Greece votes an emphatic no in the Sunday referendum, what happens next?

euroVivek Kaul

The Greeks invented democracy and, let’s not forget, tragedy,” writes Chris Allbritton in The Daily Beast. And the fact that the country invented democracy had a very important role to play in it being accepted into the Eurozone in the first place. Eurozone is essentially a term used in order to refer to the countries using the euro as their currency.
As Neil Irwin writes in The Alchemist—Inside the Secret World of Central Bankers: “Greece…was where democracy was invented, the birthplace of the European idea, the original European empire.” But all that was in the past.
Greece voted an overwhelming 61.3% no in the referendum held yesterday, to decide on the following question:
““Should the proposal that was submitted by the European Commission, the European Central Bank, and the International Monetary Fund at the Eurogroup of 25 June 2015, which consists of two parts that together constitute their comprehensive proposal, be accepted? The first document is titled ‘Reforms for the completion of the Current Programme and beyond’ and the second ‘Preliminary Debt Sustainability Analysis.’’”
The referendum essentially asked Greeks to decide whether they were ready to suffer from more austerity measures, like the government cutting back on pensions, raising taxes etc., so that the it could be bailed out again by the economic troika of the European Central Bank, the European Commission and the International Monetary Fund (IMF).
To this, the Greeks have voted an emphatic no. The question is what happens next? Will this democratic decision of the Greeks turn out to be a tragic one in the days to come? ““Greece has just signed its own suicide note” – Mujitba Rahman, head of European analysis at the Eurasia Group risk consultancy, told the Financial Times.
But the reality of the situation is not as unidimensional as that. Allow me to explain.
The Greek banks are running out of money. As former US treasury secretary Lawrence Summers wrote on his blog: “The referendum is probably the second most important event of the week in Greece. However it turns out, Greek banks will run out of cash early in the week, probably on Monday [i.e. today].”
Currently, the Greek banks are shut. Cash withdrawals from ATMs are limited to 60 euros a day and are likely to be cut further. This can’t be a good scenario for ordinary Greek citizens. Further, it would be stupid to think that those who voted ‘no’ would have not realised that voting ‘no’ would mean trouble ahead. So to that extent people are ready to bear some amount of economic pain.
Also, an economy cannot function without currency. In fact, fearing precisely this scenario, the Greeks have been stocking up on food. As The Globe and Mail reports: “Already, some basic items such as medicines were running low as cash supplies ran short and payment systems ceased to exist. Many Greeks have been loading up on food staples for fear that supermarkets will be unable to buy products.”
The Greek government employees need to be paid on July 12. How will that payment be made? Governments in the past have resorted to issuing IOUs or scrips. The Greece government could do the same as well. The problem here is that the confidence in scrips issued by a bankrupt government wouldn’t be very high.
The Greek politicians believe that with a ‘no’ vote they are in a better negotiating position with the economic troika and other leaders in Europe.  As Panos Skourletis, the Greek labour minister said: “The government can go now with a very strong card to continue negotiations [with creditors].”
The reason for this is very straight forward—with a ‘no’ vote the fear that Greece will exit the euro is even higher.  And this is something that will strike at the very heart of the euro, given that it is ultimately a political idea, which hopes to bring the entire region closer through economic integration, with the hope of preventing any future wars in the years to come.
One of the first things that is likely to happen if Greece exits is that the country will redominate all its debt in its new currency, which is likely to be the drachma. Also this will set a precedence for other countries like Spain, Portugal and Italy. And this can’t be good for the entire idea of euro.
Further, though no German politician will publicly admit to it, but the euro has tremendously helped increase the German exports. In 1995, German exports made up for 22% of the gross domestic product (GDP). By 1999, this number had run up to 27.1%. In 2004, five years after the euro came into being, the German exports to GDP ratio stood at 35.5%. In 2008, the number reached 43.5%. As the impact of the financial crisis started to spread around the number fell to 37.8% in 2009. Nevertheless, the German exports to GDP ratio has recovered since then and in 2014 stood at 45.6%.
With the euro becoming the common currency across most of Europe, the exchange rate risk that businesses had to face while exporting goods and services was taken out of the equation totally. This has benefitted Germany the most, given the productivity of its business.
And will Germans want to get rid of this advantage by chucking out the Greeks and start a process which questions the entire idea of euro? As Niels Jensen writes in the Absolute Return Letter for July 2015 titled A Return to the Fundamentals? : “Germany…actually benefit[s] from the damage that Greece has done to the value of the euro. Poor domestic demand as a result of challenging demographics have made exports the most likely way to secure decent economic growth, and a relatively weak euro has been tremendously helpful in that respect. Imagine how much stronger the euro would have been if every member country had the fiscal discipline of Germany!”
The public posture maintained by the German leaders has been very aggressive. As Sigmar Gabriel, the deputy chancellor of Germany said: “With the rejection of the rules of the euro zone… negotiations about a programme worth billions are barely conceivable.”
There are a spate of meetings scheduled between European leaders today and tomorrow. And this is where some hard decisions will have to be made. If the politicians continue to believe in the idea of euro and the Eurozone, then they will have to treat Greece with kid gloves and not push for more austerity.
On July 20, 2015, Greece has to make a payment of 3.5 billion euros to the European Central Bank for a bond that is maturing. I guess things would have become much clearer in the Eurozone and Greece by then.
So, watch this space.

(Vivek Kaul is the author of the Easy Money trilogy. He tweets @kaul_vivek)

The column originally appeared on Firstpost on July 6, 2015

Markets are not panicking over Greece exiting the Eurozone. Here’s why

In his wonderful book
How to Speak Money John Lanchester defines Grexit as the hypothetical exit of Greece from the Eurozone. Eurozone is a term used referring to countries which use euro as their currency.
As things stand as of now the chances of Grexit may have gone up. Over the weekend,
Alexis Tsipras of the Syriza party took over as the youngest prime minister of Greece. Breaking tradition Tsipras took a civil oath and not a religious one. He has also vowed not to wear a tie until he has negotiated Greece a new deal with Europe, reports the Guardian.
Tsipras and the Syriza party were elected on the plank to
end austerity in Greece and to write off its debt. “We will bring an end to the vicious circle of austerity,” Tsipras told the crowd after his party’s victory in the Greek elections.
Greece had joined the Eurozone on June 19, 2000, In the process it gave up its currency, the drachma. Before the euro was born, interest rates set by the Bundesbank, the German central bank were the benchmark for interest rates of other countries in Europe. Other central banks had to set interest rates accordingly.
Hence, Germany enjoyed the lowest interest rates in Europe. Some of this prestige was rubbed on to the European Central Bank (the central bank formed to manage the euro) and the euro. The countries which used the euro as their currency also started to enjoy low interest rates.
There were two reasons for the same. The first reason was that the weaker countries of the euro zone would no longer be able to print money to pay off their debt like they had done in the past. With the power to print money out of the hands of the government, it was widely expected that inflation would come under control. And with inflationary expectations (or the expectations that consumers have of what future inflation is likely to be) lower, interest rates came down.
The other reason for a fall in interest rates was the fact that the market assumed that in case there was any trouble with the weaker countries in the euro zone, the stronger ones (read Germany) would come to their rescue (which is how things have played out over the last few years).
As Neil Irwin writes in
The Alchemists—Inside the Secret World of Central Bankers: “In 1992, when low-inflation Germany could borrow money for a decade at 8 percent, Greece had to pay 24 percent…Greece gained the credibility of the European Central Bank, which itself was modelled after Germany’s Bundesbank.”
And this “credibility” in a few years ensured that interest rates in Greece were almost the same as they were in Germany. “Investors were willing to hand money over to the Greek government for pretty much the same interest rate they received for giving it to the German or the French governments. In 2007…German ten-year borrowing costs averaged 4.02 percent. Greek rates were 4.29 percent. Investors had become complacent, viewing Greek debt as an essentially risk-free substitute for bonds issued by better run countries like Germany, France of the Netherlands,” writes Irwin.
The Greek government made use of the low interest rates and went on a borrowing binge. The fiscal deficit of the Greek government was under 4% of the GDP In 2001. It went up to 15.7% of the GDP in 2009. The huge fiscal deficit was primarily on account of profligate public spending to finance the Greek welfare state. Fiscal deficit is the difference between what a government borrows and what it spends.
As author Satyajit Das wrote in an essay titled
Nowhere To Run, Nowhere to Hide in July 2010: “Profligate public spending, a large public sector, generous welfare systems, particularly for public servants, low productivity, an inadequate tax base, rampant corruption and successive poor governments created the parlous state of public finances.”
This led to the debt of the Greek government going up big time. When Greece joined the Eurozone in 2000 its government debt was a little over 90% of the GDP. By 2009 it had exploded to 129% of the GDP.
Since then Greece has had to be rescued by a series of bailout programmes involving the European Central Bank, the European Union and the International Monetary Fund. The total bailout amount stands at close to a whopping 240 billion euros or around $270 billion, as per the current exchange rate.
In order to ensure that the Greece government repaid its debt and the bailout amounts it was put on an austerity programme. As Mark Blyth writes in
Austerity—The History of a Dangerous Idea: “Cut spending raise taxes—but cut spending more than you raise taxes—and all will be well, the story went.”
But that did not turn out to be the case. The private sector wasn’t doing well and on top of that government spending also collapsed, leading to the Greek economy crashing. As Blyth writes: “In May 2010, Greece received a 110-billion-euro loan in exchange for a 20 percent cut in public-sector pay, a 10 percent pension cut, and tax increases. The lenders, the so-called troika of the ECB, the European Commission, and the IMF, forecast growth returning by 2012. Instead, unemployment in Greece reached 21 percent in late 2011 and the economy continued to contract.”
And the situation has only gotten worse since then. The current rate of overall unemployment in Greece is at 28% and among the youth it’s over 50%. In fact, the Greek GDP per head has shrunk by 22% since 2008,
reports the BBC. At the same time the Greek government debt has also soared to 176% of GDP by September 2014.
So, clearly the austerity programme wasn’t working and the Greek voters had had enough of it. In this environment the Syriza party came as a breath of fresh air. The rhetoric of the Syriza party and its leader Tsipras has toned down a little in the aftermath of the electoral win but it still remains very strong.
“The new Greek government will be ready to co-operate and negotiate for the first time with our peers a just, mutually beneficial and viable solution,” Tsipras said after winning the Greek election.
This posturing clearly has countries like Germany worried. The BBC reports that the German government spokesman Steffan Seibert said that it was important for Greece to “take measures so that the economic recovery continues”. What Germany is simply telling Greece here is to continue with the austerity programme and continue repaying the debt that it has accumulated over the years.
Tsipras and his party obviously don’t agree with this point of view.
As the Guardian reports: “His [i.e. Tsipras] first act as prime minister was to lay roses at a memorial to 200 Greek communists executed by the Nazis in May 1944. Analysts said the gesture left little room for interpretation: for a nation so humiliated after five years of wrenching austerity-driven recession, it was aimed, squarely, at signalling that it was now ready to stand up to Europe’s paymaster, Germany.”
And this is where the whole thing can snap. Germany wants Greece to continue with the austerity programme. Greece wants to re-negotiate the austerity as well as the total amount of debt that it owes. The question is who will blink first? Will Greece choose to leave the euro first? Will it be asked to leave?
The financial market does not seem to be unduly worried about this as of now.
One explanation that has been offered is that investors are now coming around to believe that the eurozone will emerge stronger if Greece leaves it, to the condition that other countries do not follow it.
But this is too strong an assumption to make. In case of Greece deciding to leave the euro, Greeks will start withdrawing their euros from their banks. This would happen primarily because the new currency (probably drachma in Greece’s case) would be less valuable than the euro. Hence, Greek banks would face bank runs. It would also mean that Greece would most likely default on its debt or repay them in less valuable drachmas. This could even influence the other countries( Portugal, Italy, Ireland, Spain) to do the same. Citizens of these countries expecting their countries to leave the euro would start withdrawing their euros from banks, leading to bank runs in these countries.
Long story short: The situation has become very murky to estimate how things will pan out.

The column originally appeared on on Jan 27, 2015

(Vivek Kaul is the author of the Easy Money trilogy. He tweets @kaul_vivek)