Rather late today — busy day.

What is the argument for the Troika to pull the plug on Greece and allow a messy default? It is that Greece has dragged its feet on reform. According to the New York Times, the Greek PM Papademos is saddled with a cabinet of politicians (unlike Monti in Italy) who have no incentive to push through unpopular measures before elections that could come as early as March. For example, Greece is supposed to be selling EUR 65bn of state assets, but has so far sold only EUR 2bn; a law was passed in the autumn to cut state salaries by moving 30,000 workers into a “labour reserve” on low pay, but only 1,000 have been so shifted; and a bill is presently being debated that would streamline state entities and open up various professions, in spite of the fact that the same measures were enacted in 2010 (they were never implemented). If the Troika feels that Greece is resisting reform, it may give up on Greece and allow a default — or so the argument runs.

However, I do not think that this is a very strong argument. The Troika wants to avoid a compulsory restructuring, so allowing Greece to have one — and, if it acts in its own rational interest, to force large losses on bond holders — would hardly be a reasonable response to Greek intransigence over reform. What is more, Greek politicians will also want to avoid a compulsory restructuring without Troika support, since without EU support they would have no means of recapitalising their own banks. With regard to an uncontrolled default, the Troika is extremely keen to avoid that outcome, while the argument for Greek politicians is the same as the one for a compulsory restructuring.

But perhaps I am wrong about how far the Troika is prepared to go to keep everything voluntary. According to Morgan Stanley, long the March bonds has become a crowded trade (which is why the price is at 45, rather than a more realistic number in the event of restructuring). Further, they argue, Eurocrats and politicians will be well aware of this, and they have no love for hedge funds — indeed, they can be sure that holdout speculators in Greek bonds are people who are in a position to lose money without it having a major effect on the financial system. And European politicians may be starting to understand how bad the Greek situation is — certainly, it cannot have escaped their attention that even a compulsory write-off of 50% on Greek bonds might not be enough. Thus it is distinctly possible that they might come round to the idea of compulsory restructuring before March. If this happened, the incentive for both the Greeks and the Troika (assuming the ECB could be exempted) would be to have as large a write-off as possible, in order to get Greece back onto a sustainable path. From the Troika’s point of view, this would maximise the chance of the money it has already lent being paid back. Similarly, UBS thinks it most unlikely that the March bond will be repaid in full.

All through the European crisis, Kremlinology has been more important than economic analysis. The important questions have been: what do the politicians believe, and what is in their interests? Can I make an argument that the politicians have not come to believe the truth, which is that Greece needs a large writedown and compulsory restructuring is the best way to do it? With the PSI talks apparently deadlocked, and in spite of my scepticism about the reasons for the deadlock (many of the public pronouncements must be negotiating tactics), I find I cannot make an argument that the politicians remain deluded. I will continue to watch their words and their actions, however. If it becomes clear that they remain committed to a voluntary approach, this trade could still be on. But I have grown wary of it.

Data:

China GDP 8.9% qoy b.e. Q4. 4th slower number in a row, but beat expectations.
China fixed investment 23.8% ytd/y d.e. Dec. Lowest since 2007.
China industrial production 12.8% yoy b.e. Dec.
China retail sales 18.1% yoy b.e. Dec. Something of a jump.
UK CPI 4.2% a.e. Dec. Third fall in a row. CPI ex indirect taxes 2.8%. Core CPI 3%.
German ZEW -21.6 b.e. A big increase.
Eurozone CPI 2.7% d.e. Dec. Core 1.6%.

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