Tuesday, September 20, 2011

Greece's bluff is about to be called

Here is the immediate state of play for Greece. Greece runs out of money next month, and lacks capital market access. The only way to avoid default is a further EUR 8 billion tranche from the Troika (IMF, EFSM, and the ECB).

In the past, Greece has played chicken with the Troika, by failing to comply with its agreements and saying  “if you don’t give us the money, we’ll default and you’ll regret it”. (As Donald Trump used to say to his bankers, “I’ve got a guy at the court house ready to file at any time.”

The “northern league” (Germany, Netherlands, Austria, Finland) have wearied of this game. They have decided to use this tranche to force Greece to comply 100% with their diktat, which includes a reduction in nominal wages, public sector layoffs, pension reform, privatizations, and tax compliance enforcement. And they want these demands to be certified by “inspectors” from the Troika.

These demands are perfectly reasonable and in fact inevitable. But they are politically impossible for both the ruling socialist and the opposition populist party because they represent political suicide. This is a pill that Greece cannot swallow. They can pretend; they can sign all sorts of agreements; but they can't actually do it.

One of two things will happen over the next two weeks: (1) Papandreou will force his cabinet and party to swallow the pill and, much more critically, convince the inspectors that this is not another scam; or (2) the northern league will say no, and Greece will default.

The northern league wants Greece to default, but it doesn’t want to be seen as wanting it, so they have disguised this desire behind a list of demands that Greece can’t meet. (Shades of Austria’s 1914 ultimatum to Serbia.) No matter what Papandreou does, it will never be enough.

I am confident that Greece has a Plan B to default and redenominate quickly (over a long weekend). Somewhere deep in the vaults under the Bank of Greece is an old drachma printing press that they can fire up. The New Drachma will float--downward.

The challenge is what to do about all that defaulted debt denominated in euro. There are two choice: unilaterally redenominate all debts foreign and domestic into drachma, or else redeem all foreign debts with long-term, low interest euro bonds.

This situation will crystallize quickly, because there is a deadline looming. As I said, I expect that Greece will be denied the next tranche and will then default by the end of October.

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