By Barry Norris
It is difficult to underemphasise the significance of ECB QE, which had previously been seen as a policy tool which the ECB could or would never implement but for which now there is essentially an open-ended commitment. The logical conclusion of these policies is that the ECB will, if necessary, monetise the debt of all eurozone sovereigns so long as their governments are not beyond the pale.
Whereas there was previously a risk that all eurozone governments had borrowed in a foreign currency which they ultimately could not print, the ECB has now established itself – like the Fed and the BoE – as a credible buyer (as well as lender) of last resort. As a result there should be a much diminished credibility gap as to the long-term viability of the euro. The main cause of the eurozone’s unique vulnerability to a sovereign debt crisis is arguably now removed.
QE is, however, a powerful tool which is very dangerous should it be abused. Markets need to have confidence that the ECB’s QE is not a substitute for fiscal responsibility and credible economic reform by eurozone governments. Should any eurozone government be seen as refusing to abide by the rules, then confidence in the euro, as a store of value, would be greatly diminished and Europe’s economic future put in peril. As such QE is like the ring in the Lord of the Rings trilogy: it is essential that while it exists it remains in the possession of Frodo Baggins rather than Gollum, Saruman or Sauron.
The confrontational scenario between the Syrizia-led Greek government and its EU and IMF creditors is likely to come to a head over the summer when €6.5bn of government bonds are scheduled to be repaid. The Greek government does not currently have access to sufficient funds. It is unlikely that the EU and IMF will agree to afford Greece sufficient liquidity unless a credible programme of economic reform is established. It also seems unlikely that the current Greek coalition would have sufficient political support to implement such a programme of economic reform. Should the Greek government force the Greek banks to purchase its debt as an alternative to formal EU/IMF assistance then to avoid moral hazard the ECB may feel obliged to cut off emergency liquidity assistance to the Greek banks, thus forcing the Greek government into introducing an alternative currency.
In view of the firewalls now in place, I no longer believe that the eurozone would not be better off, certainly in the longer term, by ejecting Greece from euro membership even if this leads to a short-term market negative event of Greek debt default. Greece is a small economy, accounting for just over 1% of eurozone GDP. Only 12% of Greek government debt is held by private investors: the biggest amount of capital at risk (€244bn or 78%) is ultimately owned by other eurozone governments, which have record cheap access to capital, and should be put into context of the €60bn a month of new money being created by the ECB in asset purchases. In fact the entire stock of Greek government debt (€322bn) amounts to just over five months of ECB QE.
It is a matter of debate whether a “Grexit” would lead to sustained “contagion” across weaker members of the eurozone. We think that Greece is unique in the eurozone in terms of its unsustainable debt burden and recalcitrant government and that the ECB would likely accelerate its asset purchases in order to restore market confidence. Ultimately, a more credible eurozone might emerge without Greece. In short, we would seemed to have reached a point where the risks of political “contagion” from Greece to the rest of the eurozone in terms of encouraging economic illiterate political movements now exceed the risks of financial “contagion” and as such it is time to consider whether “Grexit” is now the least worst outcome for the rest of the eurozone.
Barry Norris is founder and fund manager at Argonaut Capital
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