This morning, Greece introduced capital controls. People can only withdraw €60/day ($65) from their bank accounts. The government has also called a referendum on Sunday, after Eurozone talks on a new bailout package collapsed.
The key issue is that Greece will never be able to repay its debts. These are currently estimated at €322bn ($365bn) – far larger than its economy, which is only $238bn after having shrunk by 25% since 2008. Greece also needs new money to be invested in the country, if it is to make a new start and fund new growth.
If Greece was a company, everyone would know what needed to be done. The business would have to be put into bankruptcy; debt-holders would have to write off some debt and swap the rest for equity; and a new business plan would have to be developed to be funded with new money from existing and new investors.
But Greece isn’t a company, of course. And today’s politicians don’t like to take hard decisions or to deliver difficult messages to their electorates. This is why I feared 2 weeks ago that the “Slow motion Greek train wreck was getting ready to hit another buffer‘. The heart of the problem is very simple:
- Political union in the Eurozone was essential if economic and monetary union was to succeeed
- But although this was rejected by France in the 1990s, the Eurozone project still went ahead in 1999
Politicians instead pretended that political union existed, and banks have since lent vast sums to Greece. And although it has been clear since 2009 that these loans cannot be repaid, they failed to explain this to their electorates. Instead the Greek and Eurozone leaders decided to extend repayment to 2050.This policy of “pretend and extend” means Greece is now bankrupt on an epic scale.
None of us can now know what will happen next. But we can assume Eurozone politicians will continue to try and avoid telling their electorates what has been done in their name. The German part of the bill could easily be €86bn, and in a worst case could be the entire €322bn according to the respected IFO Institute.
But the game of “Pretend and Extend” is clearly complicated by the involvement of the IMF. It is not allowed to lend to countries who cannot repay their loan, and it has powerful members outside the Eurozone in Asia and Latin America, who want it to enforce this rule. Thus Christine Lagarde, the head of the IMF, told CNBC yesterday:
“Our objective is clearly to restore the financial independence, the stability of Greece – to make sure that growth can start again. And that Greece can be sustainable from an economic and financial standpoint. As I’ve said, it is a balancing act. There has to be measures taken by Greece, there has to be support by the Europeans. And they come in sequence. Measures have to be taken, they have to be implemented. And that triggers a different attitude and a willingness to look at both financing and debt sustainability.”
The IMF is thus coming out on the side of those who want realism to be injected into the debate. The Greeks have to develop a functioning tax system, and realistic social policies. In turn, the Eurozone governments have to agree to write off debt and finance the new start. That is the real meaning of Ms Lagarde’s emphasis on the need to look at “both financing and debt sustainability” in sequence.
This is why the concept of political union should have been agreed alongside economic and monetary union. But today, German taxpayers face a different decision – and one that has not yet been explained to them. This is simply that if they don’t refinance Greece, they stand to lose all the money that has been lent to Greece in their name.
Greece’s decision to hold a referendum highlights the impasse that has been reached:
- Greece can only implement one side of the necessary deal – reforming its taxation and spending policies. It cannot come up with the new money needed to reverse the current decline in its economic performance
- The Eurozone is in an equally bad position, as it cannot force Greece to undertake this restructuring. And so it may end up having to write off the Greek debt, and getting nothing in return
This is always the problem with ‘pretend and extend’ policies. In the end, reality has a habit of intruding.
WEEKLY MARKET ROUND-UP
My weekly round-up of Benchmark prices since the Great Unwinding began is below, with ICIS pricing comments:
Brent crude oil, down 40%
Naphtha Europe, down 40%. “Values are coming down gradually from recent highs as the product is long and its use in summer gasoline blending is limited”
Benzene Europe, down 39%. “There is still a steady stream of imports moving into the region from the Middle East and India. As a result, some traders believed that this would readjust the current supply/demand dynamic before long”
PTA China, down 29%. “The two major producers Yisheng Petrochemical and Hengli Petrochemical currently have no plans for any run rates reduction in July. This was largely to faciliate cash flow, several market participants added”
HDPE US export, down 19%. “Domestic export prices slipped during the week on oversupply, verified by industry data released on Friday.”
¥:$, down 21%
S&P 500 stock market index, up 8%