“We should not forget the historic nature of what is at stake.
“Its about whether a country can leave the euro zone and what that means for the future of an incomplete and flawed European Monetary Union.
“Its about whether there may soon be a failed state in southeastern Europe with all the geopolitical consequences that could entail in a fragile region.
“Its about whether the EU’s 58-year-old project of “ever closer union” goes into reverse, and whether the objective forces of economic divergence finally overwhelm the political will on which the euro was founded.
“The United States, China and Japan understand what’s at issue and all have expressed concern that Europeans should find a solution to keep Greece in the euro. Yet at this point, that does not appear the most likely outcome…..
“If European leaders effectively abandon a defiant Greece to its fate, neither the euro zone nor the European Union will be the same again. Some, notably among the growing ranks of Eurosceptics around the continent, will think that is for the better. The glee with which Nigel Farage, Marine Le Pen and Geert Wilders greeted the prospect of the unravelling of European integration may give euro zone leaders pause.”
This summary from Reuters’ vastly-experienced European Affairs editor, Paul Taylor, expertly sums up the real issues at stake in Sunday’s final Eurozone summit on Greece.
These have been largely ignored in the on-going arguments about Greece’s debt. Debate has instead focused, understandably enough, on the fact that the Greeks have managed to borrow large amounts of money, at least €322bn ($365bn), and cannot possibly ever repay it. Even worse, the various Greek governments appear to have done nothing to reduce their future spending, or indeed, even to raise a more sensible amount of tax.
It is no wonder that only 10% of Germans want to handover more money to the Greeks, given the history of previous loans. The word for debt in German, “Schuld“, also means “guilt” – and it is understandable that Germans and others across Europe now see Greece as a morality play, where the guilty need to be punished for their crimes.
Yet, with all apologies to my many German friends, this is not the real issue on Sunday:
- Last Saturday, 1600 Syrian refugees landed on the Greek island of Lesbos. Many more thousands are on their way. If Greece leaves the Eurozone on Monday, who will run the reception camps where these migrants now live? Nobody, is the likely answer. The Greek government will be unable to feed and protect their own population, so why should they devote precious resources to these people? Inevitably, therefore, Greece will become an open door for increasing numbers of Syrian/Libyan and other migrants into the European Union
- Equally important is the future of the Eurozone itself if Greece is to be abandoned to its fate. It will then be clear to everyone that it is no longer a currency union, bound together by treaty obligations. Instead, it will have become just another exchange rate mechanism, like its ill-fated predecessor the Exchange Rate Mechanism (ERM). Its fragility was summed up by the UK’s finance minister, who boasted that he went home that evening after leaving the ERM and “was singing in his bath”.
- The third reason why the Eurozone should pause is that Greece in many ways is just the ‘canary in the coalmine’, warning of the flawed construction of the Eurozone itself. As I have long argued, Eurozone leaders should never have set up economic and monetary union without political union. They knew this at the time, but they ducked the issue. Now it has come back to bite them, hard. And if Greece goes, we can be sure that others will follow them, if this fundamental flaw in the design is not now fixed.
Of course it will be difficult for resolve all the long-standing issues created by the Greek crisis on Sunday. But as the Chinese proverb says, “a journey starts with a single step”. And the facts are at least clear:
- Everyone knows that Greece will never pay its bills
- Everyone also knows that Greece will immediately default on its debt if it is forced to leave the Eurozone
- And everyone also knows that taxpayers in the richer Eurozone countries will end up paying the bill as a result – Germany will end up paying at least €86bn, and probably much more
So why take this pain for no gain? Why not instead deal with the cause of the problem – the lack of political union. Why not admit, as Paul Taylor argues, that the Eurozone is “incomplete and flawed”? And having recognised reality, then use the crisis to make a fresh start by agreeing a more sustainable basis for the Eurozone itself?
“Summit fatigue” is a real issue in long-running sagas like Greece. It can easily lead people to sleepwalk into a situation they had never dreamed could happen.
In this case, the risk is very clear and immediate. It is that large numbers of migrants start to pour into N Europe via the relatively safe route from Turkey to Greece. (The United Nations estimates there are now 4 million Syrian refugees, and report that total migrant crossings rose 80% in H1 versus 2015 to 137k). And in turn, their arrival leads within a short while to the triumph of nationalist parties in France, the Netherlands and elsewhere, all determined to exit not just the Eurozone but the European Union itself.
Sunday will be a critical day for all of us who live in Europe. And for the underlying stability of the political structures that have underpinned the world since World War 2.
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%
“Central banks have to be mindful that too long a period of very low interest rates can have undesirable consequences in the context of ageing societies. For pensioners, and those saving ahead of retirement, low interest rates may not be an inducement to bring consumption forward. They may on the contrary be an inducement to save more, to compensate for a slower rate of accumulation of pension assets.” Mario Draghi, President, European Central Bank
It is now exactly 4 years since we published Chapter 1 of Boom, Gloom and the New Normal: How the Western BabyBoomers are Changing Demand Patterns, Again. When writing it, John Richardson and I thought our basic premise – that demographics drive demand – was simply a statement of the obvious. We didn’t write the book to make this argument. We wrote it with the aim of helping companies and investors to develop the new business models needed to profit from these new demand patterns.
How wrong we were! Very few policymakers took us seriously, with the exception of Governor Shirakawa of the Bank of Japan. He had already made the same argument when taking office in December 2008.
Instead, they maintained that the stimulus provided by Quantitative Easing (QE) was already returning the global economy to “normal” levels of economic growth. And when, as was inevitable, this first round of QE failed, the US Federal Reserve simply did QE2 and then QE3, whilst China and the UK followed. Even worse, new premier Abe replaced Shirakawa in 2012 as a prelude to QE in Japan, and Mario Draghi followed at the ECB this year.
But of course, there has been no sustained recovery. And finally, on Friday, Draghi half-conceded that there just might be some downside to the policy in a world of ageing societies. His statement above thus stands as the first faint recognition by a Western policymaker of the fact that stimulus has been exactly the wrong policy since 2008.
Unfortunately, however, this recognition on its own is “too little, too late”. The Great Unwinding of these stimulus policies began 9 months ago, and we are already seeing rising volatility in the 4 key markets of oil, the US$, interest rates and stock markets. These are the warning tremors of the debt-fueled Ring of Fire created by the central banks.
China, the world’s 2nd largest economy, has been moving away from QE since the new leadership took office in 2013, due to the dangers that it creates. As premier Li warned last month:
“It is quite easy for one to introduce QE policy, as it is little more than printing money. When QE is in place, there may be all sorts of players managing to stay afloat in this big ocean. Yet it is difficult to predict now what may come out of it when QE is withdrawn.”
The chart highlights the problem, based on Bloomberg data. It shows that the G7 group of the world’s major economies can now be best described as the Ageing and High Debt group. Their gross government debt per person ranges from a minimum of $36k/person in Germany to $100k/person in Japan. It is hard to believe all this debt will be repaid. As I noted in February, after the Greek election:
“We all learnt one crucial lesson from Syriza’s victory in the Greek election last week – voters can halt the European Central Bank (ECB). Or in other words, protest coalitions can trump elite consensus. In places like Spain and France, this effect may not work through immediately, but it is being absorbed.”
Draghi has realised very late that the economic rules change in an ageing society. Older people already own most of what they need, and their incomes decline as they near retirement. They also have to save more. None of them ever expected that average life expectancy at age 65 would double during their lifetime, from 10 to 20 years.
There are only 3 ways that the debt burden can be resolved – by major rises in taxation, cuts in services, or default. Greece has shown that electorates will not support the first two options forever. The recent tremors in government bond markets are thus a first sign that investors are realising the 3rd option may eventually prove inevitable.
WEEKLY MARKET ROUND-UP
My weekly round-up of Benchmark prices since the Great Unwinding began is below, with ICIS pricing comments:
Benzene Europe, down 45%. “Prices have moved lower this week with excess product in Asia and the US said to be the key causes”
Brent crude oil, down 37%
Naphtha Europe, down 34%. “The naphtha arbitrage window from Europe to Asia is only marginally open but is described by traders as the best money-making option this week”
PTA China, down 27%. “Domestic prices were largely on a downtrend, attributed mainly by weaker downstream polyester conditions.”
HDPE US export, down 18%. “Domestic export prices remained stable during the week, though there were reports of increased trading”
¥:$, down 18%
S&P 500 stock market index, up 9%
We all learnt one crucial lesson from Syriza’s victory in the Greek election last week – voters can halt the European Central Bank (ECB). Or in other words, protest coalitions can trump elite consensus. In places like Spain and France, this effect may not work through immediately, but it is being absorbed.
Thus Greece and the Eurozone crisis are back in the news, again. And in reality, they have never gone away, as I noted last May at the time of the European elections:
- “Investors believe that Germany will be happy to pick up the bills for the problems in the PIIGS
- This, of course, is wishful thinking – Germany will not, and cannot, afford the cost involved
- Thus in reality the potential break-up of the Eurozone has only been delayed by the ECB’s bluff, but not avoided“
The Syriza party’s win in the Greek elections last month simply confirmed the obvious, that no country would put up with half its young people being unemployed forever.
So now we are coming back to the issue which has been hiding under the carpet all along, and has never gone away.
This dates back to the very start of the process towards monetary union 25 years ago. That was when then German Chancellor Kohl and French President Mitterrand agreed that monetary union had to be accompanied by political union.
They jointly proposed an inter-governmental conference that would “ensure unity and coherence of the union’s economic, monetary and political action“. But unsurprisingly, this political union never happened, for the simple reason that France did not want to give up its national sovereignty.
But you can’t be half-pregnant. And the issue has therefore refused to go away. At heart, in the case of Greece’s debt this means:
- Either the Germans have to support the Greeks financially, and the Greeks have to play by the agreed rules
- Or, both countries are free to what they want to do as separate nation states
Put like this, it is obvious why the issue was never resolved.
What is also becoming clear is that developments since Greece’s first default in 2012 have made the problem worse not better. They have confirmed my worst fears then, that it marked only “the end of the beginning of the Crisis“. Today, it has instead now become a fault-line on the North-South political divide within Europe:
- For many Northerners, it is a morality play as well as an economic and political issue. This is particularly true in Germany, where the word for debt, Schuld, also means guilt
- While for Greeks, and many Southerners it is an existential crisis of “can’t pay, won’t pay”. There is no ‘business as usual” scenario possible for the new Syriza government
In the meantime, as Reuters has noted, the real beneficiaries of the crisis are the other populist parties on the right and left of the political spectrum. If agreement cannot be reached in the next few weeks, then a broader upheaval in Europe’s political landscape becomes more and more likely.
This is why the Eurozone debt crisis features so prominently in my ‘Ring of Fire’. Greece is now another earthquake waiting to happen.