sanctity of debt contracts must always take precedence over electoral promises on pensions, wages or public spending. Now that the Tsipras government has been forced to acknowledge the unqualified priority of debt service obligations, Greece should have no great problem supporting its debt burden, since this is no heavier than Japan’s or Italy’s and can now benefit from unlimited monetary support from the ECB.
3) Thirdly, the domestic politics of Germany, Spain, Italy and several northern European countries, required a ritual humiliation of radical Greek politicians and of the voters who openly defied the EU’s institutions and austerity demands. Having achieved this, EU leaders have no further reason to impose austerity on Greece or to strictly enforce the terms of this month’s bailout. Instead, they have every incentive to demonstrate the success of their “tough love” policies by easing austerity to accelerate economic growth, not only in Greece but across the whole eurozone.
4) This leads to the final issue which the Tsipras government, along with many commentators, naively misunderstood throughout the Greek crisis: European political economy always relies on what might be described as “constructive hypocrisy”. In any political system, there is a gap between public declarations and genuine intentions. But in the complex multi-national structure of the EU, this gap becomes an enormous gulf. On paper, the Greek bailout will impose a fiscal tightening, thereby aggravating the country’s economic slump. But in practice, Greece’s budget targets will surely be allowed to slip, provided the government carries out its promises on privatisation, labour market and pension reform. These structural reforms are far more important than the fiscal targets, both in symbolic significance for the rest of Europe and for the Greek economy itself. Moreover ECB monetary support, which can now be extended to Greece, will transform Greek financial conditions, drastically reducing interest rates, allowing banks to recapitalise, and gradually making private credit available for the first time since 2010. This easing of conditions for private borrowers could easily compensate for any modest tightening of fiscal policy, even if budget targets were strictly enforced by bailout monitors, which seems unlikely.
In short, the essential conditions now seem to be in place for a sustainable recovery in Greece. Majority opinion among economists and investors has a long record of failing to spot major turning points; so the near-universal belief today that Greece faces permanent depression is no reason to despair.
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