The Welfare Kings of Europe

In spite of the fact that 85% of Greeks want to stay in the Eurozone, I was reasonably confident that Greeks would support Syriza to a first-place finish, and elect a new government willing to play chicken with the Germans. However Greeks — predominantly the elderly — rejected change (and possible imminent Drachmatization) in favour of the fundamentally broken status quo.

But although Syriza finished second, the anti-bailout parties still commanded a majority of the votes.

And New Democracy may still face a lot of trouble building a coalition to try to keep Greece in the bailout, and in the Euro . There has long been a rumour that Tsipras wanted to lose, so as to (rightly) blame the coming crush on the status quo parties. What fewer of us counted on was that the status quo parties wouldn’t want to win the election either. The pro-bailout socialists Pasok have thrown a monkey wrench into coalition-building by claiming they won’t take part in any coalition that doesn’t also include Syriza. This seems rational; when the tsunami hits, all parties in government will surely take a lot of long-term political damage. Pasok have already been marginalised by the younger and fierier Syriza, and Pasok presiding over an economic collapse (for that is undoubtedly what Greece now faces) would surely have driven Pasok into an abyss. The economy is such a poisoned chalice that parties seem willing to fight to keep themselves out of power.

And with more austerity, it’s only going to get worse. Once a society is hooked on large-scale debt-fuelled state spending, austerity in the name of government deleveraging is tough enough when the economy is booming, but during a depression as spending falls, tax revenues fall, very often producing (as has been the case in Greece, Spain, Portugal and the UK) even bigger deficits.

So let us not forget who the most welfare-dependent nations (i.e. the ones who would be hurt the most by attempting an austerity program during an economic depression) are in Europe (clue — it’s not Greece):

International economics is a fast game. It’s only sixty years since America was exporter and creditor to the world. It’s only fifteen years since the now-booming German economy was described as the “sick man of Europe”.

The same Euro system that is slamming Greece, Portugal, Spain and Italy today — in the aftermath of bubbles caused by easy money flowing into these countries as a result of the introduction of the Euro — could (if it were to somehow survive)  do the same thing to Germany in ten or twenty or thirty years.

A monetary union without a fiscal union is a fundamentally unworkable system and Westerwelle, Schauble and Merkel insisting that Greece play by the rules of their game is just asking for trouble. And trying to introduce a fiscal union over a heterogeneous, tense and disagreeable land as Europe is just asking for political trouble.

No matter how many nations are browbeaten by fear into committing to the status quo, it still won’t be sustainable. Greeks (and the other peripheral populations) can commit to austerity from here to eternity, but it won’t stop those policies resulting in deeper contraction, and more economic catastrophe.

But the collapse of the Euro would at most-recent estimates cost the core and particularly Germany a lot more than handing over the money to the PIGS. Eventually they will hand over the money to shield themselves from falling masonry. The real question is whether or not the entire system will spiral into pandemonium before Germany blinks.

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Will Tsipras Blow Up Europe?

The world’s eyes are on the Greek election, and whether or not Greeks will elect New Democracy’s Samaras (widely-assumed to be pro-bailout, pro-status quo), or SYRIZA’s Tsipras (widely-assumed to be anti-bailout, anti-status quo).

The Eurocrats have very sternly warned Greece against voting against austerity. Merkel said:

It is extremely important for Greeks to elect lawmakers who would respect the terms of the bailout.

In recent days, opinion has swung back toward the status quo, with Intrade rating New Democracy’s chances of winning the largest number of seats at 65%, and SYRIZA at just 33%.

While I cannot rule out New Democracy winning, I think that I’d flip those odds. Greece widely reviles German-imposed austerity, but fears the consequences of leaving the Euro — 85% of Greeks want to stay in. A vote for New Democracy would reflect fear of Drachmatization. Meanwhile, a vote for SYRIZA would seem to reflect the idea that through brinkmanship and the threat of Euro collapse, Greece can negotiate their way to a much more favourable bailout position.

So why do I think SYRIZA are the likelier winner? The election is on a knife-edge, so I think the difference might be football.

Greece — against all odds — managed to bumble through the Euro 2012 group stage, beating Russia 1-0 and likely setting up a poetic quarter final against Germany. I think that that victory against Russia will fire enough Greeks to try their luck and assert themselves against austerity.

For Greece, this is an important election. Inside the euro, their heavily state-dependent economy will continue to suffer scathing austerity. Outside the euro, they can freely debase, and — as Nigel Farage has noted — enjoy the benefits of a cheaper currency like renewed tourism and more competitive industry. If Greeks want growth sooner rather than much later, they should choose life outside the euro (and by voting for Tsipras and trying tough negotiating tactics, they will be asking to be thrown out).

But for the rest of the world, and the rest of Europe, this is all meaningless. As Ron Paul has noted, when the banking institutions need the money, central banks — whether it’s the ECB, or the Fed, or the BoE, or a new global central superbank — will print and print and print. Whether Greece is in or out, when the time comes to save the financial system the central bankers will print. That is the nature of fiat money, as much as the chickenhawks at the ECB might pretend to have hard-money credentials.

Tsipras, though — as a young hard-leftist — would be a good scapegoat for throwing Greece out of the Eurozone (something that — in truth — the core seems to want).

The real consequence throughout Europe as austerity continues to bite into state-dependent, high-unemployment economies will be more political fragmentation and support for political extremes, as the increasingly outlandish and unpopular political and financial solutions pushed by Eurocrats — specifically more and deeper integration, and banker bailouts — continue to help special interests and ignore the wider populations.

The New European Serfdom

So let’s assume Greece is going to leave the Eurozone and suffer the consequences of default, exit, capital controls, a deposit freeze, the drachmatization of euro claims, and depreciation.

It’s going to be a painful time for the Greek people. But what about for Greece’s highly-leveraged creditors, who must now bite the bullet of a disorderly default? Surely the ramifications of a Greek exit will be worse for the international financial system?

J.P. Morgan — fresh from putting an LTCM alumnus in charge of a $70 trillion derivatives book (good luck with that) — is upping the fear about Europe and its impact on global finance:

The main direct losses correspond to the €240bn of Greek debt in official hands (EU/IMF), to €130bn of Eurosystem’s exposure to Greece via TARGET2 and a potential loss of around €25bn for European banks. This is the cross-border claims (i.e. not matched by local liabilities) that European banks (mostly French) have on Greece’s public and non-bank private sector. These immediate losses add up to €400bn. This is a big amount but let’s assume that, as several people suggested this week, these immediate/direct losses are manageable. What are the indirect consequences of a Greek exit for the rest?

The wildcard is obviously contagion to Spain or Italy? Could a Greek exit create a capital and deposit flight from Spain and Italy which becomes difficult to contain? It is admittedly true that European policymakers have tried over the past year to convince markets that Greece is a special case and its problems are rather unique. We see little evidence that their efforts have paid off.

The steady selling of Spanish and Italian government bonds by non-domestic investors over the past nine months (€200bn for Italy and €80bn for Spain) suggests that markets see Greece more as a precedent for other peripherals rather than a special case. And it is not only the €800bn of Italian and Spanish government bonds still held by non-domestic investors that are likely at risk. It is also the €500bn of Italian and Spanish bank and corporate bonds and the €300bn of quoted Italian and Spanish shares held by nonresidents. And the numbers balloon if one starts looking beyond portfolio/quoted assets. Of course, the €1.4tr of Italian and €1.6tr of Spanish bank domestic deposits is the elephant in the room which a Greek exit and the introduction of capital controls by Greece has the potential to destabilize.

A multi-trillion € shock — far bigger than the fallout from Lehman — has the potential to trigger a default cascade wherein busted leveraged Greek creditors themselves end up in a fire sale to raise collateral as they struggle to maintain cash flow, and face the prospect of downgrades and margin calls and may themselves default on their obligations, setting off a cascade of illiquidity and default. Very simply, such an event has the potential to dwarf 2008 and 1929, and possibly even bring the entire global financial system to a juddering halt (just as Paulson fear-mongered in 2008).

Which is why I am certain that it will not be allowed to happen, and that J.P. Morgan’s histrionics are just a ponying up toward the next round of crony-“capitalist” bailouts. Here’s the status quo today:

Greece no longer wants to play along with the game?

Okay, fine — cut them out of the equation. In the interests of “long-term financial stability”, let’s stop pretending that we are bailing out Greece and just hand the cash over to the banks.

Schäuble and Merkel might have demanded tough fiscal action from European governments, but they have never questioned the precept that creditors must get their pound of flesh. Merkel has insisted that authorities show that Europe is a “safe place to invest” by avoiding haircuts.

Here’s my expected new normal in Europe:

After all — if the establishment is to be believed — it’s in the interests of “long-term financial stability” that creditors who stupidly bought unrepayable debt don’t get a big haircut like they would in a free market.  And it’s in the interests of “long-term financial stability” that bad companies who made bad decisions don’t go out of business like they would in a free market, but instead become suckling zombies attached to the taxpayer teat. And apparently it is also in the interests of “long-term financial stability” that a broken market and broken system doesn’t liquidate, so that people learn their lesson. Apparently our “long-term financial stability” depends on producing even greater moral hazard by handing more money out to the negligent.

The only real question (beyond whether or not the European public’s patience with shooting off money to banks will snap, as has happened in Greece) is whether or not it will just be the IMF and the EU institutions, or whether Bernanke at the Fed will get involved beyond the inevitable QE3 (please do it Bernanke! I have some crummy equities I want to offload to a greater fool!).

As I asked last month:

Have the 2008 bailouts cemented a new feudal aristocracy of bankers, financiers and too-big-to-fail zombies, alongside a serf class that exists to fund the excesses of the financial and corporate elite?

And will the inevitable 2012-13 bailouts of European finance cement this aristocracy even deeper and wider?