Grexit Sturm und Drang

Europe has problems. A barrel of Brent crude fell below $52, causing the euro to drop to a nine-year low, $1.19, against the dollar. A contentious meeting of the European Central Bank will be held on January 22, a few days prior to the election in Greece, to consider some form of quantitative easing in order to stave off deflation. As Jack Ewing explains in "Falling Euro Fans Fears of a Regional Slowdown":

The further declines in the euro and in oil did not change expectations that when the European Central Bank meets on Jan. 22 that it would unveil further stimulus, broad-based purchases of government bonds, so-called quantitative easing. 

When deciding policy, E.C.B. officials are probably focused on the inflation rate more than the value of the euro or the price of oil, and the German data indicated that inflation continues to fall to levels considered dangerously close to deflation — a downward price spiral that is poisonous for corporate profits. 

German inflation was just 0.1 percent in December, according to an estimate by the government statistics office. 

An official estimate of inflation in the eurozone as a whole is to be released on Wednesday. Analysts expect the rate to fall to close to zero or even below it, putting further pressure on the European Central Bank to act.

Germany, which is dealing with a burgeoning nativist movement that is eroding the base of support for mainstream conservative parties (Alison Smale, "Anti-Immigration Rallies in Germany Defy Calls to Desist"), will argue against quantitative easing. The Germans will reason that the oil-price drop will act as a form of stimulus:

There are still many economists and public officials, though, who maintain that in fact cheap oil and a cheap currency are overwhelmingly good for Europe. One of them is Jens Weidmann, president of the Bundesbank and an influential member of the Governing Council of the European Central Bank. 

“The cheaper oil price works like a stimulus program,” he said in an interview published Sunday by the Frankfurter Allgemeine newspaper. “Consumers and companies have to spend less and can consume and invest more.” 

The statement was a signal by Mr. Weidmann that he remains skeptical about whether more E.C.B. stimulus was needed. 

While a majority of the E.C.B. Governing Council appears to support embarking on a quantitative easing program, members may be reluctant to risk alienating Mr. Weidmann and the larger German public whose views he represents. Germany worries that it might get stuck paying a big part of the bill if the European Central Bank loses money on any eurozone government bonds it might buy as part of quantitative easing.

These German worries of being left holding a huge bag of worthless bond paper are compounded by Syriza's lead in the Greek polls. Alexis Tsipras, the leader of Syriza, has promised if elected to renegotiate and possibly repudiate loans with the troika (European Commission, European Central Bank, IMF). For the last week German government officials have been lecturing Greeks to stay in line and not monkey with austerity. Liz Alderman has a helpful summary today ("Euro Countries Take Tough Line Toward Greece") of this hectoring:

On Monday, Germany’s economics minister, Sigmar Gabriel, said Europe would not accept undermining the stability that has returned to the eurozone in the last couple of years.

“We aren’t vulnerable to blackmail,” he said in an interview with the German newspaper Hannoversche Allgemeine. “We expect from the Greek government — regardless of who will form it — that the agreements made with the E.U. will be respected.”

Last week, Wolfgang Schäuble, the German finance minister, cautioned Greece against moving away from its current economic reforms, saying: “If Greece takes another path, it will be difficult. Any new government will have to stick to the agreements made by its predecessor.”

In an acknowledgment of the delicacy of the situation, German officials on Monday quickly backed away from a weekend report by the magazine Der Spiegel that suggested that Chancellor Angela Merkel and Mr. Schäuble believed that the eurozone could cope if Greece quit the euro and returned to the drachma.

A government spokesman denied that contingency plans had been made for such a possibility, and insisted that Germany wanted Greece to remain in the eurozone.

Officials in Brussels, too, emphasized Monday that membership in the euro bloc was “irrevocable,” although they left open to what extent Greece could renegotiate the terms of its bailout after the election.

“The euro is here to stay,” said a European Commission spokeswoman, Annika Breidthardt.

Guy Verhofstadt, a former Belgian prime minister who leads the Liberal group in the European Parliament, called the idea of a Greek exit, or “Grexit,” from the eurozone “nonsense,” not only because most Greeks do not want to leave the euro, but also because European taxpayers would wind up losing billions of euros that Greece owes them.

If Greeks can hold on and weather the threats and fear mongering (incumbent prime minister Antonis Samaras is campaigning on a purely fear-based appeal asserting that a havoc-plagued Grexit will result if Syriza triumphs) and Syriza can form a government, Tsipras will have a solid bargaining position. Europe is engaged in a pestilential fiction that an austerity-ravaged Greece can actually pay back the loans she has been awarded.

Alderman concludes her story by quoting two Commerzbank economists, Jörg Krämer and Christoph Weil, who say that renegotiation is the most politically expedient option Germany has, despite all the threatening noises from Schäuble et al.:

Still, most observers expect a Greece run by Mr. Tsipras would stay within the eurozone, and that a new Greek government would reach an agreement with its European creditors following a period of turmoil. After all, if Greece were to return to the drachma, the country would likely face new economic upheaval that it could ill afford. 

Preventing a Greek exit is also still desirable for Germany and other countries, since billions of euros in European taxpayer money could be wiped out if Greece were to leave the euro, raising the risk of a political backlash against leaders in those countries, said Jörg Krämer and Christoph Weil, the Commerzbank economists. 

“It would be much easier politically to renegotiate a compromise with Greece, albeit a lame one, and thus maintain the fiction that Greece will pay back its loans at some point in time,” they said.

The fear mongering has just begun. Greeks will pummeled with every type of propaganda and every form of thought control over the next three weeks. Dire warnings of anarchy will be broadcast. The proud Scots were made to buckle recently. Can we expect the Greeks to act rationally and vote to reject the pestilential fiction of austerity?

Last week I was sanguine. Years of brutal benefit cuts and high unemployment would inure the Greek voter to fear mongering at the polls. Now I am not so sure. Deflation on the European continent is going to up the ante and turn the January 25 poll into total war. No effort will be spared to maintain the neoliberal credo of austerity. Alderman reports that Tsipras has only a three-point lead with 20 percent undecided. Not terrific numbers.

Portuguese Judiciary Deals a Blow to Austerity

Portugal is in the news because its constitutional court tossed out part of its austerity package. This from a story today by Raphael Minder, "Portuguese Debt Crisis Brings New Trouble for Euro":

In an address to his beleaguered nation on Sunday, Prime Minister Pedro Passos Coelho warned that his government would be forced to cut spending more and that lives “will become more difficult” after a court on Friday struck down some of the austerity measures put in place after a bailout package two years ago. 

The renewed tension in Portugal raised the threat of further trouble elsewhere in the euro zone, where ailing members have struggled to rebuild economic growth after enduring wrenching spending cuts. 

“The risks in the euro zone have increased markedly over the past six weeks or so,” wrote Nicholas Spiro, managing director of Spiro Sovereign Strategy, a London-based consultancy that assesses risk on sovereign debt. 

A critical moment for the latest trouble took place on Friday, when Portugal’s Constitutional Court struck down four of nine contested austerity measures that the government introduced as part of a 2013 budget that included about 5 billion euros, or $6.5 billion, of tax increases and spending cuts. The ruling left the government short about 1.4 billion euros of expected revenue, or more than one-fifth of the 2013 austerity package. 

Specifically, the court, which began reviewing the legality of the government’s austerity measures in January, ruled as unconstitutional and discriminatory the government’s plans to cut holiday bonuses for civil servants and pensioners, as well as to reduce sick leave and unemployment benefits.

Minder also quotes Jens Weidmann, the head of Bundesbank, saying Cyprus may need an additional bailout:

Cyprus received a bailout of 10 billion euros from international creditors last month. It may need even more to save its banks, a top German policy maker said on Sunday. 

“The situation in Cyprus has stabilized in the last few days,” Jens Weidmann, president of the Bundesbank, the German central bank, told Deutschlandfunk radio. “However, I wouldn’t rule out that the need for liquidity in Cyprus could increase.” 

The crisis in Cyprus reflects how urgent it is for the euro zone to establish a means to shut down failed banks without burdening taxpayers or endangering the financial system, Mr. Weidmann said. 

“There continues to be a problem with banks that may be too connected and too big to wind down without creating a danger for the financial system,” he said.

Last Friday Landon Thomas Jr. had a story, "Ex-Bank Officials Named in Cyprus Inquiry," about the findings of an investigative report commissioned by the central bank of Cyprus. Known as the Alvarez report after the financial consulting firm Alvarez & Marsal that the central bank hired to look into why the Bank of Cyprus doubled down on risky Greek bonds, it establishes what has already been widely reported. According to Thomas,

The Bank of Cyprus, long considered the better run of the two large banks that have been at the center of the Cypriot bailout debacle, decided to speculate in high-yielding Greek bonds by accumulating a 2.4 billion euro position from late December 2009 until June 2010, just as the Greece government was running out of money. 

That decision resulted in a loss of 1.9 billion euros, or about $2.4 billion, when bond investors were eventually forced to take a 75 percent haircut under the final terms of the Greek bailout, worked out last year. 

That loss and a larger one at the other big Cypriot bank, Laiki Bank, on a similarly misguided investment foray, totaled 4.5 billion euros. That was more than Cyprus, with a gross domestic product of 18 billion euros, was able to sustain. And the losses resulted in a near-collapse of the Cypriot banking sector, leading the country’s government to seek a 10 billion euro bailout from the troika of international lenders: the International Monetary Fund, the European Commission and the European Central Bank.

The Alvarez report provides new details on the extent to which Bank of Cyprus officials were hoping that the high yields generated by the Greek bonds would cover the bank’s imploding loan book. 

Alvarez investigators said that, according to the records they were able to secure from the bank, the decision to buy the bonds was based on a last gasp effort by the bank to generate profits as their loan book began to sour in late 2009 and through the spring of 2010. 

Investigators also said that the bank, like others in Europe at the time, made use of cheap financing from the European Central Bank to make these bets. As a result, executives in the bank’s treasury department bought the riskiest high-yielding bonds available and found willing sellers in banks eager to reduce their exposure to Greece. 

When it became clear not long after the Greek bailout in May 2010 that some form of debt restructuring would have to take place, the Bank of Cyprus found itself stuck with a 2.4 billion euro portfolio of Greek bonds.

Annie Lowrey has a story today, "Lew to Press for Growth in Europe," about Treasury secretary Jacob Lew's trip this week to Europe to ostensibly jawbone leaders there to dial back on austerity. What's interesting about the story is that the normally excellent Lowrey undercuts her lead halfway through the article:

But countries like Germany have shown little willingness to ease the constraints of austerity for peripheral European countries, or to engage in stimulus spending themselves. And for years, European officials have bridled at being lectured by officials from Washington — particularly because many feel that their financial crisis was largely caused by American financial products exported around the world by American banks. 

Though Mr. Lew will travel to Europe with a familiar message from Washington, it may not be delivered as urgently as in the past. The European crisis continues to weigh on American growth, cutting into exports, but many economists believe that the United States has entered a cycle of self-sustaining economic growth driven by a turnaround in housing and improving household budgets. 

Moreover, American companies have over the last few years steeled themselves against Europe’s financial woes, and the risk of contagion is perceived to be relatively low. 

Europe was the primary international concern for Timothy F. Geithner, Mr. Lew’s predecessor as Treasury secretary and a familiar face on the Continent. But perhaps as a sign of Europe’s diminishing threat to United States economic stability, Mr. Lew’s first overseas trip as Treasury secretary, last month, was not to Paris or Berlin or Brussels, but to Beijing.

Apparently what Lew is really in Europe to do is continue negotiations on a free trade agreement between the United States and the European Union. In other words, it is neoliberalism full speed ahead. Talk up stimulus, continue with austerity, and finalize the free trade agreement.