The $300B Elephant In The Acropolis: The Greeks Can’t Pay, Euro Politicians Are Afraid To Forgive

The Greek Conundrum

As you can see above, we have created a new term describing deliberations regarding the possibility of a Greek default combined with an exit from the euro area. The reason why the time for the term “Grexitology” has come is that opinions on Greece’s future in the euro zone are plentiful and are covering the entire imaginable range, from “it would actually be a good thing” (getting rid of the weakest link in the euro chain) to “it won’t happen” to “it doesn’t matter” to “it will bring about the end of the world”.

In the latter category we find the always dependable Ambrose Evans-Pritchard, pronouncing imminent doom. He thinks that everybody is too complacent about the “contagion danger” in light of financial markets so far confining their negative reaction to Greek bonds and stocks instead of meting out more broad-based punishment (e.g. Spanish and Italian government bond yields have so far barely budged from recently attained all time lows). He believes that unless Spain and Italy are getting into trouble as well, the German government just doesn’t care what happens with Greece.


Alexis TsiprasAlexis Tsipras: with these here hands I will tear up the bailout agreement…or not. What day of the week is it?

Photo credit: Remy De La Mauviniere / AP

We don’t want to get into his views into too great detail here. Some of what he writes is surely correct in a descriptive sort of way, but there is a constant insinuation that somehow, more money printing would “fix” everything, along with a “fiscal union”. This amounts to saying that the problems caused by credit expansion and reckless spending should best be tackled by even more credit expansion and reckless spending, a view we strongly disagree with. Anyway, Pritchard concludes by saying:

“Should EMU leaders choose to cut off liquidity support for the Greek banking system – forcing a return to the drachma – they might find that their contagion defenses are a fiction.”

However, Pritchard doesn’t mention an important point: 80% of Greek government debt is nowadays held by public creditors (the ESFS, the IMS and the ECB through the SMP) – European banks are barely exposed to Greek sovereign risk anymore (in fact, much of the tradable Greek debt has been bought by hedge funds if memory serves).

This is probably the main reason for the nonchalance currently exhibited by markets and EU politicians alike. Greek government bond yields do however reflect growing worries – they are at new highs for the move across the yield curve – and the curve has once again inverted. Below are daily charts of 10 year and 3 year Greek post PSI/bailout agreement bond yields (it needs to be remembered that trading in the previously outstanding bonds has ceased in 2012 – they were replaced with new bonds after the private sector haircut and the second bailout agreement. At the 2011 and 2012 peaks, short term Greek government debt yielded nearly 300% and 10 year yields reached 42%):


1-Greece 10-Year Bond Yield(Daily)Greek 10-year yields are at a new high for the move.


2-Greece 3-Year Bond Yield(Daily)-annFor comparison purposes, here are three year yields, which have risen considerably more than the 10 year variety and are now at 13.76% – almost 400 basis points more. The inverted yield curve is a strong sign that market participants are getting antsy about Greece.


The problem is of course that at the moment, it is widely expected that SYRIZA will win the election. It may not achieve an absolute majority in parliament (in spite of getting 50 extra seats), so it may take a while for a government to be formed. However, the most recent bailout tranche has not been paid to Greece as scheduled: negotiations were postponed due to disagreements over further spending cuts. Shortly thereafter, Antonis Samaras’ presidential candidate failed to get the necessary support in the third round of voting, which in turn has forced parliament to be dissolved and a snap election on January 25 to be announced. Regardless of who wins the election, it will probably take some time to form a new government, and without one, there is no-one to negotiate with.

What Does Alexis Tsipras Want?

The noises from Germany’s political circles about the euro-zone being able to withstand a Greek exit are actually an opening gambit in the EU’s negotiations with Alexis Tsipras. By telling him in advance “we don’t care”, they hope that he will lose some leverage – not least because polls continue to confirm that a very solid majority of Greece’s citizens (between 75 to 80%) want to retain the euro. It is understandable that people who once had to live with the drachma want to keep the euro.

As we have pointed out previously, Mr. Tsipras has fairly recently held meetings with various EU bigwigs, including Mario Draghi. A Greek prime minister-in-waiting meeting with Draghi is the functional equivalent of a medieval ruler seeking an audience with the pope. Nevertheless, no-one seems to really know what Tsipras actually wants. They are even making jokes in Greece about his constant zig-zagging:


“Greek political analyst Elias Nikolakopoulos is a man who doesn’t shy away from strong opinions. He regularly provides astute commentary on the state of Greek politics. But when it comes to Alexis Tsipras, the pundit is sometimes at a loss for words.

Nikolakopoulos considers it “very likely” that Tsipras, together with his radical left-wing alliance Syriza, will win snap elections on Jan. 25. At the same time, he also believes Syriza is likely to maintain the European common currency. “We will stick with the euro, no doubt,” he says. Yet he also warns against pressure and threats from Brussels or Berlin, which he argues would be counterproductive and at best serve to further unite the left wing in Greece.

Still, the veteran analyst is at a loss when it comes to questions about what Tsipras plans to do once elected or just how credible he truly is. “I can’t answer that,” Nikolakopoulos says, smiling a bit helplessly.


Members of the current conservative government have joked that Tsipras’ positions are indeed clear. “On Tuesdays, Thursdays and Saturdays he wants to stay in the euro zone, but on Mondays, Wednesdays and Fridays we’re back on the drachma, and on Sundays he wants a referendum,” they say.

Even for election researcher Nikolakopoulos, a vote for Syriza is slightly reminiscent of “Russian roulette”. Voters just don’t know what they are getting. He says that was also true of the 1981 election, which saw the rise of Socialist Andreas Papandreou to power on a raft of lofty promises that ultimately went undelivered. Greece didn’t leave NATO, for example. Instead it joined the European Economic Community. Nor did it kick US troops stationed in the country out of Greece. Nikolakopolous also believes that Syriza, the party of radical leftists, “will become better behaved by the hour once it gets closer to power.”


(emphasis added)

The reason why Tsipras’ intentions are so difficult to read and his statements so often seem contradictory is probably the fact that SYRIZA itself is actually a broad coalition of smaller leftist groups. These include everything from Maoists to slightly more centrist leftists. We conclude that he is tailoring his messages to the different audiences he needs to keep happy. A hint as to why he may think this necessary is provided by a statement recently made by another important figure in SYRIZA:


“Panagiotis Lafazanis, the leader of the influential left-wing of the party, has been clearer in his statements. “We want to exit the euro and a complete break with the totalitarian EU,” he announced.


Tsipras cannot say that out loud, as such a statement could easily lose him the election. So he is vacillating between wanting to negotiate with Brussels and “tearing up the bailout agreement” (without ever mentioning the toxic word “drachma”). The problem remains though that no-one can say with certainty what Mr. Tsipras himself actually wants – or what he can get his party to accept.


A Mexican Standoff

What has Mario Draghi told him? Very likely he has reminded him that the Greek banking system remains dependent on the ECB. Should another run on deposits occur in Greece, the ECB will have to give its nod to the provision of ELA (emergency liquidity assistance) – whereby commercial banks can obtain liquidity from an NCB in the euro system by simply issuing IOUs in return.

As to the EU, there are probably behind-the-scenes deliberations over the possibility of negotiating a deal that allows everybody to save face, although that will be quite tricky. Giving up on Greece would make its bailout one of the biggest and costliest failures of interventionism in history (if not the biggest one). Greek government debt held by the ESFS and IMF amounts to € 240 billion, as they have essentially funded all debt rollovers in recent years, plus the deficit. On the other hand, the EU’s “fiscal compact” and the fact that numerous countries in the euro area are forced to cut spending means that no politician will be very eager to provide any additional leeway to Greece in the form of debt write-offs or funding beyond the agreed on amounts. That’s a non-starter.

Upon closer inspection it is really is a Mexican standoff though. On the one hand, the EU – in spite of the rhetoric – would lose out big by not being able to continue the extend-and-pretend scheme that has been hatched to “solve” the problem of the insolvency of Greece’s government. The losses would be crystallized, and the era of pretending that they are not real would be over. On the other hand, Mr. Tsipras has made promises to his voters he cannot keep regardless of what he decides to do.

SYRIZA is a leftist party and wants to roll back reform, which inevitably will mean more government spending. More government spending is completely out of the question according to the existing bailout agreement. However, it would be just as impossible if Greece were to default unilaterally. A unilateral default would definitely lead to a bank-run, along with the ECB cutting off funding to Greek banks in short order. An exit from the currency union would then become unavoidable. The Greek government would be shut out of the capital markets. This could (it doesn’t have to, but it seems definitely possible) lead to a scenario such as the following:

A large swathe of Greece’s private sector would soon find itself unable to service and/or refinance its external debt, as the new drachma would probably nosedive. Bankruptcies would soar, the incipient economic recovery would be aborted and the government’s current primary surplus would likely disappear in a flash. The temptation to print more drachma would be vast – and this could lead to a hyperinflation-type conflagration not too far down the road.


3-ATG,dailyGreece’s stock market has by now given back the entire gain made between the summer of 2013 and March 2014 – a huge move in percentage terms – click to enlarge.


So one should perhaps also ask another question as well: not only “what does Tsipras want”, but also “does he actually understand what could potentially happen”. We hasten to add that Mr. Tsipras is perfectly correct about one point: the country’s debt is too large, and Greece cannot possibly ever pay it. It would have been best to write this unsound debt off right away. However, it is clear why in the end no EU politician wanted to risk an outright government default of a euro area member: this would have established a precedent that all modern-day welfare states want to avoid.

After all, Greece’s government debt is not the only “extend and pretend” debt out there, it is just one of the more egregious examples. In reality, almost the entire world seems to be de facto bankrupt upon closer inspection. The fiat money system makes it possible to pretend that it isn’t, which will continue until it doesn’t anymore (i.e., as long as it takes for confidence to be lost in a major country – Japan remains high on this list). From the perspective of European governments, there were powerful incentives to create a special dispensation for Greece, tied to conditions so as to make it more palatable to voters.



It is hard to say what will actually happen after the Greek election. Not even the assumption that Syriza will win can be taken for granted, as its lead is small. Assuming that it does win, it should be remembered that there have been many historical instances of political leaders deciding to take steps that later turn out not to have been the most rational ones. “It seemed a good idea at the time” is a thought that has surely crossed many a mind at some point.

It is erroneous to believe that anything can be gained by adopting a less sound currency (even though all fiat currencies are unsound, there are still qualitative differences between them). On the contrary, it must be expected that living standards in Greece would decline sharply if an attempt were made to devalue the country back to prosperity.

It is also hard to say what the wider effects of a unilateral default would be; it seems almost certain though that there would be a number of currently unexpected or underestimated consequences. Other EU member states and the IMF would have to take very large write-downs, which would transform some of what are currently only contingent liabilities into actual ones. At that point the markets may well reconsider their hitherto relatively sanguine reaction to events in Greece. Stay tuned.
Charts by:, BigCharts