A failure to tell the truth imperils Greece and Europe
If the IMF pulls out, Europe will be free to mismanage the crisis on its own
by: Wolfgang Münchau
Failure to tell truth to power lies beneath much of what is going wrong in Europe right now. It may not be the principal cause of the Greek debt crisis, which is now on its umpteenth iteration.
But it is more than a mere contributing factor.
You notice it particularly at those moments when others speak the truth, as the staff of the International Monetary Fund have done recently. In its latest survey of the Greek economy it states that “public debt has reached 179 per cent [of gross domestic product] at end-2015, and is unsustainable”.
Europeans are not used to such bluntness. The Germans protested. The European Commission protested. So did the Greeks. They all want to keep up the fairy tale of Greek debt sustainability for a little while longer.
They were particularly shocked that the IMF exposed the disagreement when it wrote that “some directors had different views on the fiscal path and debt sustainability”. These were the Europeans, who are now in a minority in the fund.
Once the Trump administration sends its representatives to the IMF board, expect the climate to become even more hostile. My expectation is that the IMF will ultimately pull out of the Greek programme, leaving the Europeans free to mismanage the ongoing Greek crisis on their own.
How did it come to this? In July 2015, the EU and Greece agreed a third bailout. Alexis Tsipras, Greek prime minister, committed himself to running a primary surplus (before the payment of interest) of 3.5 per cent of economic output each year.
No country has ever managed to maintain such a commitment over an almost indefinite period. Greek debt sustainability was thus premised on an obviously unfulfillable assumption. Greece is not only far away from achieving a 3.5 per cent primary surplus. It will never do so.
Another untold truth is that Germany will never forgive Greek debt. This is because the German parliament will not accept it, and the number of MPs hostile to Greek debt relief will be even higher after the September election.
If the German government wanted to accept debt relief measures, it could probably assemble a parliamentary majority today. The “grand coalition” led by Chancellor Angela Merkel commands about 80 per cent of the seats in the Bundestag. But with the September elections, I would expect the Free Democrats, the liberal party, to re-enter the parliament after they failed to clear the hurdle last time. Their leader, Christian Lindner, said last week that the best way forward is for Greece to leave the eurozone, and for Greek debt to be forgiven afterwards.
Alternative for Germany, the rightwing anti-European party, not only wants Greece out of the eurozone, but Germany as well. Together those two parties will probably account for some 20 to 25 per cent of MPs. If you add the large group of Eurosceptics from Ms Merkel’s Christian Democratic Union and its Bavarian sister party, the Christian Social Union, it is not hard to see why the window for debt relief will close permanently this autumn.
What is particularly galling about this story is the complicity of the Greeks themselves. There are no good and bad guys in this story. In the spring of 2015, in the months following Syriza’s election victory, Mr Tsipras’ government took the position that a fiscal surplus of 3.5 per cent is economically counterproductive and politically suicidal.
In the end he chose to cave in to European demands, and accepted the 3.5 per cent target. He then committed the catastrophic mistake of aligning himself with the EU against the IMF, the only institution that advocated debt relief. It was a political miscalculation. He thought the target was soft, like so many other European benchmarks. And he thought he could always compromise with the Europeans on structural reforms. He also miscalculated in assuming that the IMF would be complicit in such a deal.
A much overlooked part of the Greek bailout programme is that Germany made its participation conditional on IMF involvement. That gave the fund leverage. If the IMF now pulls out of Greece, one of two things will happen. Athens will either default on its debt this summer and be forced to quit the eurozone, or Berlin will accept debt relief just a few months before the elections. Either way, this is a fight in which someone ends up on the floor.
The Greek crisis is only the most glaring example of failure to tell the truth. There are many others. Italy’s membership of a monetary union with Germany is also transparently unsustainable. Yet no Italian prime minister has ever mounted a credible challenge to the way the system is governed.
When the truth dies, we should not be surprised if alternative facts are put in its place.
It’s easy to be hypnotized by stocks’ meltup, especially since the market’s calm stands in such stark contrast to Washington’s chaos. But how long can stocks remain an oasis of serenity?
There are good reasons why a 1% pullback has become as rare as civility in Internet comments sections.
U.S. earnings are ticking up anew, and global economic data is improving. There are even those, like Deutsche Bank strategist Binky Chadha, who argue that stocks’ postelection surge merely reflected the dissipation of uncertainty following tight elections, and not Trump’s promised tax cuts and fiscal spending.
“With little priced in for policy changes, selloffs on any stimulus disappointment should be short-lived,” he writes. Above all, trillions printed by global central banks now sit uncomfortably in bonds and unprofitably in cash, and computerized trading based on patterns established during years of abnormal monetary largesse keeps up the blind buying of pricey stocks.
Michael Hartnett, Bank of America Merrill Lynch’s chief investment strategist, says what he calls the market’s three Ps—positioning, profits, and policies—seem “consistent with one last 10% melt-up in stocks and commodities in 2017.” Among the many indicators he watches, the firm’s proprietary bull-and-bear barometer (of fund flows, positioning, and technical data) has risen to a 2½-year high, but is still shy of a sell signal. Fund-manager surveys show institutional cash balances at about 5.1% of portfolios, above a 10-year average of 4.5%. But indicators of market breadth show that 76% of global stock markets today are overbought, quite a change from a year ago when 89% of stock markets were oversold.
“Measuring fear is easier than measuring greed,” Hartnett writes, which is why stock-market bottoms often arrive quickly, but forming a market top can take much longer.
So what are some risks that can eventually test stocks’ mettle? The dissolution of a 35-year bond bull market should worry investors, although it has become easy to overlook that risk as bonds’ selloff slowed, and the yield on 10-year Treasuries began to consolidate near 2.5%. But make no mistake: The unwinding of one of the planet’s biggest bubbles isn’t behind us; in fact, it has barely begun, what with 10-year government bonds yielding just 0.08% in Japan and 0.32% in Germany. Here in the U.S., rates have ticked up from record lows but are still historically benign. Yet auto sales, mortgage applications, and home sales weakened in January, and personal bankruptcy filings are up 5.4%. Meanwhile, foreigners seem less willing to hoover up our bonds, and the level of U.S. Treasuries held abroad just fell below 30% for the first time since 2009.
Next, Trump’s plan to make big changes to our economy also increases the risk of policy error. Will bullying corporations from venturing abroad really overcome the structural changes wreaked by automation and globalization? According to Goldman SachsS in Your Value Your Change Short position ’ economists, less than 2.5% of layoffs from 2004 to 2012 were due to the relocation of jobs abroad. U.S manufacturing actually has become more competitive since 2000, but the decline in manufacturing’s share of all jobs has merely slowed, not reversed. Besides, Americans have also benefited from global trade—prices we pay for durable goods have declined since 1995. And emerging markets don’t just sell us stuff, their burgeoning middle classes are some of our fastest-growing customers. Apple (ticker: AAPL), for instance, earns a quarter of its revenue from emerging Asia, while BoeingBA in Your Value Your Change Short position (BA) earns 30% from emerging markets.
MEANWHILE, CHINA’S STOCKPILE of foreign-exchange reserves has shrunk to $2.998 trillion from nearly $4 trillion as recently as 2014. This puts Beijing in a increasingly tight spot: Should it keep spending its dwindling reserves to prop up its currency and maintain a stable exchange rate, or should it just let the yuan fall to market levels?
China’s reserves are shrinking because its exports have been falling, and rates are rising faster in the U.S.
The Chinese, who fear further depreciation, have been yanking yuan out of the mainland hand over fist, and buying up everything from U.S. companies to Manhattan condos. In 2016, China’s foreign direct investment jumped 189% to North America and 90% to Europe, notes Baker McKenzie.
Letting the yuan float freely could eventually boost Chinese exports, stem capital flight, and increase inflation that can help reduce the real value of its debt overhang, notes William Adams, PNC’s senior international economist. But in the short term, it could roil global markets and cause commodity demand and prices to gap lower, hurting inflation expectations and rates. Adams isn’t forecasting a yuan free float in 2017. “But without knowing the People’s Bank of China’s magic number—the minimum level of foreign reserves they’re willing to accept—the possibility cannot be excluded,” he says. This time last year, concerns about China and falling oil prices triggered a 13% U.S. correction. Let’s hope a year has made all the difference.