Scripophilists ought to be speculating right now as to whether there is, somewhere in the Hellenic Central Bank’s vaults, a stack of future monetary curiosities. I think it’s quite likely that in the next couple of months, Greece will be making use of government IOUs, and if I’m right, it’s equally likely that they’ve got them printed by now as a contingency plan. Let me explain what I’m on about …

Tax anticipation notes, California-style IOUs and so on — they’ve been suggested a few times so far in this crisis and I’ve tended to pour cold water on the idea. But that’s because so far, they’ve been suggested as if they were a good idea, or a potential alternative policy. In fact they’re a terrible idea and in my opinion, they’re not a policy option at all. But despite that, they might end up being used as a stopgap — either as a bridge to a genuine solution, or as a last grasp at a floating straw before everything falls apart.

Actually, if I’m going to explain what I’m on about properly, I’m going to need to start a little further back.

As I’ve said since the start of this crisis, Greece has two big priorities (or at least, it ought to have). These would be:

First priority has to be to keep its access to concessionary financing from the Eurozone. I explained this once with an analogy, but for people who prefer graphical explanations, here’s a chart (which also includes a friendly dig at Paul Krugman’s advocacy of taking a hard line with the institutions).

The key thing to remember is that Greece needs to run a big budget deficit, and its next-best option for financing that deficit if it can’t get funding from the troika would be really bad. In fact, there is no alternative provider of financing, so the means of financing the budget deficit would be “disorderly default and euro exit”, and this would have really bad consequences, as outlined by “The Greek Analyst” here.

The second priority still ought to be “negotiate as large a primary deficit / as small a primary surplus as possible in the program, consistent with priority number one”. I don’t have a chart to illustrate this, but here’s a link to an article discussing it earlier. This ought to be prioritised above most anything else in the Syriza program (maybe with the possible exception of the very most vital humanitarian measures) because it is the key to near term economic survival, let alone recovery. If you were elected as an anti-austerity government, you ought to prioritise the minimisation of austerity.

I think these ought to be the priorities of the Greek government, but I can’t be 100% sure that they are the priorities of the Greek government. In particular, there’s some reason, based on public statements, to think that

“Re-establish Greek sovereignty and reject anything which involves giving up control of policy”

is a higher priority. I think this is a really bad idea in terms of hardship suffered versus benefits gained, but it is not incoherent or ridiculous. It’s also possible that:

“Hold together a fragile coalition in a country where there is no real consensus supporting anything”

is so much of a constraint on decision-making that it doesn’t really make sense to think of things in terms of priorities. However, although these two possibilities have to be taken seriously, I still think that the best evidence we have suggest that the wheels are still on and that both Tsipras and Varoufakis are doing as best they can to negotiate a reduced-austerity program within the Euro, albeit on a fierce learning curve when it comes to working out how things are done.

So, with that basic analytical framework in place, we have two key short term questions to answer:

1) Will Greece default on the May payment due to the IMF (EUR774m), if the alternative is to fail to pay wages and pensions?


2) Will Greece default on the July principal payment on bonds held by the ECB, given that the amount (EUR3.5bn) is much too big to be met by any sort of scrambling about for cash reserves?

My guess would be that it’s “no” to both. I’m a lot more confident on (1) than (2).

The reasoning here is that defaulting on the IMF is the ultimate short term gain/long term pain policy. If you default on the IMF payment in May, you’re going to end up defaulting on the pensioners in June and for several months thereafter; it’s a sufficiently serious gesture of unwillingness to co-operate with the international community that it’s very likely to make the Institutions believe that Greece isn’t saveable in the Euro. So, at present Greece is looking through the local authorities and nationalised industries to try and find enough cash to pay both the IMF and the wage bill. But if there isn’t enough cash to achieve this, then my guess is that they pay the pensions and wages in IOUs, like California did for some contractors in 2009 (that’s why I’ve headed this article with a picture of one of Argentina’s “patacons”, as used in 2001). As the two examples — California and Argentina — suggest, this policy can sometimes work well, and sometimes just accelerate the inevitable. First best would be to make enough progress in Riga this weekend to not need to choose, but I think that’s unlikely. It’s the nature of these things that all the time that can possibly be taken will be taken, and that includes any time that can be created with ad hoc desperation measures.

For the July 20 payment, though, there is much less room for manoeuver. The amount of money is too big to be raised by scraping around the contingency reserves — it has to be borrowed (or more accurately, rolled over). And so the question “Will Greece default on the July 20 payment?” is basically the question of “Can an agreement on the bridging platform be reached?”. If the two sides can get to an agreement under which the Institutions are prepared to front up billions for Greece by then, the payment will be made; if not, then default will happen and capital controls, deposit haircuts and all of that stuff shortly after. So we’ve finally found the hard deadline by which all the questions need to be answered. This in turn, by the way, suggests that European risk assets are not necessarily all that well favoured between now and mid-July.

And the analysis of that question is not much different from how it was in February.

Is there unambiguous political support in Euroland for doing what is necessary to keep Greece in the Euro? No.

Is there enough goodwill to support a bridging effort to buy time for detailed discussion of how much money Greece needs and how much control the lender countries want to keep? Yes.

Is it natural for the Greek side to use that bridging period to create “facts on the ground”? Yes.

Are the institutions going to let them get away with that? No.

That would be my capsule summary.

Because the guts of the political argument are that in the longer term, the lenders need to a) understand that they have to come up with enough budget financing to put Greece back on a sustainable economic path, and write off past debts, and b) to be given confidence that if they provide such financing, it will actually be used to put Greece back onto a sustainable path, rather than spent on propping up clients and passing a few more years in the pretence that the 2007 peak was “normality”. And in the short term, the best way of establishing whether b) is true is to find out if the Syriza government are capable of delivering on negotiated promises, or whether they are going to constantly talk about “red lines”.

So between now and July, we need to find out what the democratic mandate Syriza keeps talking about actually means. In my opinion, they had a mandate to try to the “hardman” negotiating strategy and find out whether or not Euroland would give away big concessions in order to keep them in the Euro. We are reaching the limit of that strategy and so far the answer appears to be negative. Given that, they can either decide

a) that their mandate now extends to the renegotiation of the program on the basis of reality, acknowledging that this will mean that not all of their manifesto is achievable, or that

b) there is now no mandate, and that Greece needs to have another election to decide whether it wants the full anti-austerity program or whether it wants to stay in the Euro, in the public knowledge that the two are incompatible.

I think that they will choose the first of the two options; it’s sensible. And if they do, then the institutions need to see some sort of show of good faith for the next round of program negotiations, along the lines of the memoranda from February. There is definitely a deal to be done here, all that remains is to do it.

Bull Market

A collection of finance and business writing by @alexisgoldstein, @delong, @dsquareddigest, @DuncanWeldon, @felixsalmon, @jamesykwak, @Mark__Buchanan, @WhelanKarl

    Dan Davies

    Written by

    Senior Research Advisor, Frontline Analysts

    Bull Market

    A collection of finance and business writing by @alexisgoldstein, @delong, @dsquareddigest, @DuncanWeldon, @felixsalmon, @jamesykwak, @Mark__Buchanan, @WhelanKarl

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