Thursday 29 September 2016

Like Wile E Coyote, Greece is in a state of suspended animation over the cliff

Allister Heath

Published 08/07/2015 | 02:30

'Short term, Grexit will be traumatic, wiping out the assets of middle-class Greeks'
'Short term, Grexit will be traumatic, wiping out the assets of middle-class Greeks'

Plus ça change, plus c'est la meme chose. We are fond of French sayings, for good reason: the Greeks have just voted, in dramatic fashion, to defy the European establishment, and hardly anything happened. Sure, the equity markets and the euro fell slightly, and bond yields rose, but Lehman Brothers-style chaos was avoided. It was just a normal, bad day in the markets. Given the seismic nature of the event, and the fact that opinion polls had been so wrong, the fallout was eerily minimal.

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The only surprise was that anybody was surprised: a day later, Greece remains a sclerotic, over-regulated economy; it still requires tens of billions of euros in debt write-offs; its banks remain illiquid and shut (now at least until tomorrow); the country will run out of essential supplies by the weekend at the very latest; and the eurozone remains torn about whether it should surrender to the Greeks or inflict an exemplary punishment upon them.

The Greek opposition has backed the government on its negotiation, demanding write-offs and debt restructuring as part of any new deal, while the French have been making dovish noises, but other than that, we are where we were last week. Even the news that the US wants Greece to stay in the euro, presumably to prevent the country from falling under Russian influence, is merely a restatement of its existing position.

The real day of reckoning has merely been delayed. One of the European Central Bank's jobs is to provide liquidity to the banking system when it needs it by handing over euros while requiring this funding be guaranteed against the Bank of Greece's assets. Given that commercial banks have almost run out of cash, and the run from panicked depositors, Greek banks are desperately reliant on this liquidity support.

The catch is that the ECB over-collateralises its lending: it assumes the real, safe value of the Bank of Greece's assets - mortgages and loans, in the main - is worth far less than their face value. As countries get riskier, the haircut is increased, as it was last night, which means that it becomes harder for the ECB to justify extending any additional liquidity. Needless to say, all of this is hugely controversial, with endless arguments about the size of the haircut or whether there should even be one, and is the reason why a lender of last resort inevitably becomes a major political player in a crisis, especially when it is based overseas.

The issue is not just about liquidity, of course, but also solvency: as even the International Monetary Fund has pointed out, Greece will probably need €70bn in bail-outs over the next three years if nothing changes.

The immediate issue for Athens' finances is less about spending cuts - though the Greek state remains bloated, inefficient and corrupt - but about the burden of the accumulated stock of debt, worth 180pc of GDP and rising because of deflation.

Rather than resorting to French sayings, or even invoking Greek mythology, the best way to illustrate what is happening is to turn to the cartoon physics of Wile E Coyote. Like the Warner Brothers' 'Looney Tunes' character, who was able to defy gravity for what felt like an eternity when running over a cliff, Greece is in a state of suspended animation. It will eventually fall off, with monumental consequences, but for the time being the world is in awe, wondering how exactly it is managing to delay the inevitable.

Alexis Tsipras, the Greek prime minister, is clearly a brilliant operator: not only did he engineer a triumph in his referendum, temporarily consolidating his position, but he also eased out Yanis Varoufakis, his finance minister. The proximate reason for Varoufakis's departure was his interview with my colleague Ambrose Evans-Pritchard, published on Monday, where he floated the idea of Greece issuing "parallel liquidity and California-style IOUs".

But Mr Varoufakis's removal had a hugely calming effect on the financial markets, something which Tsipras undoubtedly realised when he took action.

In reality, while Mr Varoufakis used inflammatory language, his successor Euclid Tsakalotos, while more diplomatic, is a Marxist Eurosceptic who will be just as unlikely to see eye to eye with Germany.

The can could be kicked further down the road, of course, and some sort of shoddy compromise found ahead of July 20, the next firm deadline and the date on which Athens is meant to hand over €3.5bn to the ECB.

But this would merely sow the seeds for the next crisis, and embolden the Greek Left. Syriza's favourite solution would be a write-off without leaving the euro, but that is a non-starter, for two reasons: first, it would inflict big losses on EU taxpayers, infuriating Germans who were told they would never be forced to pay for others' profligacy when they gave up the Mark; and second, because once one country is allowed to write off debt while staying in the euro, others would be bound to ask for the same privilege.

All of which points to one outcome: a Greek departure from the euro, accompanied by a massive default. German taxpayers will be forced to face up to their massive losses, but at least the Greeks will be out of the single currency.

In the short term, Grexit will be traumatic, wiping out the assets of middle-class Greeks and threatening hyperinflation; over time, however, a more competitive Greece could thrive but only under a more sensible, pro-capitalist government.

Cartoon physics can only work for so long; even Wile E Coyote wasn't immune to the laws of gravity forever. (© Daily Telegraph)

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