The good news from Greece

Financial Mirror (Cyprus) - - FRONT PAGE - 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 panEuro­pean 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 breakup, 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 over­come what could be de­scribed as has 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 sidestepped 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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