Fundamental Macro

For the past couple of months I have resisted the temptation to write about the Greek situation. In part, because it has so completely dominated other blogs/Twitter that there didn’t seem to be much value in adding another voice to the cacophony, and in part because I just felt a bit fatigued by the whole thing (I have been analysing the Greek situation in both an official capacity and subsequently as a market participant since 2010).

But the odd snippet that you may have picked up in my posts have made clear my view on the likely outcome. I did not expect Greece to exit the EZ (other than by their own hand). There was no great wisdom behind that view. Instead it was based on what we witnessed in 2012, and the conversations I subsequently had with some well-connected people in Berlin.

Back in late 2012 Greece was starting to implode. Riots were regularly breaking out, extreme right-wing political parties were gaining popular support, armed vigilantes were taking to the streets and the country had gone through two inconclusive general elections in the space of three months. The austerity measures that the Greek government had agreed to in exchange for financial assistance from the EU and PSI were extremely tough, and the economy was in free-fall. It was becoming increasingly unclear how much support Greece really had in Europe, particularly in Germany, where the press (and general popular view) was unflattering to say the least. Many expected that Greece would be unable to remain in the EZ much longer.

It was into this febrile environment that Chancellor Merkel flew in October. Despite the personal and domestic political risk, she met with then PM Samaras to pledge her support for Greece and ensure that it remained part of the EZ. This was a hugely important and symbolic event. It signaled to me that Merkel was prepared to use her domestic political capital in order to keep the European project together. A year later, Merkel secured a third term as Chancellor, cementing her place in post-war German political history. While highly unlikely to reach the record five terms of her mentor, Helmut Kohl, Merkel wants to use her remaining time in office to leave a European legacy that he began. Instead of the “father of [German] unification”, Merkel would like to be the “mother of [European] unification”, the conclusion of the political and economic project that began almost immediately after the end of the war.

The European sovereign crisis has laid bare the problems of an incomplete economic and political union in Europe. And the late-night, cobbled-together solutions to fighting the crisis were largely ineffectual. In the end, it was the only great European body that could pull the EZ out of the mire – the ECB. But it could only do that with the political backing of the strongest member. Clearly many Germans disagreed, including key figures at the ECB such as Axel Weber and Juergen Stark. But it was Merkel who ultimately succeeded. The dissenters would resign along the way, cast aside so as to no longer interfere.

And so to the ‘agreement’ struck early this morning to once again keep Greece in the EZ. Many have criticised the actions of Germany and the other creditors over the past weeks/months. Of course just as many have criticised the Greek government for their delays, political games and obfuscation. No doubt blame can be apportioned to both sides. It looked bad for Germany, Greece and Europe as a whole. And the economic cost to the Greek people has been enormous, at a time they can least afford it. But at the end of the day, it was in the interests of both Greece and Europe to come to a compromise. But that path to compromise mattered for the future.

The last thing Germany wanted was for Europe to be seen to cave into the Syriza government. Aside from the significant political cost at home, the cost to the European project was arguably even greater. It would signal that in any future EZ sovereign bailout, the debtor would hold the balance of power. Indeed, if it were any of the larger EZ countries (Portugal, Spain, Italy) that power would be even greater, for fear of destroying the union. By being as tough as possible throughout the negotiations (with FM Scheuble playing the villain), to the point of near humiliation, the Germans sought to send a clear message. For the project to survive, it means ever closer union – banking, economic, political. Sins of the past could not just be swept under the carpet, but used as an example. The only way Greece would leave the EZ/EU would be at their own hand. But the risks there were incalculably large.

And so we have an agreement that means Greece cedes a bit more sovereignty in exchange for staying in the Union. Those peripheral countries who might contemplate a reversal in integration have seen the potential cost. I hope that these events can instead speed up the necessary steps outlined in the recent Five Presidents report (see here for my views). And for the sake of the Greek people, I hope that the financial package agreed is actually sufficient this time. That will mean a significant NPV haircut (via maturity extensions/payment holiday etc) to the existing debt and enough to recapitalise the banks and service existing debts. A half-baked package will not deliver the necessary boost to confidence that will hopefully spur some inward investment.

As for the broader market implications, I have been surprised just how big an impact the Greek saga has had on global markets over the past month or so. A resolution should see risk assets rally again, fixed income sell off and a return to focus on the Fed. September remains very much on the table for a first hike.