It is hardly a shock that the majority of Greek voters have rejected an austerity agreement that would have perpetuated the country’s pain of the last five years for another half a century or so. The referendum result has not helped to create a conclusion to the bailout negotiations. On the contrary, the debate will now enter a more crucial stage.
Will Eurozone leaders force Greece out of the single currency market if it continues to reject terms set by the Troika – the EU, the European Central Bank (ECB) and the International Monetary Fund (IMF)? Will Greece’s leftist government, led by Prime Minister Alexis Tsipras, accept a weakened bailout agreement? And how could it reconcile this with the will of the Greek people if so?
There are interesting times ahead. A so-called Grexit would likely see the country readopt the drachma. Many commentators say this would be disastrous for the Greek people who would come to learn the ‘real hardship’ of austerity. Its credit rating would tumble and no one would lend to the country again for a long time.
But that’s a harsh assessment. A reversion to the drachma would give Greece the opportunity to start afresh. It could reboot its economy on its own terms. Yes, structural failures would have to be addressed. Countries cannot fork out pensions and benefits without a fully functioning tax system.
Still, the drachma would be weak, improving its competitive edge with its Eurozone neighbours. A feeble currency would boost Greek exports and attract evermore tourists to what is already its most successful industry. It would help restore national pride and provide a light to an otherwise endlessly dark tunnel of debt and default risk.
Syriza has been slammed for playing juvenile games with its creditors. And it will likely find itself in a catch-22 if A) it decides against a default, much to the dismay of its electorate. Or B) it rejects a new agreement, spirals out of the Eurozone and faces a backlash from voters who were expecting a pain-free solution to the debt burden.
Living on the edge
The critical point for the peripheries are options C) and D) however. That Syriza negotiates a watered-down agreement with its creditors and significantly eases the burden on its population. Or that Greece leaves the Eurozone (and perhaps the EU) but makes a success of it – albeit not for another five or ten years.
The remaining PIIGS (Portugal, Ireland, Italy,
Greece and Spain) would have a lot to say about this. Not least because they accepted debt agreements that span decades. Generations of youngsters who never partook in the ‘party’ are left picking up the bill for their parents and grandparents. And indeed many will have learnt from their elders and enter into dismal mortgage contracts that go belly up as soon as interest rates tip upwards.
In January, the ECB decided to follow its US and UK counterparts by launching an asset purchasing programme otherwise known as quantitative easing (QE). This amounts to money printing, but is really a rechannelling of cash.
QE is when central banks buy up government bonds and high grade corporate debt to force investors elsewhere. It means banks have to look to businesses and individuals to park their cash. Thus lending rates are reduced in a bid to attract borrowers. But when central banks decide to tighten the money flow, interest rates will rise. Individuals on floating-rate mortgages will be hit hard, for example.
More than that, however, the peripheries’ national debt will escalate. It will become more expensive for the governments to issue debt because there is less demand for it. The roles are now reversed whereby banks can charge more for lending, but the governments have to offer a higher reward for their debt (when the price of a government bond reduces, the yield increases).
So in a scenario where Greece achieved a better long-term outcome, the peripheries would feel anguished. But anger may not manifest until after the €60bn QE programme ends, which is expected in September 2016. There is a fine balancing act to interest rate movements. A sharp increase will be too severe for individuals and businesses. But taking too long to increase rates risks stifling economic growth and institutional investors like pension funds and insurers suffer from low yields.
The Economist recently published an article on how central banks were running out of levers to fuel growth. Interest rates are near zero, meaning central banks will have to start increasing them again soon. But QE has so far failed to generate impressive growth in either the US or the UK. It remains to be seen how it will pan out in Europe, but the Japanese experience suggests a low-growth low-inflation environment. For Western central banks, there are no levers left to pull.
The peripheries are laden with debt. They accepted tough terms from their creditors and will be held to those promises. Greece will be punished if it continues to reject similar terms. But for Greece, exiting a Eurozone in a recovery stoked by artificial stimulus could be its future saving grace. It will take the pain now and control it. For Portugal, Ireland, Italy and Spain, the pain will come later. It will come on the ECB’s terms and likely at the expense of the entire European project.