GREECE: CLOSER TO THE ABYSS

Tsipras calls a referendum for 5 July, asking Greeks to reject creditor conditions for further loans to Greece.

Eurogroup finance ministers react by ending talks about bailout extension, which will thus expire 30 June.

ECB freezes ELAS at €89bn, potentially forcing Greece to close banks or impose capital controls soon.

Greece enters a dangerous and highly instable grey area which could lead to either political change in Athens or Grexit after a brief interlude with IOUs.

Europe is working behind the scenes to contain contagion risks, ECB hints at possible monetary policy response to protect Eurozone from Greek fallout..

Too much charisma, too little courage: He triggered an unnecessary early election, rose to power in January by promising his voters impossible things and pushed his country back into recession, aborting the Samaras/Pasok recovery of 2014 while triggering capital flight worth more one third of annual Greek GDP within six months. To make matters worse, Greek prime minister Tsipras now seems close to plunging Greece into wholesale economic and financial collapse simply because he doesn’t dare to tell Syriza’s loony left to accept the facts of life: you can’t spend money you don’t have unless you accept the terms of your only willing lenders for new loans. From the very beginning, Tsipras has shied away from the hard decision: lose his left wing (and possibly his job) or ruin his country. Having wasted five months in which his economy and bargaining position got weaker by the month, he now once again tries to have it both ways: keeping his left wing on board by rejecting creditor proposals while promising that he, as prime minister, would implement a pro-euro referendum result even after campaigning for a “no” beforehand.

That the referendum, approved by the Greek parliament last night with 178 to 120 votes, will go ahead on 5 July looks very likely but not fully certain. The basis for it is shaky. One week is not much time to prepare. In addition, there is no firm offer by creditors which Greeks could reject or approve. Creditors were still adding a few extra face-saving concession to Greece on Friday night when Tsipras announced the referendum to the surprise of his own negotiators, prompting creditors to withdraw their offer.

How would a referendum end? Unclear. Opinion polls show a consistent and large majority in Greece for the euro. Even asked if they would accept the conditions of creditors to stay in the euro, opinion polls usually give 45-60% yes versus 35-30% no. But so far, most Greeks had assumed that Syriza would back down and strike a deal. How they would vote if the still most popular politician of the country, Tsipras, now campaigns for a “no” is unclear. The risk is serious that Tsipras will once again manage to dupe some voters, telling them that a “no” would be just a vote to strengthen his bargaining position versus Europe instead of admitting that a “no” would probably mean the abyss of Grexit.

While preparing for the worst, European officials emphasised over the weekend that they want to keep Greece in the euro. As discussed before, missing the €1.54bn payment to the IMF in the early hours of 1 July and the expiry of the current bailout extension on 30 June do not spell immediate formal default or even Grexit. But it would put Greece on the slippery slope towards Grexit. While it may just manage to pay pensions, benefits and public sector wages in euros this week, it will probably have to resort to IOUs for some of these payments in less than a month from now. Also, reversing course will become ever more politically difficult after the formal expiry of the bailout and the political damage caused by Syriza’s current behaviour. We are entering the territory in which events can take on a dynamic of their own.

The ECB froze the amount of outstanding emergency liquidity assistance at €89bn on Sunday. With continuing deposit outflows, Greek banks may not be able to open for long in the coming week. After Tsipras announced the referendum Friday night, Greeks reportedly withdrew €1bn from cash machines on Saturday. This may force Greece to declare bank holidays or limit deposit withdrawals soon.

The ECB also emphasised that it is “closely monitoring the situation in financial markets and the potential implications for the monetary policy stance and for the balance of risks to price stability in the euro area. The Governing Council is determined to use all the instruments available within its mandate.” The message is clear: if financial market turmoil were to threaten the Eurozone economic recovery, the ECB would act, possibly by buying more bonds under its quantitative easing or possibly even under its OMT programmes. As the ultimate lender of last resort, the ECB will do its utmost to prevent contagion. That in itself could help to contain the market reaction on Monday somewhat.

Some three weeks ago, Greek finance minister Varoufakis answered a magazine question whether he believed that creditors were bluffing “yes, I hope so.” The belief that Europe would blink dictated Syriza’s disastrous negotiation strategy to the very end. As we had pointed out over and over again over the last six months, that was one of the great delusions of Syriza. The left-wing radicals with their flashy game theorist in charge of finance simply do not understand either Europe or economics. By triggering massive capital flight, insulting their only willing creditors and saying different things in Athens than they had said in Brussels just hours earlier, they weakened their country and their bargaining position ever further. The sorry result is that, due to the Tsipras recession, Greece now needs much harsher measures to repair its public finances than would have been the case otherwise. Without Tsipras and the recession and collapse of trust which he caused, there would have been only a modest need for extra austerity beyond raising the retirement age and continuing to streamline the public sector in Greece.

Political change? The last time a left-leaning Greek prime minister surprised creditors and Greece by wanting to call a referendum on bailout terms (Papandreou in November 2011), he was replaced by a national unity government shortly afterwards. That may still be a potential outcome this time again once it dawns on Greeks what is really at stake. While not likely for now, it is not impossible either. The situation is volatile. Even the Greek supreme court or the president might still spring an unlikely but not fully impossible surprise.

For Greece, Grexit would be the abyss: a massive rise in import prices would impoverish those most vulnerable Greeks who do not have enough savings stashed away in euros. It could be a social catastrophe well beyond anything the country had to endure in the first years of bailout programmes which, from 2010 to 2012, had indeed been overly harsh. Simply printing more IOUs and lateron drachma to top up wages, pensions and welfare benefits would just cause a further collapse of the new currency and thus a bigger surge in import prices and overall inflation. Amid economic chaos and with a Syriza-led government feeling free to finally implement all the Venezuelan-style lunacies of its programme, it would take a long time before some recovery could start in Greece’s not very open economy.

For Europe, we maintain our long-held view: it could be somewhat rough initially. It would raise geopolitical questions Europe would rather avoid. But 2015 is not 2011 or 2012. The systemic euro crisis is over. With the ECB’s OMT programme as the ultimate safety net, with banking union and well-oiled crisis-response mechanisms, Europe has the instruments it needs to contain contagion. Thanks to their reforms in the meantime, Italy and Spain are now in much better shape and hence much less vulnerable than they were four years ago. A hypothetical spike in their 10 year bond yields by, say, 50bp would leave their financing costs extremely low (yields were well above 7% when the systemic euro crisis was raging pre-OMT). And the risk that voters elsewhere would want to follow the lead of Syriza and plunge their own countries into a Grexit-style abyss looks small.

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