Is Greece just about to default?

This guest post is from Peter Doyle, a former IMF staffer…

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Who could think so? Greek government bonds have been on a tear for a year; staff-level agreement on policies has been reached and, behind double-digits in polls, Syriza MPs are set to swallow the lot this week; so the €7bn July maturities look good.

So, what fly, what ointment?

Debt reduction.

Markets presume that Lagarde and Merkel will fudge their differences on this again.

There is much scope for doing so. Virtually anything could meet Lagarde’s demand that creditors provide “appropriate” debt relief — with the size of the IMF financial contribution adjusting to the size and formulation of reduction as it “stays in”. If gaps on that prove un-bridgable, further fudges could be found in the strength of the IMF Board’s endorsement for the content of the program, even as the IMF “pulls out”, to help Merkel get the program disbursements through the Bundestag “sans IMF”.

And in the back of the markets’ mind is that, back in 2015, Tsipras huffed and puffed and blew his own house down, so … buy!

But this time really is different.

For the sake of exposition, assume that Lagarde recommends that the IMF stays out and wins Board support for that, with Greece fully program-conditionality-compliant, and with the Troika of inspectors saying so.

Well, since mid-2015, Tsipras has done as he was told for one reason alone: to secure big debt relief. So he now has every reason to pick a fight on this issue.

If he, conditionality-compliant, were now to default in protest at Merkel’s “sometime later, perhaps”, he could do so while affirming, with IMF endorsement, that his sole purpose in doing so is to eliminate risk of Greece ever leaving the Euro.

That would put the ECB in a completely different position from 2015. Then, whether one agreed or not, it justified capping ELA on grounds of Greece’s conditionality non-compliance and devaluation risk. But in this context, its only grounds for capping ELA would be in support of Mrs Merkel’s reluctance to deliver full debt reduction now — in the face of formal IMF assertion that it is essential, now. The ECB would thus ‘out’ itself as the political vehicle it is. Perhaps this conundrum explains Draghi’s recent unprecedented outburst on debt relief.

And, with default motivated by securing Greece’s euro membership, this line itself may contain risk of bank deposit flight, thereby diminishing need for ELA in default.

Further, to Tsipras’ (and others’) surprise, Greece now runs a big primary surplus — over 3 percent of GDP in 2016, up from balance in 2015, and still running strong into 2017, even if some of it reflects temporary factors. Sure enough, that scorching fiscal withdrawal is accompanied by output declines, yet again. But in that context, Tsipras doesn’t need new finance for the budget as is if deposit flight is contained or if ELA is uncapped. Only if deposits flee and ELA is capped will Greece spiral. But thereby the Euro pandora’s box of ECB legitimacy will bust wide open. If Tsipras is ever going to stand and fight on debt reduction — i.e., default — now is the time.

Merkel, likewise, faced with this prospect, also has good reason to pick a fight on Greek debt reduction now.

Glad as she may be that Mme Le Pen has been dispatched, at least for now, Merkel’s immediate task, faced with “Saint Emmanuel”, is to reassure her voters that she’s not going to go soft, not for him, nor the Brits, nor the Italians, and so certainly not for Tsipras. Given the resurgent SPD since Schultz, her key concern ahead of Fall elections is risk of loss of votes to her right. So a flat-out fight with the IMF and Tsipras over debt reduction, with an insistence on the German version of ECB “orthodoxy” on ELA, all under the rubric of “European rules”, has big political attractions.

If that is how things play out in the event of the IMF “staying out” — notably the exposed position it puts the ECB in — consider the IMF’s incentives to do so.

The staff and management’s primary concern is to rescue their battered reputations over the institution’s entire engagement with Europe since the euro’s establishment: welcoming all the factors that led to crisis; multiple failings on Greece during the crisis; and all-European Managing Directors despite personal scandal surrounding all since Camdesssus, including Lagarde’s conviction for negligence.

So, to put it mildly, they are keen to rescue themselves by making an ostentatious splash on Greek debt now. And the rush to secure Greek disbursement on the eve of Brexit, contrasted with no equivalent ahead of the French first round signals— rightly or wrongly — that IMF staff and management (and Merkel) no longer see Greece as Euro-systemic.

But the IMF, despite appearances and reporting, is not its staff and management: it is its Board.

The Europeans there, including the Brexit Brits, will almost certainly, as usual, vote as a block — formally backing Merkel against the IMF staying out on the grounds of debt reduction, even if “St. Macron” has to swallow hard on this.

So the determinant voice on the IMF Board position will be the US. That means Trump.

The tea-leaves there? Market confidence that his Goldman-Sachs alums will prevail remains undaunted by everything, even Comey. But as with all gross objects, all the signs are, to the contrary, that he bends space and time around him, as Einstein said, not vice-versa.

So, how does Lagarde’s “IMF-out” call play at the 18th hole at Mar-a-Lago:

• Pro IMF out (Bannon): far-away Greece hits back at the Queen of trade surpluses; Greece overspends NATO, Germany underspends; we remind Europeans that the US is boss; debt reduction is our home (business) turf; all under the guise of “we’re supporting the responsible IMF sustainability assessment“. No $ impact.

• Con IMF out (GS-alums): Lagarde openly opposed us in the election, accuses us of protectionism and financial-regulatory skulduggery; she can always draw her line on Greek debt somewhere else; our Euro and Federal Reserve pals, fearful of the implications for ECB, are bigly con out; Euro crisis hurts exports via the US$.

If you know which way this goes — or perhaps are betting that Jared and Ivanka can find their feet in all this — you’re a better tea-leaf reader than I am. But markets on Greece are currently overwhelmingly backing the GS-alums at the Mar-a-Lago 18th.

So what does it take to produce a Greek default in the coming months?

• Merkel concedes only tokens on Greek debt reduction

• Lagarde decides she cannot defend them to her coterie of apologists

• Trump (on the day) decides to showboat and poke Merkel in the eye

• Tsipras seizes the day.

Lagarde’s backbone may be the weakest link in this chain. But, faced with abandonment by her coterie of commentariat apologists and the shattering of her global reputation if she folds now, even someone as skeptical of her as I am says her back could prove surprisingly stiff.

And crazy as creditors’ conditionality may be, full compliance by Tsipras could be exactly what now sets the Greek cat among the Euro and IMF pigeons.

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