Daniela Gabor is a lecturer at the Bristol Business School and an expert on the economics of banking. She gave Solidarity her views about Greece and the eurozone crisis.
If a left government is formed after 17 June, and it repudiates the memorandum, the Troika is likely to cut off the bail-out funds. Would a Greek government run out of cash?
Greece has had a big budget deficit. The Greek economists I talk to say that if Greece stays on the austerity plan, then it will have a primary surplus [a budget surplus if you don’t count its debt payments] by the end of 2012.
However, a government which did not continue the austerity policies would probably increase wages and so on, and that would reverse the trend. The government would have to find money to finance the deficit.
Governments can finance deficits in a variety of ways, but two are to borrow on global financial markets and to get the central bank to print money. Greece has difficulty raising money on financial markets, and it has difficulties getting money from the European Central Bank, so probably it would have to get out of the euro and print its own separate money in order to have some leeway on financing the deficit.
How would the European Central Bank prevent the Greek government creating extra credit for itself at the Greek central bank?
Money is created in the eurozone by banks going to the European Central Bank, providing collateral [financial assets pledged to guarantee their credit], and getting cash in return. Since the crisis the national central banks have been allowed to do something called Emergency Liquidity Assistance.
Traditionally, when there is a crisis which affects the banking sector, and a crisis of confidence, then the central banks lend against lower-quality collateral in order to stabilise the system.
When, recently, the ECB said that four Greek banks could no longer get liquidity [cash] from the ECB, the Greek central bank was allowed to accept from those banks lower-quality collateral that could not be used directly with the ECB, and so inject liquidity into the Greek economy — the ECB’s governing council only needs to approve ELA access above a certain threshold, partly because the national central bank assumes all the credit risk associated with ELA liquidity injections.
Little of the liquidity in the system today is actually notes and coins. Mostly it’s accounting transactions like that.
But at some point the ECB would have to take a political decision to intervene against the Greek central bank creating more credit for the Greek government?
The ECB makes lots of political decisions anyway. Central banking is a very political activity. The ECB can tell the Greek central bank that it cannot create any more Emergency Liquidity Assistance liquidity.
For me, every day that the European Central Bank refuses to intervene in sovereign bond markets in order to stabilise them, it makes an explicitly political decision. This is because a central bank’s mandate in crisis is to improve funding conditions for banks. The eurozone efforts towards financial integration have led to this paradoxical outcome where banks’ ability to fund themselves on financial markets depends on the quality of collateral they can produce — and in a crisis, that collateral is only made of sovereign bonds.
Yet not all sovereign bonds are the same — where a government has increased deficits, be it because it resorted to fiscal stimulus during a crisis, or because it had to bail out banks, its debt (sovereign bonds) becomes less attractive (it requires higher haircuts) to use as collateral. So European banks will start dumping the debt of a sovereign that appears under threat and move to the highest quality sovereign (i.e. Germany) to ensure that in the event of a eurozone break-up, they have the kind of collateral that would be most acceptable.
The only institution that can prevent this downward spiral is a central bank — its ability to print money allows it, in theory, to make credible commitments that it will preserve the role of a government bond as marketable collateral. Yet the ECB, with the institutional and political constraints it operates under, refuses to assume this role. This refusal is political.
Instead, the LTROs [cheap three-year loans to commercial banks] that the ECB resorts to every time there appears to be an impending collapse of the eurozone implicitly rely on private European banks to preserve the role of sovereign bonds as marketable collateral (i.e. to preserve their value). But banks are reluctant to demand government bonds if confronted with the possibility that austerity will not work (and we know it rarely does). This is why the February 2012 LTRO only had very temporary effects on the Spanish sovereign bond market.
Then what if the Greek central bank says sorry, but we need to create this liquidity anyway?
I think that is far-fetched. I don’t think the Greek central bank can extend liquidity to Greek banks without ECB approval above the allowed (ELA) threshold. Anything like that would mean moving towards a system of parallel currencies where you would have Greek euros created by the Greek central bank, and an exchange-rate between those Greek euros and ECB euros. I think the ECB would say that the new euros issued without its explicit approval could not be legal tender.
Greeks are being told that if they elect a left government, then the bail-out funds will be cut off, and the next day everything will fall into a bank hole. Could the experience of the Irish bank strike in 1970 be relevant here? All the banks were shut by a strike for six months, no-one could get cash from their bank, and yet the economy continued reasonably normally, with people using cheques and IOUs.
Some people discuss a system of parallel currencies. You keep the euro for bank deposits and for foreign transactions, and you introduce some form of IOUs that will cover other transactions. This “Greek euro” will start depreciating. It’s another way of achieving an internal devaluation. It’s not clear to me that the Greek government would want that. But Goldman Sachs thinks it’s possible, and Deutsche Bank too. But if a left government is elected in Greece, it will immediately have to impose capital controls, and suspend convertibility between cash and bank deposits.
And the left government would nationalise the banks.
That’s another way of solving the problem. Nationalising the banks might be useful. It raises questions about the Greek banks’ subsidiaries in Eastern Europe; but never mind, I don’t think the Greeks will really care about financial investors at that point. It will probably mean that Greece will not have access to financial markets for quite a while.
The European Union leaders say that they have a firewall in place, so Greece can default and drop out of the euro, and they can make sure that everywhere else is all right.
It could be true, depending on what the ECB decides to do. The perceptions of liquidity in different markets are very important. I can’t see how a firewall can stabilise government bond markets without ECB intervention. If you tell banks that you don’t know what is going to happen to the value of the collateral they have on their books — sovereign bonds — then the banks will try to get rid of any bonds that are not German.
Unless the ECB completely changes track and says that now, with Greece out, it will commit to stabilising government bond markets by buying large amounts of government bonds, the firewall can’t work. The order of magnitude is too big. I really doubt there will be such a dramatic change, but who knows what a Greek default would trigger. It’s a very unpleasant scenario for Greece, to have to go away in order that the ECB policies should finally change.
Of course the ECB does not only have external pressures. It also has internal disagreements on the course it takes. The central bankers of the eurozone sit on the ECB council, and we know that the German central bank is much more concerned about compliance with austerity than anything else.
The costs to German capital of “contagion” following a Greek exit would be enormous...
Germany has benefited from the troubles in the sovereign bond markets of the peripheral countries. If you have discrimination in collateral markets [i.e. some financial assets are accepted as collateral to be exchanged for cash, but some aren’t] then you will have a flight to the safest instrument, so Germany is benefiting [i.e. the German government can borrow very cheaply]. The German government can now sell bonds almost at negative interest rates.
But the German banks have cross-border exposures, and I can’t see how a collapse of the eurozone would not affect German manufacturing and German exports.
You see a continued spiral of governments having difficulty in bond markets, and banks having difficulty because the quality of their collateral (the government bonds they hold) is worsening?
Yes. Spain is going that way. Spain is much more significant in terms of cross-border holdings of sovereign bonds than Greece is. Greece’s situation is a worry in the first place because of the social implications, but also because of the precedent it sets. As regards the EU leaders, I think they care not much about the Greek people, but more about what it shows about how the EU deals with unexpected situations.
85% of the people in Greece say they want to stay in the eurozone. They want the EU to cancel the imposed cuts, and they say that doing that would be better from the point of the view of the whole eurozone too.
Syriza seems to be betting that the European politicians will be so concerned about the consequences of a Greek exit that they will allow a change of direction. It’s a gamble. If Syriza is elected, it will have to keep up its anti-austerity policies and at the same recognise that the Greek people do not want to be pushed out of the euro. But if Greece leaves the eurozone, one of the benefits is that it will have an independent central bank that is able to redesign the banking system and provide support to its government. The difficulty will be to contain the inflation that may accompany the devaluation, particularly since I don’t see how, immediately, Greece is going to have a big increase in export competitiveness.
There is no likely equivalent for Greece to the soybean export boom which boosted Argentina after it defaulted on its debt in 2001.
Greece is definitely not Argentina. Apart from the soybeans, Argentina has a much more significant industrial base than Greece has. But Greece will be confronted with some of the problems Argentina faced in its crisis — how to prevent capital flight, how to devalue and whether to follow the deeply unpopular Argentinian restrictions on withdrawal of bank deposits (i.e. the convertibility between bank deposits and cash).
Even though the Greeks don’t want to abandon the euro, both macroeconomics and the politics of a left-wing government tell us that it makes little sense to keep the euro outside eurozone — why would Greece not want to have its own independent central bank and remove some of the restrictions on economic policy it had inside the eurozone? Even outside the eurozone, Greece would have the same dilemmas as inside it, so long as it decides to keep the euro.
I don’t see how political pressure will change the way the ECB deals with the Greek central bank. It may make the European Union leaders relax some of the austerity demands, but that’s all.
I think the EU leaders hoped they would not be confronted with a Greek government saying it does not want austerity but it wants to stay inside the eurozone. That is the worst of both worlds for EU politicians. They have to make an explicit decision to kick Greece out, or to move away from austerity, with all the implications about their fiscal compact and their constitutionally-enshrined rules for primary surpluses. It’s a huge headache.
But I can’t see how, if Greece stops payments on its debt, the ECB will respond by relaxing the rules on what the Greek central bank will do.