9 Feb 2015

Forget game theory or economics, Greece’s future depends on emotion

Market sentiment over Greece has darkened considerably in the past 24 hours.

Investors have not only been digesting PM Alexis Tsipras’ speech in parliament, which definitively re-stated his “no U-turn” policy.

Alexis Tsipras said that he will put an end to the

There is also to be a mass mobilisation across Greece on Wednesday – and if they can pull it off across Europe – in support of the far left government, and aimed at putting pressure on the Eurogroup, which meets the same day.

On top of that the UK government has begun contingency planning for “Grexit”, and numerous governments on the periphery of Europe are briefing they will not back Greece in the negotiations.

So analysts, being asked to put a probability on a Greek exit, are typically saying “40-50 per cent” – which means realistically that only the people who really want to do racecourse-style betting with their money will be holding Greek bonds.

I understand the comprehensive proposal that is set to be put by the Greek side at the Eurogroup on Thursday will attempt to defuse the situation as follows.

I understand the European Central Bank (ECB) offered the outgoing Samaras government in Greece a six-month extension to the bailout programme, but it chose two, thus shortening the timetable of the crisis. Since Alexis Tsipras refused to ask for an extension, that set the stage for a short term crunch over ECB support for the Greek banks. But if they can revive a four month window of negotiation, the Greeks will.

So everything in the short term hinges on Greece getting a “bridging programme”. That is: the Greeks won’t ask for a Troika loan extension, but will attempt to enter into an arrangement that is (a) not the Troika (b) not their own desired programme.

In this I understand the emphasis will be as follows. First, the Greeks will offer to include elements of the old, European structural adjustment demands that do not conflict with their own. For example tax evasion and anti-corruption.

Second, the Greeks will emphasise the measures on which they have already softened. For example the minimum wage, whcih is now to be hiked to 750 Euros a month, but only over four years. They will also emphasise the fiscal neutrality of some of their measures: for example the re-hiring of civil servants sacked by the last government will be done within planned hiring budgets.

There will likely have to be a form of words that signals that, though Greece does not recognise the Troika going forward, it will deal with it as part of the transitional arrangement.

So it’s fairly clear the Greeks’ aim is to produce a temporary amalgamation of their micro-economic programme and the old Troika one, front-loading those points which Brussels can sell to the taxpayers of northern Europe.

In return they will ask for “fiscal space” – that is, permission to spend more and tax less, and in different ways, than the old government agreed.

The Greek aim is to get a strategic deal on the debt, and to avoid a short term bank collapse and default – but they can only do this by taking their negotiating partners to the brink.

If negotiations fail, and Grexit happens, I would expect the sequence to be:

(i) Failure to agree a bridging program triggers more rapid capital flight

(ii) ECB signals decisively it will pull Emergency Lending Assistance, triggering a bank run and bank closures, probably between 18 February and 28 February,

(iii) Capital controls, with Greece effectively operating as semi-detached member of the Eurozone;

(iv) default on debts to European sovereigns as they come up for refinancing

(v) the possible issuance of alternative currency, or paper acting as such in the banking system.

Of course, alongside this, there would be capital flight, and social unrest.

What a lot of observers are missing is that this would not be a rerun of Cyprus: it would take place amid massive popular pressure on other EU governments, including ones like Spain, currently egging on the ECB hardliners, and would be a traumatic moment for the European Union as a whole.

More from Paul Mason – Austerity, Neo-Nazism and Protest: The Greek Crisis in full

A lot has been made of this being a game of academics vs bankers, and I think that’s overblown. But Investec’s senior bond strategist Dawn Kendall lays out the real danger in the mismatch of methodologies being played out.

Decrying the Greek finance minister’s expertise in game theory, Ms Kendall writes:

“Whereas game theory can be irrational, the combined approach of the European Commission, the ECB and the IMF is based upon mainstream economic theory and is rational. In dealing with two entirely different ideologies, it is difficult to see how the two thought processes can be reconciled, as they do not start from the same premise.”

If we get to Thursday night, in fact more likely the early hours of Friday, and there is still no common ground signalled between Greece and its creditors, I would expect the decisive factor to be neither game theory or economics but emotion.

When the Greek protesters assemble on Syntagma Square on Wednesday, if it is anything less than massive, that will be one key signal to the ECB.

If there is strong anti-German rhetoric – with nationalist-minded Greeks parading in parody SS uniforms and Swastikas as happened when Merkel visited Athens – it will be hard for German policymakers to have a rational discussion about debt relief with their voters, once those images hit the evening news bulletins.