Regime Change Option on the Table?

It has been clear from the beginning that Greece and its creditors were in a “Mexican standoff” situation. We already pointed this out shortly before Syriza won the election (see: Grexitology: A Mexican Standoff). 1. the “institutions” (formerly known as the “troika”) couldn’t possibly let Greece go, but could also not possibly give in and climb down from their demands and 2. Mr. Tsipras was in essentially the same situation; he couldn’t cross Syriza’s aptly named “red lines”, but defaulting and leaving the euro zone is likewise not palatable to him.


road closed

Moving too far to the left is unlikely to end well

Cartoon by Lisa Benson



The enfant terrible and his creditors.

Photo credit: Guido Bergmann / Reuters


In mid June, we speculated that given their perspective, the creditors may be considering an option that has already worked several times in the course of the euro area’s debt crisis: go for regime change.

Any concessions Tsipras happens to make are putting him on a collision course with Syriza’s left-wing hardliners, including his own wife. These people seriously believe that economic examples worth following are countries like Venezuela. In other words, they are hopeless ideologues supporting an economic model that has demonstrably and consistently failed for more than a century wherever it has been tried.

On the other hand, exiting from the euro means that Syriza would be in conflict with what the vast majority of Greek citizens wants, who understandably have no desire to readopt the drachma. Tsipras may be able to get the necessary votes for a compromise in parliament with the opposition’s help, but that would almost certainly lead to new elections, and very likely would split Syriza (which itself is a coalition of various leftist groups). We cannot imagine that a default and a subsequent euro exit wouldn’t provoke new elections as well.

As a result, the creditors may well be gambling on winning by confronting Greece with a “take it or leave it” offer, which they essentially appear to have done yesterday. If the offer isn’t accepted, the hope may be that a new government will subsequently come to power in Greece and prove easier to handle. In the meantime it has however emerged that the “differences between Greece and the EU have narrowed”, so maybe it won’t come to that.

As a side note: €7.2 billion in creditor funds are to be released if an agreement is struck, but Greece not only has a 1.544 bn. repayment to the IMF coming due on June 30, it also has altogether €6.934 bn. in repayments coming due in July. In short, by the end of July, more than the €7.2 bn. will be needed to make all these payments. The biggest chunks in July are €3 bn. in short term treasury bills, another €452 m. to the IMF, €2.096 bn. to the ECB and €1.361 to euro area national central banks. The bond repayments due to euro area central banks are the remnants that were exempted from the haircut imposed in the 2012 PSI (“private sector initiative”).

In recent weeks, deposit outflows from the Greek banking sector have accelerated markedly. We have updated our charts with the most recent available official data, which include the month of May, but not the panicked withdrawals of the past two weeks. One can probably deduct another €10 billion from private sector deposits to arrive at the current figure. This is pretty grim, as the banking system is undoubtedly running out of collateral (collateral presented for “ELA” is subject to very large haircuts). We are guessing that this may already have happened, and that the BoG is by now getting IOUs from the banks they issue themselves (this is how ELA worked in Ireland a few years ago).


Euro System LiabilitiesEuro system liabilities of Greek banks as of May (includes nearly €90 bn. in ELA funding) – click to enlarge.


Private sector depositsPrivate sector deposits in Greek banks at the end of May – back to 2004 levels – click to enlarge.


TARGET-2TARGET2 liabilities at the end of May – click to enlarge.


Tsipras Presents “Reforms” – Stop the Presses, we Agree with the IMF

What has been totally lost in all the haggling is the fact that the Greek economy needs to be reformed no matter what the outcome of the negotiations is. Greece has gained a bit in terms of competitiveness due to internal price and wage deflation, but since it isn’t a big export powerhouse, this is by itself far from enough. As we have previously pointed out, Greece remains hamstrung by an utterly inefficient and corrupt bureaucracy, regulations that would be funny if they weren’t so awful, a political culture that has by all appearances not changed under Syriza (helping one’s cronies is the top priority) and highly inflexible over-regulated product and labor markets.

No significant reforms have been undertaken in any of these areas. Naturally, every small reform has these days become a bargaining chip, which is in our opinion utterly absurd. Last week, Mr. Tsipras finally decided it was time to move a little closer to the creditors’ demands by offering a concrete reform package. Here is a list of the most important reforms he offered:


Athens accepts that negotiations over debt relief are to be undertaken after the implementation of new reform measures (previously the government insisted these had to be linked). The new post negotiations budget for 2015 would be voted on before 01. July and be valid retroactively

Value added tax: three different tax rates to remain (6, 13 and 23 percent), but more goods and services are to come within the ambit of the highest rate, and VAT rebates for islands are to be discontinued.

Pensions: de minimis changes in terms of cutting pensions, but contributions to the pension system to be raised by 3.9% and contributions to health care by 4 to 5%.

Company tax to be hikes by three percentage points to 29%, plus introduction of a special tax of 12% for companies making more than €500K per year. Anyone making more than €30K per year to pay a “solidarity levy”.

Labor market: demand to reintroduce collective bargaining dropped, but examination of “European framework conditions” with International Labor Organization ILO to be performed, which then are to be transposed to Greece.

Privatizations: resistance to privatizing certain state-owned companies dropped, but only modest revenue targets aimed for (meaning, they want to drag the process out as much as possible).


After studying the proposal, it was the IMF that came out with a proper assessment. According to the Washington-based bureaucracy, the Greek proposal “relies too heavily on new taxes on labor and capital”.

Indeed, this has been the problem with Euro area style “austerity” all along. Wherever governments were forced to do something to bring their budgets closer to the Maastricht deficit and debt targets, the preferred method has been to bleed the private sector dry with new taxes. No-one wants to reduce the size of the State – they would rather destroy what’s left of the market economy before doing that. Examples for this method are Italy under Monti and France under Hollande – and not surprisingly, the economies of both have been performing horribly ever since. Greece is most especially in need of shrinking the State. We have shown the chart below before, but it bears repeating:


greece-government-spending-to-gdpSpending by Greece’s government amounts to almost 60% of economic output. Admittedly GDP is a severely flawed measure of economic activity, but this is even higher than the corresponding ratio in France – click to enlarge.


Obviously, this cannot work. It is quite likely that once these tax hikes are implemented, tax revenues will decline instead of rising (apart from an initial bump as people rush into shops to beat the VAT increase). We would also point out that higher “taxes on labor” are not going to be paid by labor – they will be paid by companies. If one adds all of the above up, a company making more than €500K per year will be hit with a direct tax increase of 15%, its labor costs will rise by 7.9% – 8.9%, and in addition it will lose money on having to remit higher VAT prepayments henceforth.

To this one must consider that a €500K per year profit may well be achieved on razor-thin margins. It is easily imaginable that numerous companies could be immediately pushed over the edge by the additional labor costs alone. Even more jobs would likely be lost. Others may just decide to “go Galt” or relocate to a different country. Entrepreneurs not only have to take great risks, as a rule they also have to work long hours. Unless there is at least a chance that such efforts will pay off at the end of the day, they have no reason to do any of this.

Meanwhile, if the left wing of Syriza were to get its way, Greece would indeed end up a smaller version of Venezuela. As Mish notes here, the “Aristeri platform” of Syriza wants to go for an “Icelandic default”, nationalize the entire banking system and establish a new central bank with its own printing press. Due to the workings of the fractionally reserved fiat money system, banks are closely intertwined with the State (in the euro area this incestuous relationship is now at one remove, as the ECB is a supra-national institution). Even so, it can hardly be expected that a fully nationalized banking system would be superior to private banks. In fact, given the likely direction economic policy would take under Syriza, it is a good bet that such a nationalized banking system would be used to inflate all-out. Moreover, none of the urgently needed reforms of the Greek bureaucracy and regulations would likely ever take place if Greece were to go down this path.



All the parties involved in the haggling over the Greek extend-and-pretend scheme apparently can’t see the forest for the trees anymore. The actual goal should be to establish the foundations for sustainable economic progress in Greece. The debate over Greece’s debt seems actually secondary to this objective. Given how far into the future the bailout repayment terms stretch and how low the interest on this debt is, a big debt haircut via inflation is actually already baked into the cake. The focus on the debtberg and the associated can-kicking exercises ultimately means that the real challenges aren’t getting the attention they deserve.


The BuBa has recently complained about the ECB’s “bridge financing” of Greece via ELA. It is clear though that the ECB doesn’t want to provide the trigger for a collapse of the Greek banking system as long as negotiations continue. It would never be able to live that down.


Charts by: Acting Man, TradingEconomics




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