The deteriorating situation in Greece raises major questions not just about its future but also about the make-up of the entire world. To us, the biggest question is: how far west is east? Throughout the entire crisis we believed that somehow Greece and the European troika would devise some sort of solution that would—while not eliminating the fateful day in which Greece says goodbye to the euro—at least postpone it until other alternatives were available, and in particular the BRICS bank, was on stronger footing. We’d still make that same bet; in other words, we’re betting that the Greeks will vote “yes” in the July 5 referendum and/or the Greek government will come to terms with the troika—the International Monetary Fund, the European Central Bank, and European Commission. That was certainly the bet to have made in 2011 when Greece was arguably in worse condition than today.
To be fair, over four years at least two things have changed. First, though some basic Greek economic numbers have improved somewhat, the extent of poverty and suffering for a large swath of the Greek population has worsened. Second, while it hasn’t received much coverage, Greece today does have an alternative, albeit one that won’t find its way onto any ballot. What I mean is that if Greece chooses to abandon the euro, the Eastern counterpart to the IMF—the BRICS bank (where S stands for South Africa)—will likely step up to the plate. Russia has already offered Greece membership in the bank.
Whether Greece joins BRICS or not, we’d guess that China, clearly the bank’s most important member, won’t be in a hurry to fully challenge the IMF. Instead, it would likely prefer to work in concert with the IMF and other European-involved institutions. So, for at least a while Greece must endure further suffering. But in the end we think it almost certain that Greece will side with the East and become a member of the BRICS bank as well as the AIIB. Here’s why: the East is in a much better position to offer Greece the infrastructure—trains from China and pipelines from Russia—that its economy needs to improve.
China’s likely reluctance to move quickly reflects China’s desire to have the yuan included in the IMF’s SDR basket. Once part of the SDR, China will have many options to achieve the kind of monetary hegemony it wants, which would be difficult to achieve if it tried to go it alone. With the yuan part of the SDR, China could elect to partially back its currency with gold, and by doing so make the yuan the most anchored and preferred reserve currency.
Our guess is that China and BRICS will not throw down the gauntlet at least for a while. Sometime in the next year or so China will be in a position to offer to BRICS a melded currency—consisting of the yuan, gold, the rouble, the drachma, maybe more—to rival the euro and the U.S. dollar. That would be a much better time to offer Greece and who knows what other countries a chance to join the China-led bank.
While Greece will face pain—no matter what happens in the immediate future—the country and the BRICS bank will be in much stronger position relative to the rest of Europe within the next year or so. A so-called Southern stream to send Russian gas through Greece and into the rest of Europe will be lucrative for Greece; it will also give the country much more leverage to bargain than it has today. Additionally, the Chinese facing a temporarily weak Greece will be in a better position to buy full control of the Greek port of Piraeus. This port will serve as a point of entry for Chinese goods delivered to Europe. The infrastructure accompanying the port will include fast Chinese trains that run up to Budapest—a short trip to major trading centers in Germany. In other words, the near-term loser under any scenario will be Greece. Over the intermediate term, China and the East will gain a fabulous geopolitical prize.
China’s major concern: establishing an economic bloc that largely defines the Eastern world, in which China has hegemony. America may have a place in it but the Chinese will control the bloc. To a great extent the bloc will be defined by trading relations and infrastructure within the East. Will Germany be part of the Eastern bloc? To some that may sound like a silly question; it is not. China is already the largest investor in Germany. Trains linking China and Germany come by way of Russia and soon will also come by way of Greece. The latter’s role will expand in the East, that is, and may be fully established, before Greece breaks away from the euro zone.
While Greece has a major role to play in the ultimate East-West divide, Germany will be the more important player. Recently we referred to a Foreign Affairs article that suggested Germany’s more natural proclivity toward Russia and the East than to America and the West. More recently, an International Economy piece discussed the same issue.
In short, while Russia’s government is inimical to everything good that America stands for, the Americans went some distance to even the score with persistent spying on Germany and other European countries—not how friends should act. (No wonder Mr. Snowden found so many friends in Russia.) To the extent the spying episode lowered the U.S. moral scales, Germany now faces the question, which side makes for a better economic partner. Here the answer would appear to be Russia and the East. But clearly the Germans must travel far before fully aligning themselves with Putin’s brutality; at the same time given Germany’s lack of trust in America, it will probably have a prominent role to play in China’s silk road. Greece will at least in part facilitate that role—and better facilitate it if it delays its withdrawal from the euro zone.
Of course, the elephant in this room is China itself. China, though it is by a wide margin the largest Eastern economy and by some important measures the largest economy in the world, must according to many yet overcome several near-term problems or risk a major crash. We continue to believe that China can effect a change to greater consumption without risking a major slowdown in investment. Last week China’s government instituted three major changes that promise increased liquidity to its economy, setting the stage to eliminate its stringent 75 percent loan-to-deposit ratio for commercial banks; over the weekend, China reduced interest rates and lowered the reserve requirement ratio (RRR). Most significant, the lower RRR was not broad based but targeted to smaller businesses, exactly the businesses that Nicholas Lardy has indicated lead China’s growth, as we have previously discussed.
China is determined to keep the economy strong even in the face of somewhat diminished investment growth. Perhaps the statistic that is most often cited when talking of China’s troubling slow growth is the PPI—a commodity-based index that has been for more than three years in negative territory. Boosting the PPI will mean boosting commodity prices, a goal to which we believe China aspires. Higher commodity prices will come longer term as infrastructure spending picks up across the East, but China does not want to take chances. After all, if commodity prices stay too low for too long then future supplies could be jeopardized. Besides, two critical BRIC countries plus South Africa will benefit from higher commodity prices.
We would not bet against China here. We think commodity prices will in fact rise—though until the Greek situation is resolved they may still face psychological hurdles. But over the next six months a strong rise in commodities would be wholly consistent with all China’s long term goals for itself and the East.