Act III of the Greek Tragedy

The curtain has opened on Act III, and the denouement is upon us. Oedipus will gouge out his eyes and in the play Antigone, folly will demand King Creon experience death of wife and children. Since 2009, Greece has been given their bailouts, restructured a couple hundred billion in debt and done little to reform the bloated pension system or the oligopolistic cartel-like economy. Adoption of free market policies seems anathema to the ethos of the country. What is about to happen in Greece could be another Sophocles sequel.

The June 30 deadline for Greece to repay $1.75 billion to the IMF is pivotal for several reasons. That is the official expiration date for previous Greek bailouts. Also, non-payment could ultimately result in Greece being removed from the IMF. The most worrisome impact is what could happen to Greek banks. The massive deposit outflows over the past months have left the banks dependent on loans from the Bank of Greece (the equivalent of our Federal Reserve) to fill the resulting funding gap. The Bank of Greece gets its cash to lend from the ECB under the ELA or the "Emergency Liquidity Assistance" program. Every week the ECB's governing council votes whether or not to continue extending credit. A two-thirds negative vote shuts off the money spigot, and Greek banks would immediately collapse and anarchy could ensue.

Given this data set, Prime Minister Alexis Tsipras and Finance Minister side-kick Yanis Varoufakis strangely continue to approach ECB and IMF negotiations as if they reside in some position of strength. These two "paper tigers" are firing blanks; they rest all on European paranoia of what a breakup of the Union would mean. (More on "Grexit" in a minute.)

Greek leaders are all about assigning culpability to their economic predicament. Tsipras and Varoufakis would make good sitcom characters. The goofiness of their babblings is as nonsensical as it is damaging to the Greek populace. The IMF bears "criminal responsibility" for Greek economic hardships is one carp. No, Greek state overspending, excessive pensions and ant-free market policies are the culprits. The ECB is trying to "humiliate our country." Wrong again, they just want to get their loans repaid. My hint to the Prime Minister; you are humiliating yourself and fellow countrymen.

The Greece relationship with the IMF and ECB is being acted out like a parent and the recalcitrant child. The parent is guilty of overindulgence, and now that the rugrat has cavities and rotted teeth it is all the fault of the parents. Were Greece a schoolboy the analog would have merit. But the Greek Republic is an adult that behaves like a child....grown-ups take responsibility.

The adults in the room have a conundrum. They can wither and capitulate and approve the pending $7.2 billion new Greek bailout package without getting nearly all of the proposed financial disciplines. The "kick the can" metaphor is so overused, but that's what this does; the money is toilet flushed. Between now and July 20, Athens owes around $10 billion to the IMF, ECB and Treasury bills coming due....the can is so heavy now you can't kick it too far.

Or German Chancellor Angela Merkel can, with prodding from her own Christian Democrats, call the Hellenic bluff and let them default and begin the path to Euro exit. Whether Teflon Angela has the stomach for this is a debate. She worries about her legacy, about the economic fallout from a "Grexit," about geopolitical risks of perhaps pushing Greece towards the orbit of an acquisitive Putin. At the same time, the diligent and employed Germans recoil at continuing to fund Greek profligacy. Politically, many in her party view Greeks stratagems as little more than blackmail. German anger towards the Southern neighbor is high. Seems the Sword of Damocles hangs tenuously over Ms. Merkel.

Conversely, the Greek people overwhelmingly want to remain part of the Euro (of course they do) but Tsipras's far left mantra that got him elected hinged on anti-western, anti-austerity rants, holding a hard line on pensions and promises of debt forgiveness.....all the benefits of card membership without paying even the monthly minimums. Syriza's most radical members have some clean lines drawn in the sand; think pensions for one. So, poor little Tsipras clearly is cornered in an untenable position. Looks like Alex has a Sword over his throne too.

As both cars rush headlong towards collision who will blink in this high stakes game of chicken? The reality is that Greece cannot ever pay back their debts. Even if Greece acquiesced to European demands, it is an economy with a debt to GDP ratio of 180 percent that has shrunk twenty-five percent over the last half decade. Greece has not lived up to past bailout promises; why is this time expected to be different? Should Europe continue to throw more billions at an unsolvable problem to delay the inevitable? Answers will come shortly.

What a "Grexit" Would Mean

A "Grexit" would not be anywhere near the financial cataclysm vaticinated by some financial mavens. The country is an economic pimple with total output less than 1.5 percent of America. Much of the privately held debt was restructured and over fifty percent written off in a 2011-2012 deal. Therefore, the major remaining creditors are government institutions like the IMF and ECB. Financial infection to commercial banks and insurance portfolios will not be a threat to their solvency. Default is a long planned for scenario, rehearsed like a fire drill and much of the risk has been hedged or long disposed of.

Perhaps a more far-reaching apprehension is the contagion factor spreading to Italy, Spain and maybe Portugal. While not an impossibility, the benefits of low borrowing costs conferred on Eurozone membership is powerful incentive to make structural economic changes.

There will be some temporary bond market volatility that will calm in a matter of days. European stock markets have largely discounted the event as the Eurostoxx 50 is down nearly ten percent from April highs. The whole shock will be absorbed within a couple of weeks.

The Greek side of the ledger will be painful. The reborn Drachma will be sharply devalued, maybe by half or more. Imported necessities will become very expensive so inflation will be high. Greek exports will initially become much more competitive on world markets. Overall, per capita income and the Greek standard of living will decrease dramatically.

My Thoughts and Predictions

It is in best interests of Europe to call the Greek bluff. While many countries have flouted mandated EU budget deficit mandates, Greece has been an especially egregious offender. Europe can easily survive without Greece. Down the road, the success of the Euro experiment does depend on serious free market reforms by the Southern contingent of Italy, Spain and Portugal. Socialist France is in a downward spiral as well. A "Grexit" will topple the Tsipras government and with luck some sanity will return.

The Greek population must alter the current zeitgeist to understand that wealth is created by the ingenuity of human capital and not the largesse from the government spending money it doesn't have. Until that transformation occurs, Greece will be largely relegated to an inexpensive tourist destination and be regarded as barely more than a third world state. A couple of generations of Greeks have been inculcated to look to the state for support, so a change of attitude won't come overnight. Free markets that allow the new business formation to compete openly with the state protected oligopolies is a necessary reform. Greece is a textbook example of failed socialist policy where competition is restricted, and natural entrepreneurship of citizens is snuffed out.

Sadly, only lingering shards remain of this once proud nations past. The structural changes needed are so radical; to succeed Greece must go to economic rehab.....and we know that the success rates are often not encouraging.