Rejecting Austerity Means the Germans Must Blink

Tongues are wagging today about a Greek withdrawal from the euro sooner rather than later. The Wall Street Journal:

NEW YORK—U.S. blue-chips were on pace for their eighth loss in nine sessions, as worry mounted about Greece’s possible exit from the euro zone.

The Dow Jones Industrial Average lost 92 points, or 0.7%, to 12728 in midday trading. The Standard & Poor’s 500-stock index declined 10 points, or 0.7%, to 1343 and the Nasdaq Composite shed 17 points, or 0.6%, to 2916.

Art Cashin:

Many floor types think that there is a kind of “rationality put” in the markets. It evolved in the post-Lehman chaos. The premise goes something like this: world leaders were shocked and stunned by the scope and size of the nearly instant damage from Lehman’s fall. That shock caused them to rescue AIG, a far, far bigger project than Lehman.

Since then, central banks and governments have stepped in quickly as each new crisis emerged. (Think things like QE; LTRO; the first Greek bailout, etc., etc). As long as the crises remained in the financial arena, they could be softened and postponed (not cured). Now it is likely there will be a new Greek election and the risk that the Greeks may see it as a chance to make a loud and clear anti-austerity statement. Others, however, seeing the proximity of payment deadlines, and such, may see it as a vote on exiting the Euro.

The smart kids think that everybody including the Greeks are bluffing:

Is a Greek departure from the Eurozone imminent? The smart set in the world media seems to have decided overnight that it is, but I’m not so sure.

The key player, pictured above, is Alexis Tsipras the 37 year-old leader of Syriza, the Coalition of the Radical Left. Greek politics has long been dominated by to main parties, the center-right New Democracy and the center-left PASOK both of which are more patronage networks than real ideological parties. Then off on the far-left was a Communist Party. That party, like many European Communist parties, split between a Moscow-dominated faction and a more independent-minded Eurocommunist tendency. Syriza is coalition of far-left parties with the Eurocommunist faction of the old Communist party at its held. Tsipras, at the age of 37, is obviously too young to be a cold warrior but the point is that the party’s origins are outside of the Greek mainstream. Except that at the most recent elections Syriza emerged as the second-largest party—bigger than PASOK—and even a New Democracy / PASOK grand coaltion couldn’t govern without Syriza participation. Syriza refused to participate, and Greece now looks to be headed to new elections in which Tsipras will do even better.

So what’s his view?

Well on the face of it, his policy makes no sense. He says he rejects the EU-imposed austerity program but wants to stay in the Euro and in the European Union. But Greece has a large primary budget deficit and no source of market financing. The EU is insisting on an austerity program, but it’s also giving them cold hard cash in the interim. Reject the austerity program and you lose the EU/IMF money and need to implement an even harsher austerity program. Tsipras is a bit like a guy standing in your living room threatening to blow his own brains out unless you pay him money, a proposition he offers on the theory that you’d rather not see your furniture ruined.

I have a question for anybody who thinks that austerity for Europe, particularly for Greece, is a bad policy, austerity presumably defined as taxing more and spending less. Austerity is the price that the French and German bankers and European central bankers are demanding of Greece to continue lending money to Greece. If Greece leaves the euro, the new drachma will, presumably, have a value 30 to 50% lower than the euro it replaces and Greece will experience even more austerity than they are under the extend and pretend scenario that’s been going on for well over a year.

What’s Greece’s alternative? I think the only other alternative is for Germans to blink and accept a Greece that spends more than it produces, much of that spending being money “borrowed” from Germany. Needless to say the Germans don’t think much of that plan.

Update

Here’s Felix Salmon’s take:

Up until now, only pariah countries have defaulted to the IMF, but Greece is the exception to many rules. And given the choice between default and devaluation, it seems to me that Greek politicians — and the Greek population as a whole — clearly prefers the former to the latter.

Once you strip out Greece’s debt payments, the country’s primary deficit is pretty modest — just 1% of GDP or so. So could Greece make one more round of cuts, default on all its debts, and remain within the Eurozone?

I think the answer is no — and the reason is the banks. If the ECB were to stop funding the Greek banks, and if Greece were to default on its debts, all of Greece’s banks would be insolvent. And you can’t have a functioning economy without banks. Basically, Greek depositors need to be able to withdraw something from their checking accounts. And if the EU stops supporting the banks, that something can’t be euros any more.

It really appears to me that exiting the euro, in all likelihood shortly followed by other countries, is not only in Greece’s future but in Greece’s interests. But even default, exiting the euro, and devaluing is likely to mean more austerity for Greece. Unless the Greeks want to risk becoming Zimbabwe on the Aegean.