Markman Capital Insight

The real meaning of austerity in Greece

Stocks initially plunged in trading Tuesday as a meeting of Eurogroup finance ministers broke up with no new deal for Greece, taking the S&P 500 down below its 200-day moving average for the first time since October.

That threatened a level of support that has held stocks aloft, save last year's Ebola-driven scare, since late 2012. No wonder President Obama stepped into the breach, with calls to Greek Prime Minister Alexis Tsipras and German Chancellor Angela Merkel urging both sides to come to a "durable" agreement.

That, along with reports a short-term deal is in the works to help Greece make a July 20 debt payment to the European Central Bank, unlocking financing to reopen its financial institutions, lifted stocks into the green by the closing bell. Well done, Mr. President. For the moment.

The problem for Obama is that the Greek debt problem is intractable with no easy solutions. If he thought he had it tough dealing with congressional Republicans on budget issues; it's nothing compared to the standoff between Greece and its hardliner creditors.

The Greeks want debt relief and voted against structural reform, also known as austerity. The Eurozone wants fundamental governmental and financial reforms, and are worried that debt relief will unleash moral hazard. The country has been given debt relief at least twice before, and come back asking for more. Time is running out to find a compromise: The European Central Bank's increase of Greece's collateral haircuts on Monday -- which have the effect of bringing Athens banks closer to insolvency -- effectively tightened the noose.

Guy Verhofstadt, a leader of the European Parliament, urged Greece leaders to come forward with “a credible reform package” that included a clear calendar and efforts to stamp out clientalism.

The latter term may be new to many readers. It is a type of government that was largely introduced to Greece following the end of a seven-year military dictatorship in 1974. We would call it a "patronage" system in which politicians distribute benefits to individuals or groups in exchange for electoral support.

"Clientalism" is often used interchangeably with corruption, but that is not always the case. Corruption involves dishonest or fraudulent dealings, whereas clientalism typically involves straightforward grants of government jobs for electoral support. Clientalism has been blamed for a vast ballooning of employment in the public sector in Greece at unproductive jobs.

Basically the European Union is asking the Greek government to take tens of thousands of people off the public payrolls as a step toward reforming its financial structure. The eurozone leaders are afraid that one more bailout package is just going to disappear right down the same drain as previous bailouts -- into the hands of self-serving political appointees.

So you can see why it is too simple to group all of the European Union's demands under the label of "austerity." The EU is asking the Greeks to fundamentally change a manner of political organization that has become embedded in their way of life -- and suits the leadership most of all.

It would be as if overseas holders of U.S. debt suddenly demanded that they would stop buying Treasurys unless powerful American politicians stop earmarking congressional bills in ways that send borrowed government money to their districts in the form of new military or highway construction contracts. The politicians in Washington know that their financial support would dry up if they could not dole out riches to their campaign backers, so they would fight such rules tooth and nail.

And of course it's more than that. James Mackintosh at the Financial Times summarizes: "If the Greeks are allowed to walk away from that debt, Spaniards, Portuguese, Italians and Irish will quite reasonably say they should be let off, too." Thus, Germany and other core nations can't indulge Greece's demands for fear of fueling similar anti-austerity political movements such as Podemos in Spain and the Five Star Movement in Italy.

If a stalemate persists, the next big deadline will be a $3.8 billion payment to the ECB on July 20. A default on this by Greece would likely force the central bank to pull back its liquidity support, force Greece to issue California-style IOUs, as reported by the Telegraph , and precipitate the move towards the restoration of the country's pre-euro currency, the drachma. That currency would then be used as a means of exchange in Greece but would likely be snubbed by governments and businesses in other countries, leaving Greeks with no means to buy imports.

Unless Obama can encourage Europe to put debt relief on the table, and Greek leaders to embrace the austerity measures their people just voted against, the situation will quickly deteriorate, pulling U.S. stocks back down. Credit crises undermine the foundation of capitalist systems as they lead to a questioning of the meaning of contracts and the value of money.

The latest from a French official is that the short-term deal in the works would require Athens to pass budget measures in exchange for the prospect of debt reduction as part of a long-term deal. The short-term deal would fund Greece through the end of the month.

More ultimatums are being made. Merkel is demanding a Greek austerity proposal by Thursday. And Italian Prime Minister Renzi has said the final and definitive meeting of all 28 European Union leaders on the Greek bailout will take place on Sunday. Don't be surprised if Obama decides to hop on Air Force One and drop in to try his hand at international finance diplomacy.

-- Jon D. Markman


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