Mish's Global Economic Trend Analysis

Greece Walks Out After 45 Minutes, Talks Collapse; Default Math: Who Foots the Bill? How Much?

Posted: 14 Jun 2015 09:22 PM PDT

Congratulations to Greece for walking out of 11th hour Troika talks. Greece is going to default sooner or later and the sooner the better for everyone involved.

The Financial Times reports Greek Default Fears Rise as 'Eleventh-Hour' Talks Collapse.

Talks aimed at reaching an eleventh-hour deal between Greek ministers and their bailout creditors collapsed on Sunday evening after a new economic reform proposal submitted by Athens was deemed inadequate to continue negotiations.

Greek negotiators, including Nikos Pappas, aide-de-camp to Prime Minister Alexis Tsipras, left the European Commission only 45 minutes after entering.

In a sign of how far attitudes had shifted, Sigmar Gabriel, Germany's vice-chancellor and head of the country's Social Democratic party — long seen as a more conciliatory political group — penned an article for Monday's daily Bild newspaper in which he warned patience towards Greece in Germany was running thin .

"The game theorists of the Greek government are in the process of gambling away the future of their country," Mr Gabriel wrote, in a thinly veiled dig at Yanis Varoufakis, the Greek finance minister who is an expert on game theory. "Europe and Germany will not let themselves be blackmailed. And we will not let the exaggerated electoral pledges of a partly communist government be paid for by German workers and their families."

Gambling Away the Future

I have no love of radical left governments, communists, etc. But I do commend anyone willing to tell the IMF to go to hell. I also commend anyone bright enough to avoid suicide, and that's what accepting the offer would mean.

If Greece defaults, as it should, it will have the opportunity to cram the entire bailout straight down the throats of the nannycrats and the IMF. All it has to do is initiate genuine reforms, make an alliance with Russia, cut taxes instead of raising them, and thrive.

Alas, the odds of genuine reform is slim, but at least it's possible. Raising taxes to run the required current account surplus to pay back creditors while Greece goes into a 10-year depression is not going to happen.

At this point, any alleged gamble is better than a zero percent chance of success.

Farce of the Day

The Bild statement "Europe and Germany will not let themselves be blackmailed. And we will not let the exaggerated electoral pledges of a partly communist government be paid for by German workers and their families" is the farce of the day.

I commented at four years ago that German taxpayers would foot the bill one way or another. Their choice, like it or not, is the same now as it was then: Write down Greek debt voluntarily, or Greece would default on it.

This position is not taking sides, it is simply a mathematical certainty based on a simple truism, what cannot be paid back, won't be paid back.

Nothing to Lose

On June 11, in "Air of Unreality"; "Do You Feel Lucky, Punk?"; Who Has the Gun? I said Greece has nothing to lose by defaulting.

I quoted Bob Dylan "When you ain't got nothing, you got nothing to lose."

I emailed that post to Financial Times writer Wolfgang Münchau but he did not respond. I do not know if he read my email or not, but I do know he agrees.

Today Münchau writes Greece has Nothing to Lose by Saying No to Creditors.

So here we are. Alexis Tsipras has been told to take it or leave it. What should he do?

First, contrast the two extreme scenarios: accept the creditors' final offer or leave the eurozone. By accepting the offer, he would have to agree to a fiscal adjustment of 1.7 per cent of gross domestic product within six months.

My colleague Martin Sandbu calculated how an adjustment of such scale would affect the Greek growth rate. I have now extended that calculation to incorporate the entire four-year fiscal adjustment programme, as demanded by the creditors. Based on the same assumptions he makes about how fiscal policy and GDP interact, a two-way process, I come to a figure of a cumulative hit on the level of GDP of 12.6 per cent over four years. The Greek debt-to-GDP ratio would start approaching 200 per cent.

My conclusion is that the acceptance of the troika's programme would constitute a dual suicide — for the Greek economy, and for the political career of the Greek prime minister.

Would the opposite extreme, Grexit, achieve a better outcome? You bet it would, for three reasons. The most important effect is for Greece to be able to get rid of lunatic fiscal adjustments. Greece would still need to run a small primary surplus, which may require a one-off adjustment, but this is it.

Greece would default on all official creditors — the International Monetary Fund, the European Central Bank and the European Stability Mechanism, and on the bilateral loans from its European creditors. But it would service all private loans with the strategic objective to regain market access a few years later.

The second reason is a reduction of risk. After Grexit, nobody would need to fear a currency redenomination risk. And the chance of an outright default would be much reduced, as Greece would already have defaulted on its official creditors and would be very keen to regain trust among private investors.

The third reason is the impact on the economy's external position. Unlike the small economies of northern Europe, Greece is a relatively closed economy. About three quarters of its GDP is domestic. Of the quarter that is not, most comes from tourism, which would benefit from devaluation.

If Mr Tsipras were to reject the offer and miss the latest deadline — the June 18 meeting of eurozone finance ministers — he would end up defaulting on debt repayments due in July and August. At that point Greece would still be in the eurozone and would only be forced to leave if the ECB were to reduce the flow of liquidity to Greek banks below a tolerable limit. That may happen, but it is not a foregone conclusion.

The eurozone creditors may well decide that it is in their own interest to talk about debt relief for Greece at that point. Just consider their position. If Greece were to default on all of its official-sector debt, France and Germany alone would stand to lose some €160bn. Angela Merkel and François Hollande would go down as the biggest financial losers in history. The creditors are rejecting any talks about debt relief now, but that may be different once Greece starts to default.

The bottom line is that Greece cannot really lose by rejecting this week's offer.

Default Math

If Greece defaults on its official-sector debt, Münchau calculates France and Germany stand to forfeit €160 billion.

And what about Spain? Portugal?

Münchau has numbers higher than my January 22, post Revised Greek Default Scenario: Liabilities Shifted to German and French Taxpayers; Bluff of the Day Revisited.

At that time, I had French exposure at €55 billion and German exposure at €73 billion (a total of €128 billion).

I also had Spain at €33 billion and Italy at €48 billion. Both of those numbers are likely way higher today. Even if my numbers are still accurate, where the hell is Spain going to come up with €33 billion? Where will Italy come up with €48 billion?

The answer to both questions is simple: they won't.

Loaded Gun

So who has the loaded gun and who doesn't?

If Greece is smart, it will not implement capital controls until the ECB shuts down the ELA, forcing the issue. Greece will then have the ECB and Germany to blame for the resultant controls.

By the way, Münchau is a staunch supporter of the eurozone and I certainly am not. Yet, we both arrived at the same conclusion: Greece has nothing to lose by defaulting.

The only people who have not figured this out are the nannycrats who believe they have a loaded gun pointed at Greece, when it's Greece that really has the gun.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com

"Last Try" in Greece Before Capital Controls: Then What? Best Case Scenario for Greece

Posted: 14 Jun 2015 10:45 AM PDT

"Last Try" in Greece

For years we have heard phrases like down to the last hour, one minute before midnight, now or never, etc. But on every previous occasion, the Troika negotiators pulled an agreement rabbit out of the hat.

So, when we read Greece Locked in 'Last Try' Talks with Bailout Negotiators it's easy to be more than a bit skeptical of the serious "final" mature of it all.

Talks between Athens and its international bailout creditors were expected to resume late on Sunday after Greek government officials were told to submit a final list of economic reforms in order to secure €7.2bn in desperately needed rescue aid.

A spokesman for Mr Juncker would only say that talks would continue on Sunday. But others briefed on the talks said the meeting had been "difficult" and that senior eurozone officials were concerned whether a deal could be reached in time for Greece to access the aid before its bailout expires at the end of the month.

"Positions are still far apart," said one EU diplomat. "It's not certain there will be an outcome." Another senior eurozone official said the Greek team returned to Brussels on Saturday without new proposals and that Sunday's evening session would be a "last try."

"Greek movement [is] not discernible," said the official. "I think they do not want a solution."

Mr Pappas, the Greek minister of state and a longtime political ally of Mr Tsipras', took to Twitter to push for politicians to become engaged in the negotiations rather than technocrats who normally hammer out such agreements. "A political solution is needed to permanently exit from the crisis," Mr Pappas wrote.

"A credible proposal needs to be tabled by the Greeks in the next 24 or so hours," said Mujtaba Rahman, head of European analysis at the Eurasia Group risk consultancy. "Otherwise it's looking like game over for Athens."

Under the creditors' plan, Athens would need to find measures to hit a primary budget surplus — revenues less expenses when interest on sovereign debt is not counted — of 1 per cent of gross domestic product this year, rising to 2 per cent next year and 3 per cent in 2017. By 2018, the primary surplus would need to hit 3.5 per cent.

"1.2 per cent was utterly feasible in late March," Yanis Varoufakis, the Greek finance minister, wrote on Twitter over the weekend of this year's target. "1 per cent infeasible after three more months of induced asphyxiation."

Primary Surplus Infeasible?

The creditors targets for a primary surplus are not infeasible, but they would amount to "induced asphyxiation".

And for what?

Every bit of that surplus would go to pay creditors. If Greece could get a primary surplus, it's best strategy is simply to default, and use that surplus for internal use rather than to pay back absurd "bailout" loans that should never have been granted in the first place.

Grexit might have cost perhaps €30 to €60 billion euros up front had the nannycrats just let Greece go when the problems first arose years ago. Two bailouts and growing Target2 imbalances ever since have turned this into a €330 billion problem, minimum.

Capital Controls Coming?

The Financial Times reports Greece Running Out of Options to Avoid Capital Controls.

Just a few months ago, the possibility that capital controls would be imposed in Greece still seemed distant.

But with the government fast running out of money — and nervous depositors pulling cash from the country's banks — talk of such extraordinary measures is widespread and analysts are warning Athens may soon be forced to employ them

"We are four to six weeks away from the possible imposition of capital controls," said Daniel Gros, director of the Centre for European Policy Studies think-tank in Brussels. "There is always some temporary solution [eurozone politicians] can pull out of thin air, but now we are getting really close."

Four to Six Weeks Away?

Four weeks is a long time. Is it a minute before midnight or not?

This is what happened in Cyprus, and it happened in a take-it-or-leave-it offer in a matter of hours, not weeks.

Under pressure from its EU partners, Nicosia [capital of Cyprus] agreed to a deep restructuring of its banking sector and a "bail-in" of large depositors — forcing them to accept bank shares for some of their cash — in exchange for a €10bn loan.

The measures took a heavy toll on ordinary citizens: under government orders, Cypriot banks were closed for nearly two weeks. When they reopened, there were tough restrictions on domestic and external payments, including a domestic cash withdrawal limit of €300 per day, a €5,000 limit on credit card payments abroad, and a requirement of central bank permission for any transfer of more than €5,000.

But the measures were ultimately credited with preventing a full-fledged meltdown of Cyprus' banks and therefore helping to keep the country in the eurozone.

Bank Meltdown

Nonsense. There was a bank meltdown and capital controls are proof of it.

To bail out the banks and the bondholders, depositors suffered massively, all for a €10 billion loan that still has to be paid back.

Capital Controls, Then What?

Here's a link I picked up from ZeroHedge. Open Europe discusses The how, what, when and why of Greek capital controls.

How would Greek capital controls be implemented and what form might they take?

It's likely that such controls would need to be brought in over the course of a weekend, though I expect they may also need to be combined with some bank holidays anyway.

Cash/ATM withdrawal limits: This would be a vital control in order to halt the huge outflow of deposits which has been taking place and which will pick up if a deal isn't struck soon. In Cyprus the limit was set at €300 per person per day. However, I suspect ones in Greece may go even lower. This is because Greece is suffering from serious domestic withdrawals while the primary concern in Cyprus was foreign outflows.
Foreign transfer controls: The aim here would be to limit the amount that people can transfer abroad from Greece in one go and also over a set period. Obviously some transfers are needed for businesses to function so there would need to be a process by which businesses related (and other verified) transactions could still go through.
Time requirements or taxes: Other options or versions of the above include taxing certain withdrawals or foreign transactions heavily. This has the advantage of potentially creating a revenue stream for the government, though it may come at a very high cost. The government could also decree time limits on certain deposits or investments in an attempt to limit withdrawals indirectly.
Physical controls: Obviously with free movement within the EU it would be quite easy for people to move large amounts of cash or assets across borders. As such there will need to be checks and limits on the amount of cash people can take abroad with them. This may also have to extend to assets. For example, someone could purchase a car and then try and drive across a border and sell it on. This is tricky to police but some attempts may well be made.

What's the Aim Capital Controls?

The more interesting discussion is the "What's the Aim?" question. I generally agree with the Open Europe writer Raoul Ruparel on this one.

Why would Greece go for capital controls?

This seems an obvious answer given all of the above – to halt bank runs and stop money flowing out of the economy. But there is a wider question that needs to be answered. What would be the aim and end goal of capital controls? Ultimately, capital controls are only really of use when it comes to buying to time or pushing through some tough policies. In Cyprus and Iceland the controls were needed to impose tough write downs on foreign depositors/investors but stop huge outflows of money. But the actual write down was over fairly quickly. But in Greece the problem is a long term malaise and huge uncertainty over its future position in the Eurozone – not a singular one off event for which time needs to be bought.

In the end then, I find it hard to see why the Greek government would want to go for capital controls. They would only be of use if we got to the stage where a deal was close but couldn't be struck in time. But if we get to that it will be because the differences between Greece and its creditors could not be solved over the past 6 months. It's not clear that a few extra days, weeks or months under capital controls would drive an agreement. It's also not clear why the government would want to put the economy and people through the pain of such controls to then just agree a deal. Why not just agree one now? Surely, it doesn't seem likely that Greece's negotiating hand would be stronger under such controls?

So, while capital controls are technically possible, I have failed to see any clear answer as to why they would actually desirable, especially from the Greek perspective.

That is why I believe that capital controls would most likely be a prelude to a Grexit. At least here they would serve a clear purpose – allowing time for the transition to a new currency to be organised and negotiated. They would likely need to be even more stringent and probably involve longer term bank holidays. Therefore, when capital controls start to become seriously discussed, it is probably quite a negative sign.

Aim of Dragging Out the Talks

My disagreement is the last sentence. I find it hard to believe capital controls are not already seriously discussed - by four groups: Greece, Germany, IMF, ECB.

Greece and the ECB are the important ones. If the ECB shuts off Emergency Liquidity Assistance (ELA), Greeks will not be able to withdraw cash.

I propose it's likely that Greek Prime Minister Tspiras purposely dragged out the talks for the express reason of giving people time and reason to withdraw cash. While the negotiations were underway, all to no avail, Greeks pulled money.

Unless there is a disorderly mad dash for the exit, the ECB may allow this to continue. We will find out soon enough tonight. But at some point (and I expect far sooner than four weeks from now), Greece will be forced to impose them as soon as ELA is shut down.

Bottom line: If you still have money in Greek banks, you are begging for a haircut.

By the way, capital controls are in violation of EU rules. Then again, what nannycrats cares about rules?

Best Case Scenario for Greece?

I outlined the "best case scenario" for Greece in "Air of Unreality"; "Do You Feel Lucky, Punk?"; Who Has the Gun?

Best Case Scenario

Greece defaults.
Greece sheds €330 billion worth of debt.
Greece opens up trade with Russia, killing EU sanctions once and for all (and exposing the stupidity of the unanimous nature of EU rules in the process).
Greece threatens to yank US access to the US military base in Crete.
Russia builds pipeline through Greece. In turn, Greece collects shipment and storage fees.
Russia provides interim funding for Greece until Greece runs a primary account surplus.
The interim agreement from Russia requires Greece to initiate some market reforms that will pay big dividends down the road.
Greece reforms and does very well in a relatively short time frame.
Italy, Spain, Portugal, get some clever thoughts of their own.

Default the Best Option

Whether or not Greece chooses to quickly get to a primary account surplus position so that it can stay in the eurozone, it's best option is to default.

And if it defaults, capital controls will come as soon as the ECB shuts off ELA (if not before). That discussion has to be going on at the ECB right now.

Meanwhile every day that passes by without capital controls is another day Greek citizens have to get their money out of the banks.

Why there has not been a mad dash for the exit instead of a slow bleed of cash remains a mystery.

Finally, the real fear of the nannycrats has to be that the best case scenario for Greece does indeed happen, proving what any sensible person knew all along: Exit is possible, and there is life after the eurozone.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com

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Sunday, June 14, 2015

Mish's Global Economic Trend Analysis

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