Greece Is Still Trapped, Act Three

And so Greece’s parliament has endorsed the first stage of the deal struck last weekend when its prime minister, Alexis Tsipras, completely caved in to an exasperated Angela Merkel.

He is now on a shorter leash than ever, forced to take the lead role in carrying out a stricter Troika reform program than the one initially proposed to him back in February.

As I’ve been explaining since late January when Tsipras first came to power, Greece is trapped by simple economic reality. The Greek government had zero primary surplus in 2014, which means that even if it defaulted on all its debts, including to Greek banks, it would still have no room to fund fiscal stimulus.

The only way Greece could get such room would be to quit the euro and accept a large devaluation of all Greek financial assets, including deposits in Greek banks. That’s a political non-starter in Greece: only a minority of Tsipras’ Syriza coalition and a couple small far-right parties are willing to go there.

It will be interesting to see how long Tsipras can last in this situation. He appears to be under no near-term threat in parliament. An accommodation appears to have been reached for now in which the centrist opposition will support the reform program while the farthest-left and far-right corners of Tsipras’ ruling coalition will cast symbolic protest votes against reforms but not do anything to bring down Tsipras or his government. The farthest-left factions lost minister and deputy minister positions. The far right kept the defense ministry.

Tsipras’ resounding victory in the July 5 referendum has proven that he is skilled at channeling the public mood into support for himself. The fact that he won the referendum completely dishonestly, by urging Greeks to vote for an anti-austerity option that he knew didn’t exist, doesn’t seem to have cost him much in Greek domestic politics, at least not yet.

Meanwhile European political leaders are hurriedly working on rolling over Greece’s €2b of overdue debts to the IMF and another €3.8b of principal and interest due mainly to Euro Area central banks on Monday. The European Central Bank’s governing council has reportedly added €900m to Greece’s “emergency liquidity assistance” allowance, the lifeline that was keeping Greek banks liquid until the council stopped approving increases in late June. Greek banks are expected to open on Monday, though I don’t think €900m is nearly enough to enable the Greek government to lift all of the protections it has granted to Greek banks from their depositors.

Understanding the meaning of “debt relief” in IMFese

As I wrote back on July 2 when the IMF first published its report saying Greece needs “debt relief,” the meaning of those words is being widely misunderstood. Gradually more and more journalists have been figuring it out, but there’s still a lot of confusion around, so it’s worth clarifying this point a little further.

The IMF was not saying that Greece needed a write-down. What the IMF said was that Greece needed extensions of the maturities of its official debts that fall due after 2018, plus another €52b of official loans. That breaks down to: €30b to roll over the debts that fall due by the end of 2018; €20b to clear arrears, rebuild run-down cash balances, and replace bank bailout reserves that the EU seized in February after Greece threatened to default; and €2b to roll a portion of interest due before 2019 into more long-term official debt. The crucial point to understand here is that the IMF considers new official lending to be a kind of debt relief, because it’s long-term and low-interest.

With all that, the IMF opined, Greece could probably sustain its debts without any more official lending after 2018. That was a very optimistic projection. Few people really believe Greece won’t need another EU-IMF lending program in 2018, to continue rolling over its various other kinds of debts as they come due into long-term, low-interest official debts.

But the IMF’s rules say that before it lends it must ensure that the recipient country will be able to sustain its debts after the lending stops. And there is no political will right now to commit to lending to Greece past 2018. So the IMF needed to meet a high standard of sustainability that assumes Greece won’t have any more access to official lending after 2018.

The need for €52b of new lending and maturity extensions of official debt due after 2018 was the IMF’s opinion three weeks ago (the report was written a week before it was published). On July 14 the IMF published an update dramatically increasing its estimate of Greece’s financing needs from €52b to €85b, and saying Greece needed either maturity extension with “a very dramatic extension with grace periods [of deferred interest] of, say, 30 years on the entire stock of European debt, including new assistance” or “explicit annual transfers to the Greek budget or deep upfront haircuts.”

The latter two options are obviously politically unpalatable. So the IMF is really calling for the first of those options: extensions of maturities and grace periods of deferred interest on Greece’s debts to the EU.

How could Greece’s financing needs have grown by €33b in three weeks, you ask? The IMF says, “the events of the past two weeks — the closure of banks and imposition of capital controls — are extracting a heavy toll on the banking system and the economy, leading to a further significant deterioration in debt sustainability.”

The IMF probably also took an opportunity to climb down from over-optimistic nominal growth forecasts built in to the three-week-old report. The experience of not being paid on time tends to push creditors to revisit such things. The IMF is undoubtedly maintaining the high hurdle that Greece’s debts must be plausibly sustainable without any further official lending after 2018.

The IMF is also apparently not taking into account the new reform program’s section on privatization, which calls for Greece to raise €50b and put half of it towards repaying debt. That would imply €25b less financing needs, though the program document doesn’t say how soon Greece would raise so much money. Anyway €50b is a wistful fantasy, which could only come true if things go so well in Greece that it won’t need the money.

A clarification of Greece’s fiscal position

Most media covering Greece have reported that the new reform program represents a deepening of fiscal austerity.  Dan Davies has written a popular blog post arguing the opposite, that actually Greece is being given room for fiscal stimulus. So who’s right?

The mainstream view here is much closer to being correct. The deal is fiscally austere. Greece had zero primary surplus last year, and the new program calls for that to tighten to 1% of GDP this year and to 3.5% of GDP from 2018 on. Unless you believe there are growth forces at work in Greece that will greatly improve the fiscal position without any change in tax or spending policy, that is a big fiscal tightening.

On the other hand the deal is not any more fiscally austere than the one offered to Greece in June. When I say the new program is much stricter, I mean its regimen of supply-side reforms. The fiscal numbers are exactly the same. And they’re much easier than the fiscal path Greece committed to under its 2012-2015 bailout program. The latter called for Greece to tighten to a 4.5% of GDP primary surplus from 2016 on.

What the media have missed is that Greece has actually already severely tightened its fiscal position in the first half of 2015. Remember that Greece kept current on its debts until the last day of June, and its repayment schedule is not light. Greece hasn’t been able to raise any new private financing since last year, and has only been able to roll over debts owed to Greek banks and other captive local creditors.

The only way Greece could make its debt payments was by sharply tightening its fiscal position. And it did so in a completely ad hoc manner, by running up arrears or just not making budgeted expenditures. As the table below shows, Greece’s state budget (the core central government) ran a primary surplus of 3.1% of GDP in the first half of 2015. That’s probably about equal to an overall primary surplus of 2.6% of GDP, judging from the fact that Greece’s core central government ran an 0.5% of GDP primary surplus in 2014 while the IMF calculated a zero overall primary surplus.

Note that my calculations rely on Greek government data, but I don’t use the Greek government’s own count of its state budget primary surplus, which wrongly counts privatization receipts and refunds of previously paid interest as primary income. The IMF consolidates all central and local government entities and makes other adjustments.

So this is the valid point that Davies could have made: relative to the severe austerity that has prevailed so far this year, a 1% of GDP primary surplus target for this year does represent something like a fiscal stimulus. It means Greece is allowed to run a primary deficit of around 0.6% of GDP in the second half. Actually Greece is likely to endure another couple months of severe austerity and then enjoy a rush of public spending in the fourth quarter.

But Davies’ actual argument is all wrong. He thinks Greece will enjoy fiscal stimulus because the primary surplus of 1% of GDP minus interest costs he estimates at 3% to 4% of GDP leaves an overall deficit of at least 2% of GDP. But fiscal stimulus is a negative change in the fiscal position, not a negative level. For fiscal stimulus Greece would need to be able to spend more and/or collect less revenue than it did last year. And no one is offering to lend Greece enough money to do that.

Besides, Greece’s actual interest costs are around 2.5% of GDP, net of expected refunds but including deferred interest, and about 1.6% of GDP in terms of cash paid net of refunds. And payment of interest to foreigners, in cash or not, is never a fiscal stimulus.

Tsipras Caves, Again

Alexis Tsipras, the Greek prime minister, has pulled another duplicitous about-face. He has, with what appear to be only very minor proposed changes, accepted the Troika’s June 26 offer.

Last Sunday’s referendum, it turns out, was entirely without substance. It was nothing more than political theater. So too was the past two weeks of hardship in Greece, of closed banks and limits on ATM withdrawals. All of that served no other purpose than for Tsipras to pretend to the Greek public that he was standing up to the EU. Less than a week after the referendum, he turned around and proposed to the Troika almost the same program they proposed to him on June 26. The main difference is that he is asking for €53.5bn of new loans, and they were offering only €50bn. If Tsipras had countered with this proposal two weeks ago, I think it would have been accepted, and Greek banks never would have closed.

Come to think of it, Tsipras’ offer is not really all that different from the Troika’s first offer to him back in February.

I guess one should never be surprised by the brazen duplicity of politicians. But this is so extreme, European leaders are probably having trouble believing their eyes. I imagine politicians across Europe today forwarded Tsipras’ offer to their staffs with virtually the same questions: “What am I missing? Where’s the catch?” Perhaps somebody will find one. I didn’t.

Tsipras has just put European leaders through a hell of a wringer. He insulted and denounced them vehemently in front of the Greek nation. He swore he could never accept their humiliating demands. He urged Greeks to back him in his defiant stance, and received their backing.

And then he turned around and asked European leaders to let him take their old offer, with what appear to me to be minor changes that could easily have been accepted if he had made them two weeks ago. European politicians would normally care more about the fundamentals of any Greek offer than how they are dressed up for the benefit of Greek domestic politics.

But Tsipras may have simply gone too far with this stunt. Europeans may be too insulted and annoyed to let him get away with it. It will be interesting to see.

(UPDATE: Bloomberg is reporting that Tsipras is asking for “debt restructuring and reprofiling of Greece’s long-term debt due after 2022,” which if true could be the catch I missed. I see no such language in the version of Tsipras’ proposal that I linked to above, which was published by Le Monde. A demand for a write-down would be rejected. A demand for some maturity extension might be considered. Le Monde, by the way is reporting that the French government had a big hand in crafting Tsipras’ proposal.)

Greeks Back Tsipras’ All-In Bet

Tsipras has won his referendum, with 62.5% turnout and 61.3% of votes for “no.”

In other words, the Greek nation has thrown itself  behind Tsipras’ all-in bet that European leaders will fold and bow to his demand to roll over Greece’s debts on looser terms. Even though Greeks are holding the weakest of all possible hands.

Greeks simply don’t have much in the way of credible threats to hold over the rest of Europe, especially since markets are reacting fairly calmly. The only potent card they have, if Tsipras is willing to try to force them to play it, is their willingness to endure what could be widespread suffering, if he carries out his threat to let Greek banks run out of euros and not introduce any new currency.

The bet is to the ECB Council

Play now goes to the European Central Bank’s governing council, which will hold a conference call on Monday to decide how to react. Just before that, the ECB chairman, Mario Draghi, will hold a conference call with top EU political leaders.

Hanging over the council’s decision is one powerful fact and another powerful inevitability. The fact is that Greece defaulted on June 30 to the IMF. Due to cross-default clauses, Greece has since also been declared in default on most of its debts to the EU by the EU’s bail-out fund, the European Financial Stability Facility.

The inevitability is that Greece will default on €2.2b of principal and interest due to the ECB and another €1.4b of principal and interest due to Euro Area national central banks. The €3.6b of payments are due July 20.

The council has three options, but realistically, only two. In theory, the ECB council has the power to inject new liquidity into Greek banks and allow them to open and start paying out on deposits normally. The council would have to vote to increase the cap on Greece’s use of Emergency Liquidity Assistance, a way that EA NCBs are allowed in crisis situations to create and lend euros to their banks against substandard collateral.

Such ELA loans are backed by the NCB’s own guarantee to the ECB. Which could be a little difficult for the ECB council to justify accepting just now, given that an NCB’s guarantee is only as good as that of the government behind it, and the Greek government is in default to another EU institution.

The second option, and the nicest the ECB council could realistically be to Greece in this situation, would be to maintain the cap on Greece’s use of ELA at its present level of €89b. That would allow Greek banks to continue to disburse €50 or €60 a day to depositors for a little while longer. Nobody outside the Greek government and banks knows exactly how much cash and unused ELA allowance Greece has left at the current pace of withdrawals, but I think not more than a few weeks worth. See here.

The third option, which ECB councilors will likely feel legally compelled to take despite how harsh it is, would cancel most of Greece’s ELA allowance except the €2b that all NCBs are normally permitted. According to an ECB summary of the secret rules governing ELA, any NCB with an ELA allowance above €2b automatically loses it unless re-confirmed by a council majority “within a pre-specified short period of time.”

The council has lately been holding ELA re-confirmation votes for Greece about once a week, most recently on June 28, after Tsipras called the referendum but before he missed the IMF payment. My guess is that without a positive vote, the €89b ELA allowance would expire sometime this week.

Losing the ELA allowance would mean Greek banks would run out of cash faster. They would probably stop reloading ATMs the next day. It would amount to an order from the ECB to the Bank of Greece (the national central bank) to immediately recall about €87b of loans to Greek banks. The BoG would probably be obliged to seize Greek banks’ deposits at the BoG, without which they would have no way of paying each other electronically. The BoG might even be obliged to come for the banknotes in their vaults and cash drawers.

The argument for taking the nice option will be to leave a door open to Tsipras to make his new offer, and that Monday is simply too soon. But I don’t sense that European leaders are really expect much serious from him, or that they’re really all that eager to see what he comes up with. The argument for taking the harsh option will be that with the Greek government in default to the EU, the ECB can’t accept the guarantees of the Greek national central bank.

The council is very different from other EU bodies, as it decides by simple majority, and small countries carry much more weight. The ECB council is made up mainly of the 19 EA NCB chairmen, plus six EU-appointed ECB governors, including Draghi.

That means Germany lacks the veto power at the ECB that it has over most EU bodies, which is good for Tsipras. But it also means the former communist European countries carry a lot of weight at the ECB, which is very bad for Tsipras. The council tends to follow Draghi, and if EU political leaders weigh in strongly one way or another, that would likely carry their vote.

The Greek nation volunteers to be taken hostage

Tsipras knew what he was getting into. I’m pretty sure his voters did not know, and it will not be a pleasant awakening.

The Greek nation has essentially volunteered to be Tsipras’ hostage as he heads into his final show-down with European leaders. Tsipras says he is determined not to issue any new currency. But his government and banking system are very near to running completely out of euros. If he continues to resist issuing a new currency, and Europe gives him no fresh supply of euros, the economy will collapse into deep crisis.

The first big problem for Tsipras is that he has made European leaders hate him. They want very much to do him personally no favors.

His second big problem is that the EU strictly adheres to the rule of law, and he is in the wrong side of it. His government is in default to the EU and will be soon to the ECB and EA NCBs. That greatly limits European leaders’ options.

And the third big problem for Tsipras is, when the money runs out and the cupboards run bare, Greeks will not stay behind him. Despite the convincing vote, there will soon be mass protests against him. If we take Tsipras at his word that he will not issue any new currency, then when euros run out, Greeks will literally starve.

Tsipras will probably back down long before it gets that far, probably by introducing IOUs or some other kind of pseudo-euro and denying its a new currency. I don’t rule out that he could ultimately cave in and accept Europe’s conditions for a roll-over of Greek debts.

But the Greek people have committed themselves to a very dangerous bet. Tsipras and his game-theory professor finance minister, Yanis Varoufakis, could be planning to deliberately make the Greek people suffer in order to pressure the EU to back down. But the pain would really be all Tsipras’ doing, and it wouldn’t take his hostages long to figure that out.

[UPDATE: The ECB council chose the nicer of its two realistic options, and kept Greece’s ELA cap at the same level it had been for about two weeks, which Bloomberg reported a bit more precisely at €88.6b. Haircuts on collateral were increased, but not by so much that Greek banks can’t make up the gap with other collateral. All in all a very mild reaction to Greece having defaulted to the EU and IMF. There will be lots of meetings ahead, but probably the most important upcoming events are 1) the inevitable default of Greece on €3.6b owed to the ECB and EA NCBs on July 20, 2) the ECB council’s reaction, which could be immediate or after a likely grace period expires, 3) the inevitable exhaustion of Greek banks’ euro supply, anytime within a few weeks and 4) probably about the same time as that, the introduction of new money, probably some kind of pseudo-euro, backed only by Greece.]

Why Greeks Will Be Voting Their Birthdates

The Greek polling agency Public Issue has published the results of a poll that breaks down Greeks’ voting intentions by age group, and the results are sobering.

Whichever side of the debate you’re on, you’d probably like to believe that this is a vote about policy and ideology. A “no” majority would throw off the strictures of euro membership and give a mandate to the leftist prime minister, Alexis Tsipras, to steer economic policy independently. A “yes” vote would sack Tsipras, submit to European policy oversight and probably move policy back towards centrism.

In a country and continent where leftism is conservative and reforms are driven by free market ideology, one might expect to see young Greeks leaning right and older Greeks clinging to leftist tradition. After all, the “red-line” issue over which Tsipras walked out of talks with the Troika last week was their demand to cut pension spending.

But it’s the other way round. The younger you are, the more likely you want to defy Europe and support Tsipras. The older you are, the more likely you want to sack Tsipras and cling to Europe.

Obviously, ideology is not the crux of this vote. This is between hanging on to what you have, and risking it all in hopes of finding a better way.

Taking the Argentina comparison too far into the future

Lars Christensen has a post that has received a lot of attention predicting a robust recovery if Greece votes  “no” and introduces a new floating currency. In it, he compares Greece today to Argentina in 2001, as I have done, and shows that Argentina bounced back strongly in the following years.

The biggest problem with that argument, as Lorcan Roche Kelly points out to Christensen here, is that Argentina’s economy is driven by commodities exports. Argentina’s crash in 2001 and boom over the next several years were obviously driven by the commodities cycle.

What then could we expect in Greece after a “no” vote? Initially, a big mess. Tsipras would have a strong mandate, but on the basis of the false claims he is making that he will still be able to secure the support from Europe he needs to preserve the euro value of Greek bank deposits. After a “no” vote, that support would not come, and those deposits would be devalued.

Tsipras’ policy-making is also likely to turn very bad. I think he would most likely introduce some kind of pseudo-euro with a dual exchange rate, with one-to-one convertibility for the government and select importers and a value far less than that for everybody else. I think his distribution of pseudo-euros would be very politicized, aimed mainly at defending himself from the mass protests that would inevitably come against him.

On the positive side, I don’t think Tsipras would last long. But I suspect that after him would follow a long period of political and economic turmoil, and policy could turn even worse before it turned better.

So the scenario that Christensen is touting, of Greece with a new floating currency and, by implication, no sharp deterioration of other economic policies, isn’t likely to happen anytime soon. It’s one of many possible places Greece might eventually get to after the turmoil that would follow a “no” vote.

Devaluation’s Winners and Losers

Even after all the decline in incomes and asset prices of the past several years, Greek assets and labor are still somewhat overvalued relative to where they would need to be to spur enough investment to re-employ all of Greece’s recently unemployed.

No doubt a currency devaluation would be the easiest way to solve that problem. A floating currency would indeed be better for Greece’s GDP, over the long run, than euro membership.

But a devaluation is what it says it is. Your income shrinks and you lose wealth, at least in terms of foreign goods and assets. The hope is that national income and wealth will grow back, over time. But that rebuilding of incomes and wealth is not symmetrical.

Real GDP tends to bounce back quickly after a devaluation, since real GDP counts only domestic products. Real wealth takes longer to recover, especially for countries like Greece that import a large portion of what they consume.

And there are all kinds of other asymmetries. There are winners and losers.

I personally don’t see anything to gain from endorsing Tsipras, even for young people. I think the result would be not at all what his supporters are imagining. But I can understand a young patriot wanting to throw off European strictures, believing that in the long run Greece will find a better way. For young people there’s a good enough chance that policy will turn out okay and their long-term income-earning prospects will be better outside the euro than they would have been inside it.

For older people that possibility isn’t there. They have far more savings to devalue, and usually the kind of savings that don’t rebuild, such as pensions. And they will be far more dependent on those savings for their livelihood.

IMF Greece Update: Zero 2014 primary surplus, €5b of new arrears

Back in February, I published a very wonky blog post, which to my surprise has proven to be my most popular post by far: Greece’s Primary Surplus Was Smaller Than Reported. In it I explained why Greek data purporting to show the government ran a primary surplus of 1% of GDP in 2014 was phony. The data wrongly counted privatization revenues and refunds of interest previously paid as primary income. Those were worth a combined 0.5% of GDP.

I also explained that the Greek data referred only to the state budget (the core central government) and can’t be directly compared to the primary surplus benchmark used by Greece’s creditors, which refers to the general government (the whole public sector, except state-owned businesses).

And I explained that although Greece publishes general government budget results that can be used to estimate its primary surplus (I came up with 0.7% of GDP for 2014), the EU and IMF apply very different accounting rules from Greece when they calculate the primary surplus of a country. So we wouldn’t know what Greece’s 2014 primary surplus really was by EU or IMF standards until one of them counted and published it.

Today that happened (see page 19), and here’s the answer: Zero. Greece had no primary surplus at all in 2014, by the IMF’s calculation.

That came after a 1% of GDP primary surplus in 2013, by the IMF’s count. So the Greek primary surplus actually deteriorated in 2014, when according to Greece’s adjustment program, it was supposed to improve, to 1.5% of GDP.

Another €5b of arrears

I’m not really surprised, nor am I by this: according to the report, the Greek government has run up an additional “about €5b” of arrears since the IMF’s previous review, published in May 2014. That underscores the severity of what I have been calling “ad hoc austerity”: the ostensibly temporary withholding of budgeted expenditures, in order conserve scarce cash.

The IMF doesn’t give any details of exactly how or when “about €5b” of arrears piled up since May 2014, but probably most of it built up since February. The report includes this interesting comment: “Cross-country experience suggests that unreported arrears may be significant under tight financing conditions because agencies may not report all invoices received in such a constrained budgetary situation. This would impart an upside risk to the estimate.”

Here’s an update of Greece’s state budget expenditures. It shows how the core central government spent €2.6b less than it was budgeted to spend in February through May. That’s almost 16% of budgeted expenditures other than interest that weren’t paid, and more than 4% of the period’s GDP. It doesn’t include local governments and some central government bodies.

Withholding 4% of GDP worth of budgeted expenditures is a whole lot harsher than anything the Troika of Greece’s official creditors asked for, even at the beginning of talks in February. If all of the roughly €5b of new arrears were run up in February-June, that would be more than 6.5% of that period’s GDP.

And now, with access to euro banknotes restricted and many businesses accepting nothing else, austerity just got a great deal harsher still. I have trouble understanding how limiting bank deposit withdrawals to €60 per day can be sold to the public as throwing off austerity. I guess we’ll see soon enough in Sunday’s poll.

But Tsipras wasn’t bad at collecting taxes

What puzzles me most about Tsipras’ move is that he put such effort into avoiding default all the way through the end of June. As the next table shows, his government’s tax-collection performance in February through April was actually right on target and significantly better than the Samaras administration’s average last year.



Even after poor performance in May – possibly related to taxpayers being on the wrong side of those arrears – the four-month average was still not too shabby, by Greece standards.

That €50b is proposed new lending, not debt relief  

This, by the way, is the same IMF report that’s being widely misreported in the news as calling for €50b of debt relief for Greece. Actually the report says Greece would borrow €50.2b more from the EU and IMF over the next three years under the Troika’s new bailout offer.

Of that, €29.8b would merely roll over maturing debts. The other €20.4b plus the government’s projected €11.4b of primary surpluses and privatization proceeds would pay for €13b of interest payments (net of refunds), clear €7b of arrears, rebuild €7.7b of run-down public sector cash balances, and put €5.9b into the government’s bank bailout fund (see page 7, table 1).

Tsipras Shoves All In

And so, months after I abandoned my prediction that Alexis Tsipras would lead Greece into an international default, he has gone and done just that.

Far from humbly accepting that Greeks want to keep the euro more than they want to reverse austerity, as it appeared to me in March that he had, Tsipras is making the most wildly high-risk bet he could possibly make. In poker terms, Tsipras has just pushed all his chips into the pot and dared his opponent to call – while holding the worst of all possible poker hands. Unless he’s extremely lucky, he’s going to crash out, and probably never play a major tourney again.

The play now goes to the people of Greece, who in this game can either confirm or reject his bet. He’s campaigning hard for a “no” vote against accepting the terms that have been offered to roll over Greece’s debts, and doing his best to persuade Greeks that if they support him, European leaders will fold and improve their terms.

If the vote goes against him, then Tsipras is out, and some new, more pro-European government will probably replace him, probably after another general election. But he will very likely win, mainly because he has given Greeks so little time to live and think through the real implications of a “no” vote.

Greeks are getting a taste of it this week, and it’s not at all pleasant. Sending money abroad is banned. Withdrawals of banknotes from bank accounts are limited to €60 a day, and practically available only to those who line up early at ATMs. Pensioners who wanted their pensions in banknotes were offered one partial payment of €120 this week after waiting in long, angry lines.

Some importers can still make payments abroad, if they receive approval from a newly established government committee. And Greeks can still make bank-to-bank payments among themselves, with payment cards or online. But Greek bank deposit balances are obviously already worth less than face value.

I haven’t yet seen anyone report a market exchange rate of cash euro banknotes for bank deposit balances, but I’m sure it would be hard to get more than 50 cents on the euro. Big businesses are facing a very tough decision whether to continue accepting payment cards and bank transfers, and most small businesses have already stopped.

And even this situation is too good to last. Greece can’t afford to keep up those €60 and €120 payments. Soon the euro supply in Greece will dry up, and the government will only be able to offer some kind of new notes, which will probably be nominally valued in euros but worth less than half their face value.

In other words, Greeks’ real spending power just fell off a cliff, and it’s going to roll further downhill from here.

Grexit: officially impossible, de facto all too likely

But many people will gladly suffer a week of hardship for what they see as a patriotic stand-off, and many will be willing to risk suffering more and longer.

If Greeks support him, Tsipras will continue to steadfastly deny that he’s quitting the euro, and technically, he won’t be. Despite what you might have read, there is in fact no way whatsoever to formally expel Greece from either the Euro Area or the EU.

To kick Greece out of the EU or euro, the EU would first have to amend EU treaties to allow it. That would be an agonizingly slow and difficult process, similar to amending a federal state’s constitution. It would unsettle other periphery countries, and invite anybody and everybody with a complaint about the EU to try to inject it into the treaty process. Nobody wants to open that can of worms right now, or for that matter even suggest the possibility.

So even if Greece de facto introduces another currency, which is very likely, the rest of Europe will still consider Greece to be formally a euro member. And legally that’s what Greece will still be.

If the “yes” vote wins on Sunday, and there’s a prompt election of a new, pro-European government, I think Europe will make a serious effort to rescue the Greek economy and restore it to its June status quo ante. There would be no new Greek currency.

But if Tsipras wins, the odds that European leaders will fold and cave into his demands are practically zero. To return to the situation that prevailed in June, Tsipras would need to convince the EU to welcome him back to renewed negotiations and the European Central Bank to renew its support to Greece while those negotiations proceed.

Call me pessimistic, but I for one just can’t see that happening, no way no how. The negotiating table that Tsipras wants to go back to no longer exists. If he wins the vote, he will be left to manage the Greek economy without European support, and Greeks will be left to learn the hard way how much they like that. Europe will wait for Tsipras’ government to fall, which probably won’t take all that long.

Greece is almost out of euros

It’s hard to say exactly how many euros remain in the Greek banking system, but it can’t be many. As of the end of May, there was somewhere between €4.2b and €4.9b in the banking system under the control of the Greek government and Greek banks, down from somewhere between €8.4b and €10.4b at the end of December.

The Bank of Greece (the national central bank) also had €2.6b of unused “emergency liquidity assistance” allowance as of the end May. ELA is a way that the ECB permits Euro member NCBs in crisis situations to create euros and loan them to local banks in return for substandard collateral, which the NCB must guarantee to the ECB. The point is that Greece being a junk-rated sovereign has very little quality collateral, and what little there is has already been pledged. The BoG’s total allowance has been raised by €8.8b since then, to €89b as of June 26.

But increases in the BoG’s ELA allowance are generally signs that the Greek banking system has bled even larger amounts of cash. The ECB raised the BoG’s ELA allowance by a total of €11.9b in March through May, while a net total of €14.4b was wired abroad or withdrawn as banknotes from Greek banks during the same period. Even when the ECB was supporting Greece with repeated ELA allowance increases, the supply of euros in the Greek banking system was gradually dwindling.

The BoG also had €5.3b of gold and €19b of debt securities not including those held for ECB monetary policy. I don’t know if the BoG could or would consider selling those. The government must also have some banknotes in safes and cash drawers.

Meanwhile, even after all the austerity, Greece has still been running a current account deficit of around €800m a month for most of the year. Last year that swung to a large surplus during the summer tourist season, with more than 40% of the year’s international tourism revenues coming in July and August. I’m afraid this summer’s tourism revenues will be far lower.

In any case, the current account must right now be undergoing a hard, sudden adjustment in the positive direction. Most payments abroad are blocked, and people’s limited ability to spend from their bank accounts must be cutting deeply into sales of fuels and other imports. In any event, without ECB support, Greece must balance its inflows from exports and tourism with outflows for imports.

The government can’t for long on top of that pay to distribute euro banknotes through ATMs and to pensioners, even in seemingly limited amounts. Withdrawals of €60 a day per person can add up quickly. There are at least 6,000 ATMs in Greece and more than 8 million adults. If the ATMs are well stocked, outflows could easily exceed €100m a day.

Think Argentina, not Cyprus 

If the “yes” vote wins on Sunday, the following section will probably be scratch. But given the strong chance Tsipras will get the “no” vote he’s looking for, it’s worth looking at what would come next.

There would be, I’m sure, no return to serious talks anytime soon and no further increases to the ELA allowance. Within no more than a couple weeks, Tsipras would be forced to admit that even limited disbursals of euro banknotes are no longer possible.

This situation is a close parallel to what Argentina went through in 2001. Whatever funds aren’t withdrawn while the €60 a day allowance lasts will be permanently devalued.

Greece’s experience with “capital controls” won’t be anything like that of Cyprus, which enjoyed continued ECB support and had some relatively easy ways available to improve its current and financial accounts. Greece will have much more capital flight, and is likely to undergo a long period of political uncertainty when inward investment will be very limited. “Capital controls” is a shabby euphemism for what’s happening in Greece, which is a sudden collapse of the real value of bank deposits.

The only way Greece could afford to keep the euro as its actual everyday currency without ECB support would be to apply sharp haircuts to bank deposits. That of course would be political suicide. It’s not in Tsipras’ nature to be so brutally honest.

Instead, look for Tsipras to introduce a new de facto currency, with a nominal value in euros, but backed only by the Greek government. These could be called “IOUs” as many are suggesting, or whatever, it’s not important. Banks would open and offer pseudo-euros, not euros, to anyone wishing to withdraw from their accounts.

All the while Tsipras will insist these are temporary measures and that Greece remains officially a euro member. And the latter at least will be true. I expect a Greek pseudo-euro to be worth less than half a euro.

The big question is how the Greek government will deal with imports and foreign payments. The intelligent way to do it would be to dispense with all pretenses and force all holders of pseudo-euros to buy hard currency at market exchange rates. Banks could then make foreign payments from anyone’s bank account or card by simply applying the market exchange rate.

In other words, one possibility is that the new Greek currency could be a de facto separate floating currency, linked to the euro only in name. In such a scenario Greece would suffer a short steep recession but could recover relatively quickly from there.

But there’s also a stupid way to do it, which I fear is likely to happen. The government could maintain the pretense that its pseudo-euro is actually worth a euro. The government and other privileged organizations would be able to convert pseudo-euros to euros one-for-one, while most people and companies would have to
go to black-market money-changers to buy real euros.

In other words, another possibility is that Greece could become a dual exchange-rate country, like Venezuela or the communist parts of Europe back in the 1980s. And that of course would be an economic disaster.

But let’s face it, when left truly to his own devices, this is the kind of thing that Tsipras will very likely do. Indeed there’s already an element of dual exchange rates in place: a new Committee For The Approval of Bank Transactions is deciding which importers have the privilege of being able to convert their Greek bank deposit balances to euros.

(The chart data is all from the BoG: BOP data, aggregate bank balance sheets and BoG balance sheets version 1 and version 2. ELA appears in version 1 under “other claims on euro area credit institutions.” I did some addition and subtraction.)