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Greece and the Rest of the Eurozone Remain on the Road to Hell

Marshall Auerback

So for the short term, it appears we won’t have a “Grexit”, which has led many commentators to suggest (laughably) that a crisis has been averted. Typical of this sentiment is a headline in Bloomberg (18/6/12) “Greece avoids chaos; Big Hurdles Loom”. To paraphrase Pete Townsend, meet the new chaos, same as the old chaos. It is worth pondering how acceptance of the Troika’s program (even if cosmetic adjustments are made) will help hospitals get access to essential medical supplies, whilst the government persists in enforcing a program which is killing its private sector by cutting spending and not paying legitimate bills, and an unemployment rate creeps towards 25 per cent and 50 per cent for youth.

Prior to the June 17th vote, Greek voters were intimidated with a massive number of threats of what would happen if they didn’t vote “the right way” (i.e. anybody but the “radical leftists” in Syriza). Even then the conservatives on just led the vote count from their main anti-austerity rival. Amazingly, New Democracy leader Antonis Samaris suggested in his victory speech that the results reflected a vote for “growth.” There is more than a touch of Orwell at work when one can redefine the kinds of programs which the Greeks will be forced to swallow as conducive to “growth” and “prosperity”.

So the Greek government will continue to plug away at austerity and the Troika will continue to pretend that such policies will ultimately lead to a Greek economic recovery. There will be some fake advertising about Europe making it easier on the Greeks, but it will be something without substance. Then things will get worse to the point where Samaras might have to take a helicopter to flee the crowds.

From the Opposition Syriza’s perspective this is not the worst outcome, since the 3rd place Pasok (Greece’s ostensible “socialist” party) is likely to join New Democracy (despite some posturing last night which suggested that they wouldn’t join a coalition in the absence of Syriza’s participation, thereby ensuring that all parties are tarred with these awful austerity policies). Then both Pasok and New Democracy will have to watch as Syrizai leads the opposition and probably wipes them out in another election within a year. Maybe even, within the year.

In the meantime nothing fundamental will change in Greece. It can’t, given that the circuits of credit in Greece are so badly damaged that even efficient, profitable firms have been cut out of the capital markets but also out of the international markets (their suppliers will no longer accept the Greek bank guarantees without which Greek firms cannot import raw materials, as Yanis Varoufakis has pointed out). I asked Yanis why those profitable Greek businesses don’t simply shift their deposits to, say, a German bank, in order to get “reputable” letters of credit, and his response was that a German bank would simply not issue a guarantee on these businesses if they are registered in Greece.

The upshot will be that even profitable businesses will be forced to sell out to outside interests, after which the letters of credit will be forthcoming. If this isn’t an example of “hit man economics”, it’s hard to know what is.

As all of us on this blog have argued repeatedly, in the eurozone we have a solvency problem and a crisis of deficient aggregate demand. Unfortunately, within the European Monetary Union these twin crisis ultimately fall entirely in the realm of the issuer of the currency- the ECB, and not the users of the currency- the euro member nations. So without the ECB, directly or indirectly, underwriting the currency union, solvency is always an issue, whether that be Greece, Portugal, Spain, Italy or, indeed, Germany. Likewise deficient spending power has been exacerbated via the austerity imposed as a condition of the ECB’s help. It is akin to putting a patient on a drip feed, allowing him to recover, then breaking his legs again so that he remains bed- ridden.

That includes the banking system, which, to serve public purpose, requires credible deposit insurance, again meaning support from the issuer of currency. Warren Mosler noted (

“The last few weeks have demonstrated that the ECB does ‘write the check’ for bank liquidity even though it’s not legally required to do that, (and even though some think it’s not acting within legal limits) but it won’t just come out and say it. And, apart perhaps from the Greek PSI (100 billion euro bond tax), which they still call ‘voluntary’, no government has missed a payment, also with indirect ECB support either through bond buying or via the banking system, but, again, it won’t just come out and say it’s an ongoing policy.”

So while the ECB has continued to underwrite the Greek (and now Spanish) banking systems, via all sorts of programs – LTRO, ELA, etc., the bank (and the member nations of the EMU) refuse to make explicit commitment of the kind that it will continue to backstop the system and thereby ensure its solvency – i.e. the long awaited “bazooka”. The ECB argues that this is a “fiscal role” which cannot be undertaken by the central bank, conveniently omitting the fact that there is no relevant fiscal authority in the Eurozone, which could take up this role. The ECB is the issuer of the currency

and only they have the capacity to create unlimited quantities of euros. Paradoxically, by making this commitment explicit, they would find less need to use the “bazooka”, once the markets became convinced that they were serious. Instead, the ECB effectively plays poker with the markets by exposing its hand from the start, encouraging speculators to persistently call their bluff.

Of course, nobody in Brussels actually acknowledges that the problem rests on the Eurozone’s fundamental architectural flaw (which is to say that there is no corresponding supranational fiscal authority), and they continue to castigate “profligate” governments, which run large budget deficits almost inevitably as a consequence of the collapse in private sector economic activity. That has been the story of Greece, the rest of the European periphery and now the disease is spreading into the core (Dutch April retail sales were down 11% year-over-year, so this is no longer a “north vs south” problem in the euro zone). A good economy with rising public deficits and ECB support to keep it all going isn’t even a consideration at this point. They have painted themselves into an ideological corner, as Europe’s banking system continues to suffer from the throes of a massive bank run. The Greek election results won’t change that fact.

Contrary to arguments that she doesn’t ”get it”, one has the sense from reading her recent remarks that Chancellor Angela Merkel actually does understand the nature of the problem. More to the point, it is likely that she is also aware (via her economic advisors) of the extent of the Eurozone’s deposit run, which is now massive (probably in the trillions of euros). But to draw attention to the real problem risks highlighting Germany’s legal conundrum.

It seems clear that the German Constitutional Court ruling on the Greek bailout in 2010 was quite explicit in terms of its meaning: According to this court ruling Target 2 and various other forms of the ECBs lender of last resort programs are unconstitutional, because they involve an open ended indeterminate exposure of the German people to losses involved in the bailout of the periphery. Yes, these are contingent liabilities, but the irony is that the more that Mrs. Merkel says “Nein” to any genuine proposal which could avert a solvency crisis, the more likely that these counterparty risks become real, rather than contingent. And the German parliament has no say in the disbursements.

And that’s just Target 2. The deposit insurance program, which is now supposedly being discussed at the G-20 summit in Mexico represents a new initiative. That might be more readily challenged before the constitutional court as it is more readily understandable than the arcane and highly technical workings of, say, Target 2.. Chancellor Merkel may realize this. She may realize that a challenge to a deposit insurance initiative might bring to light the issue of the constitutionality of Target 2 and thereby threaten an even more intense run on the banks of the periphery of Europe.

So consider the following: there may well be a constitutional court challenge were the ECB to respond to the challenges posed by Greece and other members of the periphery via a deposit insurance scheme which they backstopped. Unfortunately, the day that a court challenge happens and becomes public the bank run should accelerate greatly. regardless of the ultimate result. If I’m a depositor in a Greek, Spanish or Italian bank and I think there is even the slightest possibility that an ECB-directed deposit insurance scheme could be nullified by a German court ruling, then I’ll raise to take my money elsewhere as quickly as I can. No wonder the issue of capital controls is now being quietly discussed.

This is the real reason why Mrs Merkel says that there are limits to what Germany can do on its own and why she has continued to take such a hard line with Athens over the course of the Greek election campaign.. Of course, she rejects the alternatives because they are politically unpalatable, in part because she hasn’t been honest with her own electorate in spelling out what the real implications of Germany’s position is if the Eurozone blows up. She’s in a corner. This also explains why the Germans are so keen to involve entities like the IMF, because it helps get around this legal conundrum.

Back to Greece. it looks like the economic ‘torture chamber’ of mass unemployment can, operationally, persist indefinitely, even as, politically, it’s showing signs of coming apart. There has been increasing evidence in the last few weeks or so that suggest that the public deficits across the EU are propping up demand just enough to stop the currency union from blowing up.

But the actions of the Troika are neither politically desirable, nor sustainable over the longer term as the recent election results, not just in Greece, but all across Europe continue to demonstrate. Note that the Socialists claimed a huge majority in France’s Parliamentary elections held this past weekend, which suggests that the French too are getting fed up with the austerity led policies championed by Berlin.

Fiscal austerity of the kind imposed on Greece is in its death throes. And thank goodness for that. Because if this form of Kevorkian economics continues, the crisis will surely spread to America’s shores, just at a time when the American ideological soulmates of Europe’s austerian brigade are seeking to shred what’s left of our own social safety net via a manufactured fiscal crisis. As the great Greek tragedian Euripides wrote, “”Whom the gods would destroy, they first make mad”


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