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Greece’s Varoufakis still holds a trump card

Athens could impose capital controls, which come with their own form of austerity

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Greek Finance Minister Yanis Varoufakis gives a press conference on Monday at the end of an Eurogroup finance ministers meeting.

Yanis Varoufakis, the game theorist turned finance minister of Greece, seems outnumbered and outmaneuvered in his 18-against-one fight with other European governments over the country’s future in the euro bloc.

Yet Varoufakis still has some powerful cards to play in the brinkmanship he is enacting over the terms for an extension of Greece’s bailout package from the European Union. 

One of them concerns the possible use of capital controls, which could be introduced to protect money seeping abroad if Greek banks face further deposit withdrawals as a result of speculation that the country will leave (or be ejected from) the 19-member euro EURUSD, -0.06% area.

The possibility of such measures to block flows of capital has risen after the collapse of Monday’s night’s Eurogroup meeting. The new Syriza-led government termed “absurd” and “unacceptable” the euro ministers’ resolve to hold Athens to the terms of its hotly debated €172 billion bailout agreement which the government blames as heaping unacceptable austerity on suffering Greeks.

The Eurogroup has given the Greeks until Wednesday night to change course — a deadline that Varoufakis has rejected as an ultimatum that he claims (romantically yet erroneously) is out of keeping with European traditions.

Capital controls were vilified in the free-market 1990s. These measures attracted great international criticism from the International Monetary Fund and U.S. policy makers when they were implemented in Asian countries to overcome some of the damaging excesses of the Asia financial crisis in 1997-98.

However, as Julia Leung, a former official at the Hong Kong Treasury and Monetary Authority, now a leading Hong Kong securities regulator, writes in a new book (see note at the end of this article), these instruments have now become widely accepted around the world as a legitimate part of countries’ defensive armor at times of financial stress.

The IMF gave its approval to capital controls, after a lengthy investigation, in December 2012. As Leung writes, “The IMF’s welcome for what it described, with due obfuscation, as ‘capital flow management measures’ cannot hide the reality that the IMF is sanctioning, mainly on a temporary basis, some kind of control scheme.”

Another troubled part of the euro area, Cyprus, remains part of the single currency only because capital controls were imposed, allegedly on a temporary basis, in the banking crisis of spring 2013 — and these are continuing.

Companies and banks in Greece and abroad are known to be making contingency plans for the introduction of capital controls and a parallel currency regime — under which Greece could conceivably remain part of the eurozone but with different arrangements for domestic and international transactions — in the event that the talks with creditors break down.,

Greece would have to print its own currency, the new drachma (ND), which would be heavily depreciated. All domestic wages and prices would be fixed in ND, with the euro still in force for international payments. The government could initially peg the ND wherever it wished, maybe 10% below par with euro, but could then leave it to float lower. Very likely the new currency would settle 20 to 30% below the current imputed value of the Greek currency against the euro.

Greece would almost certainly renege on, or seek to reschedule, its debts in euro, but it would still need euros to pay for imports, so unpopular steps such as privatization, squeezes on revenues and controls on excessive demand would have to continue. Conceivably, under an exchange controls regime — as countries ranging from Cuba to Russia have found out — Athens would simply be swapping one form of austerity for another.

The political stakes surrounding the Greek negotiations remain high.

Sunday’s election breakthrough in west Germany by the anti-euro Alternative for Germany (AfD) party offers a stern reminder to Chancellor Angela Merkel. The message: concessions to Athens to keep the Greeks in the European single currency will be punished by the German electorate and, as in other parts of Europe, will strengthen the appeal of fringe parties of both left and right.

On the other hand, the rise of fringe anti-European parties all over the continent will make establishment parties even keener than hitherto to hold on to the middle ground. Keeping Greece in the euro area as part of a broad consensus on preventing the unraveling of Europe will be uppermost in governments’ minds.

Other governments’ fear of fragmentation is an important instrument which, if he deploys it well, could still be of use to Varoufakis on the next stage of fraught negotiations with the EU’s ministerial bureaucracy.

Note: Julia Leung, former undersecretary for financial services and the treasury in Hong Kong, becomes executive director for investment products at the Hong Kong Securities and Futures Commission on March 2. Her book “The Tides of Capital” is published by OMFIF Press.

David Marsh