Potholes in the road to resolving the Greek crisis

Mohamed El-Erian

Jun 25 05:30

Alexis Tsipras, the Greek prime minister, took to Twitter yesterday to signal that some of the country’s creditors are resisting his government’s new policy proposals. While this needn’t derail totally derail the upcoming European meetings, including this evening’s finance minister gathering and tomorrow’s leaders’ summit, it should remind markets of the considerable potholes facing a rapid and meaningful resolution of this tragedy.

With gains of 4 per cent in Germany and 9 per cent in Greece on Monday, markets were right to respond positively to signals out of Brussels that several European officials deemed the Greek government’s latest policy submission to constitute a “robust proposal” that opens the door for potential agreement. Remember, this came after a period of nearly-dysfunctional negotiations that saw material policy disagreements made worse by insults and accusations from both sides, even leading IMF Managing Director to regret the absence of “adults in the room.”

But rather than a qualified optimism — that is to say, one that is guarded, and is a lot more relative that absolute — many market participants jumped to the view that the latest Greek policy concessions, including a series of fiscal new measures, would quickly unlock some €7bn of committed but undisbursed aid. And the temptation for such hopefulness is considerable.

Without this emergency assistance, Greece would likely default on this month’s debt payments to the International Monetary Fund, and do so in the context of a banking sector implosion, capital controls, and the introduction of government IOUs to meet domestic obligations. Such a series of events, along with the further chaos they would engender, would likely push Greece out of the Eurozone.

Yet today’s Tspiras warning serves as an important reminder that optimism over Greece needs to be placed in its proper context, if only because the parties involved — be it Greece or members of its creditor grouping — can no longer be readily united after so many false starts and broken promises on all sides. Indeed, this speaks to four bigger risks that face current (and future) attempts to avoid a “Graccident” and to restore Greece as a healthy functioning member of the Eurozone:

If they do indeed manage to iterate to an agreement this week, and this is still far from certain, Greece and its creditors face the difficult challenge of selling it to their domestic constituents, including gaining parliamentary approval in Athens and then Berlin and some other European capitals. At best, it would be naive to expect anything but a really bumpy ride. Domestic political rejection is not out of the question.

If domestic constituents are brought on board, the implementation of the agreement would then face a series of other challenges on the ground that could easily derail it. Chief among them is a precarious Greek banking system whose ECB life-support system is not sufficient to restore the flow of credit to an economy that is back in recession and likely to contract further, adding to an already alarming unemployment tragedy.

When viewed in the larger context, the agreement being discussed this week is actually quite a limited one. Most importantly, it is insufficient to generate the growth and economic dynamism that the Greek people desperately need and genuinely deserve. So even before the ink dries fully on the interim agreement, all parties involved would have to transition to the much larger task of agreeing on a comprehensive third bailout package whose scope and scale (policy, financing and debt reduction) would need to be more ambitious on all sides.

Creditor co-ordination is getting a lot harder as illustrated by today’s signals, and for good reasons. The ECB, EU, IMF and European governments differ on important aspects of their economic assessments, policy aspiration, political sensitivity, and financial burden sharing.

In sum, markets’ optimism on Greece should, at best, be both guarded and relative. Yes Greece and its creditors now have a better basis to sit together and negotiate as they seek to avoid an increasingly threatening big accident. Yet, because of the incomplete solutions of the last few years, the road ahead of them all has become a very long indeed; and it is one that comes with already-identifiable potholes, as well as the material probability of further disruptions that wouldn’t cope well with the ever-tempting reversion by all sides to excessive grandstanding, incendiary rhetoric, and a harmful blame game.

Euro Danger Zone

Is Greece Lehman Brothers, or Is It RadioShack?

Neil Irwin

JUNE 24, 2015

There is one big question that hangs over the last-ditch negotiations this week between the Greek government and its lenders, even if no one involved would frame it quite this way: Is Greece more like RadioShack, or more like Lehman Brothers?
Whenever a company files for bankruptcy, it is damaging for that company’s employees and shareholders — though it is often a necessary exercise to shed debt and give the company any hope of thriving in the future. But no two bankruptcies are the same.
Sometimes, as when the retailer RadioShack filed for bankruptcy protection earlier this year, the widespread reaction is not shock, but rather, “Wait, weren’t they bankrupt already?” Stores close, workers lose their jobs and the company just may relaunch under new ownership and in a leaner form, getting a fresh start. 

Other bankruptcies go a little differently, none so dramatically as when Lehman Brothers filed in September 2008. Even though it was known that Lehman was ailing for months, the world was utterly unprepared for the idea that a major investment bank could default on its obligations.
Protesters held Greek flags outside the parliament building in Athens on Monday during a rally demanding that Greece remain in the eurozone. Credit Yannis Kolesidis/European Pressphoto Agency       
The ripple effects were countless. The short-term funding on which all the biggest global banks relied froze up, and other financial firms that had similarities to Lehman, including Morgan Stanley, Goldman Sachs, Wachovia and Citigroup, were soon in peril. A global freeze-up in credit led to a sharp recession across much of the world. Seven years later we’re still grappling with the consequences.
Which brings us back to Greece. The country’s negotiations over the extension of a bailout program were coming to a head Wednesday as Prime Minister Alexis Tsipras flew to Brussels to confront skeptical leaders of other European nations.
An overriding premise of the response by European and Greek leaders over the last five years has been that Greece is more like Lehman Brothers than like RadioShack. If it were to do the nation-state equivalent of filing for bankruptcy — repudiate its debts, exit the eurozone, devalue its currency — it would cause catastrophic ripples across Europe.

With hindsight, it is clear that European creditors bungled their response by demanding extreme fiscal austerity without any pressure release valve to lessen the economic pain for Greek citizens. Normally when the International Monetary Fund lends money to a country in financial trouble, austerity measures are paired with currency devaluation and debt write-downs; in Greece there was no such relief.
But every time European lenders and Greek leaders have stared into the abyss, they have concluded that Greece was, or might be, Lehman Brothers.
The widespread thinking, particularly five years ago when the nation’s fiscal troubles began, was that allowing Greece to undertake its version of bankruptcy would have immediate and horrendous effects on the rest of Europe and the rest of the world economy. Major French and German banks, loaded up with Greek debt, might fail. The markets for bonds of other Southern European countries would collapse, too, creating a debt crisis in Portugal, Spain and Italy. Sixty years of progress toward a united, peaceful Europe may have been obliterated over a single failed debt negotiation.

Those fears help explain why through five years of interminable negotiations to set and then renegotiate bailout terms, no matter how close Greece and the European Union seemed to the brink of a split, there was always a resolution.
Which brings us to 2015. Everyone is fed up. And there is a much stronger case than there was when this whole saga began that a Greek default and exit would be more like RadioShack than like Lehman.
Greek debt is now overwhelmingly held by European governments and its central bank, not private banks, so a default is unlikely to trigger a continentwide banking collapse. The European Central Bank has pledged to do “whatever it takes” to prevent a crisis of confidence in euro members’ debts, meaning it would backstop Portugal, Spain and Italy should markets lose faith.
You could even imagine that if Greece defaulted and left the eurozone, the politics would improve such that the remaining countries would become that much more united, moving toward still greater integration of bank regulation and fiscal policy.
Maybe. Or maybe that’s wishful thinking among people who are burned out on trying to salvage the Europe-Greece relationship and those who think a clean break five years ago would have been better in the first place.
German officials in particular have sent signals in recent months that they believe a Greek exit would be, if not ideal, fully manageable in a way it wasn’t a few years ago, and private analysts tend to agree that the landscape is different than it was from 2010 to 2012.

For the rather darker view, look to Larry Summers’s most recent Financial Times column, in which he warned that an independent Greece could become a failed state that would ultimately cost the rest of Europe much more than any bailout. For a slightly less alarmist take, Paul Krugman argued that the risk of a Greek exit lies more in the precedent it might set for the Portugals of the world, which could create continuing instability in the eurozone.
But there is a common thread in their work, and in that of many other commentators who have tried to make sense of what comes next for Europe: A breakdown in the talks and Greek exit really would open up some dark possibilities, even if figuring the exact odds of each of them is impossible. We may not know exactly what a collapse in the Greek talks would mean, but the bad outcomes are just bad enough to make muddling along look pretty darn good.

Heard on the Street

Challenging the Emerging-Markets Consensus

The usual response to financial turmoil is to sell emerging markets, but that looks like outdated thinking

By Richard Barley

Updated June 24, 2015 10:10 a.m. ET

Moscow skyscrapers sit on the skyline beyond the Kremlin building, right. Russia has managed to withstand a sudden and almost total loss of access to international financial markets—something that in the past could have had a far bigger impact. Moscow skyscrapers sit on the skyline beyond the Kremlin building, right. Russia has managed to withstand a sudden and almost total loss of access to international financial markets—something that in the past could have had a far bigger impact.

U.S. interest rates rising? Sell emerging markets. Eurozone standoff with Greece? Sell emerging markets. Problem in a couple of emerging-market countries? Really sell emerging markets.

The received wisdom is that emerging markets are risky and volatile—and therefore are first in the firing line when risk aversion rises. The latest jitters over U.S. interest rates and Greece have proved no different. Investors’ exposure to emerging markets stood at a 15-month low in June, with a big reduction since May, Bank of America Merrill Lynch’s global fund manager survey showed.

That looks increasingly like outdated thinking, however. The story since the global financial crisis broke out has been one of belated realization that risks in developed markets have been underpriced. Vast swaths of apparently low risk or “risk-free” instruments, from U.S. mortgage-backed securities to eurozone government bonds, turned out to be anything but.

Developed-market investors have had to cope with concepts such as sovereign credit risk that are bread and butter for their emerging-market counterparts. The latest manifestation of this is the lower liquidity and higher volatility being seen in advanced markets, traits normally more associated with emerging markets.

The temptation with emerging markets always seems to be to take the glass half-empty view.

Take the latest worries about lower growth—some of which, at least, is due to reforms that could make growth more sustainable. Emerging countries are still growing faster in aggregate than their developed peers. They will account for more than 70% of global growth this year, the International Monetary Fund thinks, and already account for more than half of world gross domestic product on a purchasing-power-parity basis. The bigger puzzle surely is the lackluster growth in developed economies given the sheer scale of stimulus thrown at them since the crisis.

Meanwhile, emerging-market crises have been loudly proclaimed as imminent several times in the past few years but have failed to live up to that billing. The buffers of cleaner government balance sheets, more flexible exchange-rate regimes and high reserves are proving powerful.

Russia, while undoubtedly suffering as an economy, has managed to withstand a sudden and almost total loss of access to international financial markets—something that in the past could have had a far bigger impact.

Indeed, with the power of extraordinary monetary policy potentially waning, the fact that emerging markets have been largely unloved may be to their advantage. Developed-market valuations for both bonds and stocks look rich; yields look to have troughed. Emerging-market stocks and bonds look much more attractive in terms of future returns given their starting point. Pictet Asset Management strategists forecast double-digit annualized returns for shares over the remainder of this decade. Emerging markets are risky—but at least investors get paid for taking that risk.

A rise in U.S. interest rates is likely to prove testing for all markets, after so many years of loose policy. And knee-jerk selling of emerging stock and bonds at the first sign of trouble may still be hard-wired into market behavior. But it is time for investors to question more carefully its validity.

The Jihadist Trap of Here and Now

By Scott Stewart

June 25, 2015 | 06:00 GMT

In recent weeks, I have found myself spending a lot of time thinking about the jihadist strategy of al Qaeda and how it compares to that of the Islamic State. Earlier this month, I wrote about the possibility that the al Qaeda brand of jihadism could outlast that of the Islamic State. Last week, I wrote about how ideologies are harder to kill than individuals, focusing on the effect that the death of al Qaeda in the Arabian Peninsula leader Nasir al-Wahayshi will have on the group and the wider global jihadist movement.

But beyond the impact of leaders like al-Wahayshi, there are other facets of strategy that will influence the war for the soul of jihadism. Specifically, I am talking about time and place. Both al Qaeda and the Islamic State seek to establish a global caliphate, but both differ quite starkly in how to accomplish this task and how soon it can be achieved.

Al Qaeda argues that the caliphate can be established only after the United States and its European allies have been defeated, to the extent that they can no longer interfere in Muslim lands — either because of a lack of ability or a lack of desire. The organization pursues a long-war approach that emphasizes the need to attack the United States, "the far enemy," before focusing on overthrowing local governments. The Islamic State takes the opposite tack. It has adopted a more urgent "why wait?" approach and concentrates its efforts on immediately taking, holding and governing territory.

This strategy banks on being able to use any conquered territory and resources for the purposes of continued expansion. The direct approach explains the Islamic State's decision to quickly proclaim a caliphate at the beginning of Ramadan last year, after it had captured a large portion of Iraq and Syria. The group's message to the Muslim world is that the caliphate is here and now, and there is nothing the world can do to stop its inexorable expansion.

Since the fall of the Taliban's emirate in Afghanistan, several jihadist organizations have attempted to create Islamist polities, with the current attempt by the Islamic State (the organization's second try) being the most recent. So far, each of these attempts has ended in a spectacular failure and in each case, including the Taliban's emirate, western military intervention has played a key role in the downfall of the jihadist polity — and it will do so again in the case of the Islamic State's so-called caliphate.

Recent Jihadist Polities

In 2006, an array of jihadist groups led by al Qaeda in Iraq announced that they were forming an Islamic state in Iraq. They even began to refer to themselves as the Islamic State in Iraq. While the group initially eclipsed the al Qaeda core in terms of attracting foreign fighters, outside funding and publicity, the U.S. surge in Iraq and the Anbar Awakening greatly weakened the group. By 2010, when a U.S. airstrike killed Abu Omar al-Baghdadi and Abu Ayyub al-Masri — the group's top two leaders — the organization had become only a shadow of its former self. The 2011 U.S. withdrawal from Iraq and the sectarian policies of former Iraqi Prime Minister Nouri al-Maliki's government allowed the group to survive, and the civil war in Syria helped the organization recover its strength and grow into what it is today. 

In 2011, as Yemen was struggling through a crisis that pitted elements of the military against each other, al Qaeda in the Arabian Peninsula seized the opportunity afforded by the chaos to grab large quantities of weapons, while also extending its influence over large areas of territory in Yemen's south. However, by mid-2012, Yemeni forces aided by U.S. intelligence and training (and some air support) were able to recapture most of the territory taken by al Qaeda in the Arabian Peninsula. 

A unique window into the thoughts of al Qaeda in the Arabian Peninsula during this period was revealed with the discovery of letters sent by al-Wahayshi to Abu Musab Abdel al-Wadoud, the leader of al Qaeda in the Islamic Maghreb. In the letters, which journalist Rukmini Callimachi discovered in the Malian city of Timbuktu, al-Wahayshi shared some of the lessons he learned — and mistakes his organization had made — so that al-Wadoud and al Qaeda in the Islamic Maghreb would not repeat them.

According to one of al-Wahayshi's letters, his group suffered significant losses of men, materiel and money in 2012, far surpassing what they had gained in 2011. The group's higher profile and level of operational activity also resulted in al Qaeda in the Arabian Peninsula losing a number of important members to U.S. airstrikes, including Anwar al-Awlaki and Samir Khan.

In another of the letters, al-Wahayshi explained why his group purposefully did not proclaim an emirate in southern Yemen: "As soon as we took control of the areas, we were advised by the General Command here not to declare the establishment of an Islamic principality, or state, for a number of reasons: We wouldn't be able to treat people on the basis of a state since we would not be able to provide for all their needs, mainly because our state is vulnerable. Second: Fear of failure, in the event that the world conspires against us. If this were to happen, people may start to despair and believe that jihad is fruitless."

He encouraged al-Wadoud to also refrain from proclaiming an Islamic polity, but his advice went unheeded. Shortly after receiving the letter from al Wahayshi, jihadists aligned with al Qaeda in the Islamic Maghreb declared an Islamic state called Azawad in northern Mali in April 2012. But the French intervention in Mali in January 2013 rapidly pushed the jihadists out of the territory they had conquered, ending the short-lived jihadist state of Azawad.

Past attempts to create an Islamic polity in Somalia were also thwarted by an international coalition. And in recent months Boko Haram, which now calls itself Wilayat al Sudan al Gharbi after pledging allegiance to the Islamic State, lost most of the territory the group had previously seized in northern Nigeria.

Al Qaeda in the Arabian Peninsula made another land grab in 2015 as the country fell into chaos. In April, the group took control of Mukalla, Yemen's fifth largest city and the capital of Hadramawt province. Meanwhile, jihadist groups in Libya, such as Ansar al-Sharia, the Mujahideen Shura Council and the Islamic State's three Libyan Wilayats (or provinces) are all fighting with secular, nationalist and tribal forces for control of the country.

And of course, the Islamic State took control of large portions of Iraq and Syria last year and declared the re-establishment of the caliphate there. The group's theatrical, genocidal violence resulted in the formation of the coalition that began an air campaign against it in September 2014. Since then, the group has lost much of its strategic momentum, as well as a great deal of its economic infrastructure and many weapons and personnel. The Islamic State also lost control of a good deal of territory in Iraq and Syria, including places such as Tikrit, Kobani and, most recently, Tal Abyad. Still, the Islamic State has taken control of the cities of Ramadi in Iraq and Palmyra in Syria, though the group is under attack from the international air campaign, as well as local ground forces.

Bin Laden's Strategy

The United States and the West played a critical role in the downfall of recent jihadist polities in Iraq, Yemen, Mali and Somalia. This fact would certainly not surprise Osama bin Laden, who lived to witness such events. From the beginning of his public campaign to establish the caliphate, and in his 1996 "Declaration of War against the Americans Occupying the Land of the Two Holy Places," bin Laden warned that the United States had to be driven out of the region before progress could be made. Bin Laden noted the way that Hezbollah's activities in Lebanon had driven U.S. and French forces out of the Levant, which gave the group space to become a powerful player in the region. He sought to replicate that success elsewhere.

It was a strategic vision bin Laden held until his death. In a letter written to his assistant, Atiyah Abd al-Rahman — likely around March or April 2011, based upon the events commented on — he asked al-Rahman to dispatch a letter to al Qaeda in the Islamic Maghreb asking it to focus on attacking U.S. embassies and oil companies, rather than local security forces. Bin Laden also wanted to warn the franchise about the dangers of prematurely proclaiming a caliphate:
We should stress on the importance of timing in establishing the Islamic state. We should be aware that planning for the establishment of the state begins with exhausting the main influential power that enforced the siege on the Hamas government, and that overthrew the Islamic emirate in Afghanistan and Iraq despite the fact this power was depleted. We should keep in mind that this main power still has the capacity to lay siege on any Islamic state, and that such a siege might force the people to overthrow their duly elected governments. 
We have to continue with exhausting and depleting them until they become so weak that they can't overthrow any state that we establish. That will be the time to commence with forming the Islamic state. 
Bin Laden understood that while the United States struggles with ephemeral, ambiguous entities, it is very good at attacking a well-defined enemy that it can identify and locate.

Declaring an Islamic polity and attempting to hold and govern territory automatically makes an organization a fixed target on which the United States and its allies can focus their formidable power.

Yet, even knowing this fact, al Qaeda has not been immune to the trap of place. The al Qaeda core has always needed a sanctuary to operate effectively, like Sudan or the Taliban's Afghanistan.

Lacking a suitable sanctuary, the group's operations since the invasion of Afghanistan have been limited. There are reports that the al Qaeda core sent a group of operatives from the Afghanistan-Pakistan border area to Syria to attempt to establish a base there — the so-called Khorasan group.

That group was struck by some of the first U.S. airstrikes in Syria in September 2014. Evidently, having an address has its downside.  

It is also not entirely surprising that al Qaeda in the Arabian Peninsula has lost three senior leaders in Mukalla since the group conquered the city in April. After the loss of two of his lieutenants, al Qaeda in the Arabian Peninsula leader al-Wahayshi still visited the city for some unknown reason — and it must have been an important reason to override security concerns.

In the aforementioned letter to al-Rahman, bin Laden asked him to "send a letter to the brothers in Yemen to have them implement security measures, avoid moving about except for dire need."

Bin Laden knew that controlling territory is a dangerous trap, unless the United States and its allies are vanquished from a given region. But there are times when even groups affiliated with al Qaeda need to run the risk of exposing themselves in contested territory.

The Eventual Progression

When the Islamic State in Iraq and the Levant broke from al Qaeda and declared a caliphate in a specific location, the organization once again made itself a fixed target. Its ideology and claims also serve to tie the group to a specific piece of terrain. It suffered major losses the last time it was so bold, surviving only by abandoning territory, reducing the group's overall profile and returning to a low-level insurgency and terrorism campaign. Of course, the group's survival was also greatly aided by Sunni sheikhs in Iraq who did not trust the government of former Iraqi President Nouri al-Maliki government and thus sought to maintain some sort of jihadist presence as a tool to wield against Shiite sectarianism. Allowing the Islamic Sate to survive in Iraq is something those sheikhs surely regret now.

Despite the criticism that U.S. President Barack Obama has received over his administration's policy toward the Islamic State, the organization's expansion has been stopped and is beginning to be rolled back. There are some who would claim that the organization has not been contained, as demonstrated by the proliferation of existing jihadist groups and factions that have declared allegiance to the Islamic State. But make no mistake, these franchises clearly lack the resources and leadership of the Islamic State core, and they have not gained any capacity previously lacking. They are essentially the same groups with the same capabilities. Only their names have changed, as well as perhaps a little bit of their operational and media philosophies.

It may take some time, but eventually U.S. air power paired with local ground forces will drive the Islamic State from its perch in the same manner as the Taliban and the Islamic State in Iraq. It took seven years to cripple the group last time with U.S. forces on the ground. It will likely take years this time — especially without the presence of a reliable allied ground force in Syria. But there is little doubt that the group will slowly be strangled on the ground as it is repeatedly pummeled by precision airstrikes.

The Islamic State, consequently, will eventually follow the same strategy as the Taliban, al Shabaab, al Qaeda in the Arabian Peninsula and al Qaeda in the Islamic Maghreb. The group will abandon its territorial gains to return to an amorphous, low-level insurgency and terrorism campaign. It is, of course, the same strategic shift the group made in 2010. If it had not done so, it would not be here today. If the Islamic State does not abandon its here and now attitude, deciding to stand its ground and defend its caliphate to the end, it will be destroyed.