The Austrian physicist Erwin Schrodinger offered a thought experiment to illustrate the incompleteness of the Copenhagen interpretation of quantum mechanics and sub-atomic particles in 1935. In the experiment, Schrodinger’s cat is placed in a box with a device that is triggered by a single particle’s behaviour. If activated, the device kills the cat, but quantum theory holds that the particle’s behaviour is indeterminate until it is observed, which is when its “probability wave” collapses. The cat then can be considered both alive and dead at the same time until the box is opened and the cat observed.
Does this not capture the essence of Greece?
When the Socialists were swept into power in late 2009, the dire condition of state finances were observed and thereby triggering a debt crisis that remains unresolved at this late date. That said, reports suggest that some European officials knew or should have known the state of Greek finances prior to the election. Perhaps, like Schrodinger’s thought experiment, it matters who is observing the cat.
In any event, the probability wave has collapsed and Greece is on the precipice of failure. The economy is entering its fifth year of contraction. Its economy now is back to the size of five or six years ago, while its debt is significantly higher.
Unemployment stood at nearly 21% in November (most recent data available) and near 50% for young people. Despite the collapse of domestic demand, Greece ran a current account deficit of 8.6% of GDP in 2011.
The market has long been pricing in a Greek default. The probability is now certain, while the size of the loss to investors continues to rise. Last week, a large Dutch bank reported that it is writing off 80% of its sovereign Greek exposure.
However, like the two states of Schrodinger’s cat before observation, Greece is not going to make good on its financial obligations, but it still may not default. This indeterminate state is a product of seeking to avoid the triggering of insurance (credit default swaps) while getting private sector investors (though apparently Greek pension funds as well) to participate in the burden sharing.
The state of Greece’s sovereignty is also akin to Schrodinger’s cat. It is sovereign, but it isn’t. Some have advocated Greece leave the monetary union and reclaim its monetary sovereignty to devalue. To the contrary and ironically, Greece’s sovereignty would likely be less outside than inside.
It is not clear that Greece could “re-drachmatize” the economy even if it wanted to. Who would accept as payment a currency whose sole purpose for being is to depreciate as tender? The risk is the economy remains heavily euro-ized.
Greece manufactures practically no goods for the international market. It produces no machines, electronics or chemicals to speak of, according to Harvard Professor Ricardo Haussmann. His work finds that of every $10 in worldwide trade in information technology, Greece accounts for one cent. Simply if crudely put, Greece appears to lack the industrial infrastructure and capacity to benefit from a devalued currency.
Among the Troika demands in exchange for a second aid package, is a more than a 20% cut in the private sector minimum wage from the current 750 euros per month and the immediate cut of 1500 civil servants (as part of a larger plan to reduce government payrolls by 150k by 2015). If Greece were to reassert its sovereignty, these would still take place in some form and fashion. The state, not just the government, would collapse.
Inside the euro zone, the Greek economy is projected to contract by 5% and this may be conservative. It is reasonable to believe that if Greece were to leave, the economic contraction would be deeper and more prolonged.
Recently, Germany proposed an EU Commissioner be put in charge of Greece’s fiscal policy. This went over like a lead-zeppelin (pardon the pun). However, the events in recent days indicate how close this has been achieved, but rather than an EU Commissioner, the Eurogroup of finance ministers, are directing Greece. Greek officials appeared to agree to all of the Troika’s demands only to have the euro zone finance ministers seemed to come up with new demands.
The brinkmanship tactics have brought both sides to the point of breaking. A number of European officials appear to be more willing to contemplate a hard default and possible exit of the Greece from the euro zone.
The sharp recover of the European sovereign bond market and the ability of Spanish and Italian banks to issue bonds in recent weeks has boosted confidence in (some) official circles that the 3-year LTRO has rebuilt a firewall around Greece. The moat of liquidity will be further enhanced by the second 3-year LTRO in a couple of weeks and the new more liberal collateral rules, which conservative (Draghi) estimates could boost borrowing by another 200 bln euros.
Greece has been brought to the breaking point. The technocrat government led by Papademos (previously the vice president of the European Central Bank) has collapsed as the small nationalist party (LAOS) has withdrawn. A cabinet reshuffle is necessary. Social unrest has intensified.
Judging from the coverage of the demonstrations, many Greek people realise what few international observers do—the lion’s share—some 80% of the funds Greece is to receive is essentially earmarked for servicing its debt directly or recapitalizing Greek banks so they can service their debt. It too is like Schrodinger’s cat—the loan package is aid for Greece and not aid for Greece, dependent on the observer.
The debate in the Greek parliament is taking place in the run-up to the opening of the Asian markets on February 13th. Despite the large scale protests and a many members of parliament from the New Democracy and PASOK (Socialist) parties have indicated they will not vote in favour of agreement, it looks as if the agreement will be approved.
There are several next steps. In Greece, a new cabinet needs to be named and pressure will build for a date certain for elections. Recent polls suggest is slackening for the major parties, with the Socialists polling less than 10%.
The European finance ministers will likely meet Wednesday February 15th and may give their approval. Yet privately they must know that this is still not closure. The goal of 120% debt/GDP in 2020 is a farce. It is twice the Growth and Stability Pact requirements. It is does not meet any meaningful definition of sustainable. Like Schrodinger’s cat, Greece is indeterminate.
February 15th is also when the EU is expected to report the flash estimate for Q4 GDP, which the market expects will show a contraction. While the debt crisis will be blamed for the economic weakness, it seems that the policy response to that crisis also bears some responsibility. The austerity regime being adopted throughout Europe, by surplus and deficit countries alike, amid deleveraging, begs the question of where will aggregate demand come from?
The same day the Troika will begin its third review of the implementation of Portugal’s aid package. While Portugal’s bond market has recovered in the past two weeks and officials continue to praise the government’s commitment, it is still not clear that it will be prepared to return to the capital markets in 18 months. If Greece can lower its debt burden by transferring some of it to its creditors, is it not in Portugal’s interest to explore the scope for forgiveness?
Assuming that the Greek parliament does approve the agreement, the euro can recover some of the ground lost before the weekend. Given the hard stance taken by the European finance ministers, their approval on Wednesday may be needed to sustain the euro’s recovery. The new collateral rules and anticipation of the next LTRO may see the euro bought on dips more aggressively than sold on rallies. Technically there is potential back into the $1.3400-$1.3600 area, provided that $1.2980 support holds.
Read more posts on Marc to Market »