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Analysis
Varoufakis still holds important cards

Varoufakis still holds important cards

Brinkmanship goes a step further

by David Marsh

Tue 17 Feb 2015

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 bail-out 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 area.

The possibility of such measures to block flows of capital has risen after the collapse of Monday night’s Eurogroup meeting. The new Syriza-led government hit out at euro ministers’ resolve to hold Athens to the terms of its hotly-debated €172bn bail-out 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 is out of keeping with European traditions.

Capital controls were vilified in the free market 1990s. These measures attracted criticism from the International Monetary Fund and US 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 OMFIF book (see below), these instruments have now become widely accepted as a legitimate part of countries’ defensive armour 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 euro area 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 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 unravelling of Europe will be uppermost in governments’ minds.

 

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 2 March. Her book The Tides of Capital is published by OMFIF Press. See /omfif-press/the-tides-of-capital/.

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