Sayonara?

Photographer: Yorgos Karahalis/Bloomberg

Does Greece Have a Diabolical Plan B?

Leonid Bershidsky is a Bloomberg View columnist. He was the founding editor of the Russian business daily Vedomosti and founded the opinion website Slon.ru.
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Perhaps the most baffling thing about the current Greek crisis is the sheer stubbornness of the country's leaders: Don't they understand they are committing economic suicide by refusing to make more concessions to the country's creditors? What are they playing at?

QuickTake Greece's Fiscal Odyssey

Hans-Werner Sinn, president of the Ifo Institute for Economic Research in Munich and an adviser to the German government, has a chilling answer to this question. In his view, every day that Greek Prime Minister Alexis Tsipras and Finance Minister Yanis Varoufakis maintain their irritating good cop-bad cop routine, the euro area digs itself deeper into a financial hole, which is what the Greeks want. The way it does that, according to Sinn, is by funding Greek capital flight, which the Tsipras government intentionally allows.

Related: Greece Default Watch

It's a riff on Sinn's old obsession with countries' balances in the euro zone's interbank payment system, Target2. When Greeks get money out of the country -- by, say, acquiring German property -- they draw the money from a Greek bank, which becomes liable to the central bank of Greece for the amount. It, in turn, develops a debit at the European Central Bank. The German bank that receives the money from the house purchase now has a claim on the Bundesbank, which has a claim on the ECB.

The net result is that when all this Greek money borrowed from the ECB flees the country, Greece's Target balance becomes more negative. And in recent months, that's what's been happening at an alarming rate:

In effect, Sinn wrote in a column for Project Syndicate, Greek capital flight has been funded by the ECB. It provides money to the Bank of Greece so it can maintain the liquidity of local banks (the current limit on this assistance is set at 80.2  billion euros, or $88.4 billion). Clients of the Greek banks then move the liquidity out of the country. Sinn wrote:

A Greek exit would not damage the accounts that its citizens have set up in other eurozone countries -- let alone cause Greeks to lose the assets they have purchased with those accounts. But it would leave those countries’ central banks stuck with Greek citizens’ euro-denominated TARGET claims vis-a-vis Greece’s central bank, which would have assets denominated only in a restored drachma. Given the new currency’s inevitable devaluation, together with the fact that the Greek government does not have to backstop its central bank’s debt, a default depriving the other central banks of their claims would be all but certain.

The German economist argues that the Greek government is procrastinating on purpose -- to allow the negative Target balance to build up, increasing the potential fallout for Europe if it doesn't ease pressure on Greece to reform and pay its debts, and thereby strengthening its negotiating position.

This would be flattering to game theorist Varoufakis, implying that he has outsmarted the leaders of Germany and France in the debt talks. In the event of a Greek default on the Target balance, the ECB would probably need to be recapitalized. According to their shares in the ECB's paid-up capital, Germany would have to contribute 25.6 percent and France 20.1 percent of the necessary amount. That means between January and April, their combined exposure increased by 10.4 billion euros -- a high price to pay for stubbornly demanding that Greece come up with a coherent reform plan.

The problem with Sinn's logic is that it makes no sense for Greece to default on its Target balance. As Karl Whelan of University College Dublin pointed out in a 2013 paper, Greece would still need to settle international payments in euros even if it were to leave the euro zone. Four countries from outside the currency area -- Bulgaria, Denmark, Poland and Romania -- are connected to Target2, because they have significant euro-denominated trade. So would Greece after the so-called Grexit. Besides, Whelan wrote, "because there is no maturity date for Target2 liabilities, the claims can be honored simply by making the necessary interest payments. The cost of making these payments would be relatively low even when adjusting for the decline in the value of Greek nominal GDP after a currency devaluation."

In other words, the threat that Greece would cut itself off from euro clearance by defaulting on a timeless, low-cost debt (the interest paid on it now is so close to zero as to make no difference) is far-fetched. While it might be tempting to ascribe Greek recalcitrance to Varoufakis's diabolical cunning, the more obvious explanation -- that the Greek government is constrained by its election promises and lacks good negotiators -- is probably the correct one.

Contrary to Sinn's assertion, time is not on Greece's side: If it runs out of cash to pay salaries and pensions, as it may do as soon as this month, a default on the Target balance won't do it much good.

This column does not necessarily reflect the opinion of Bloomberg View's editorial board or Bloomberg LP, its owners and investors.

To contact the author on this story:
Leonid Bershidsky at lbershidsky@bloomberg.net

To contact the editor on this story:
Marc Champion at mchampion7@bloomberg.net