The euro zone has become a political economy black hole
since the Greek economy is on the verge of collapse, German voters demanding more pain means there is little hope in the economic and political situation in Europe for Greece continuing in the euro zone. The political situation in Greece mandates noncompliance with the existing austerity regimen, which will result in European Union and International Monetary Fund assistance being withheld. Greece will have no choice but to default and exit the euro zone.
That’s my conclusion on Greece via today’s piece at US News. The full link is below.
Given how politically devastating a euro zone breakup is, I am still looking for other ways the euro zone can pull a rabbit out of its hat here.
In my latest member piece on the coming Grexit, I noted that you would need to see a massive infusion of liquidity into Europe if Greece exits. We’re talking defaults by the Greek sovereign and defaults by Greek corporates and banks or writedowns from New Drachma depreciation. The ECB and potentially the IMF would take hits and there would be Target2 problems as well.
Without going into the detail of my member posts, here’s what I would say that I didn’t say at US News: while it is clear Greece will eventually exit the euro zone, the real question is the timing. Although my post at US News makes it seem like a Greek exit is imminent, I still believe that we are going to see more ways of extending this because the euro zone is not ready politically for what the consequences of a Greek exit entails (bailouts, bank recaps, massive ECB intervention and a lot more). The political about-face necessary to prevent contagion is a lot larger than politicians are now prepared to take. Does that mean a swag is coming so Greece can default and remain in the euro zone? No one knows. Anything is possible. The situation is completely unpredictable. The euro zone has become a political economy black hole.
Source: Goodbye Euro, Welcome Back Drachma, USNews
I am not so sure exit is inevitable. No one within the euro area wants Greece out and neither do any of the greek political parties. What could happen is that far larger write offs could turn Greece’s fiscal position around. Without debt repayments the Greek fiscal position might improve dramatically. That can lead to an end of austerity and stability.
That would save the euro but could end the banks. Banks will have to take their losses. Longer term the ECB needs to become responsible for banks regulation as sovereigns without the funds to do so are incapable of supporting banks. Don’t forget that all along that this has been a banking crisis. If Ireland had dumped the banks it would be growing by now. It is still stagnant with massive losses still to be taken privately.
But that still doesn’t fix the key problem with the Euro – the competitiveness/trade imbalances. Say they write off all the debt. Unless Greeks can become MASSIVELY more competitive versus Germany (something not possible through simple economic reforms), they will either be starting over running deficits and re-accumulating debt (something the Germans will not tolerate), or will need fiscal transfers (something the Germans will not tolerate) or their economy stabilises but at such a low level of output (third world stuff) that life sucks so much that they will ultimately realise leaving the Euro is in their best interests…
Yes but exiting the euro will not make it any more competitive overnight either. It might be forced to use another currency like the dollar to trade. If writing off all debts eliminated the fiscal deficit then it could comply with running a small surplus without much trouble. There could still be transfers to Greece to maintain infrastructure which would create jobs, though oversight might be essential. Significant political reform is also essential to stop the corrupt practices of the past.
Could somebody please explain why default almost certainly leads to exit? Is this a subtle argument to do with bankruptcy law? I get the arguments for why exiting the euro would allow Greece to become more competitive, but it doesn’t immediately follow that defaulting would require Greece to then exit. I can see why exiting makes default almost certain. Assuming Greece’s debt is redenominated in Drachmas, and then devalues, this is as good as defaulting.
Plus why is it always described as bailing out Greece? Isn’t it fairer to describe it as bailing out Greece’s creditors? Can’t Greece default, draw a line under the past, reform, and rebuild its reputation and credit rating? All easier said than done I know. Reform would obviously involve cutting prices and wages, and improving tax collection. But it would also require improving accountability, transparency and credibility within the government and implementing the institutional checks and controls to reassure future creditors.
It doesn’t:
https://pro.creditwritedowns.com/2011/09/eurozone-default-is-not-synonymous-with-breakup.html
Reform would definitely mean improving tax collection, but cutting wages still further would mean that the EU would be creating a third world nation on its doorstep. The real solution is a cram down on asset prices, and rents. That would mean existing incomes would be tolerable and allow more spending. That might mean bankruptcy of the Greek banks but that would also eliminate the pressure on the Greek central bank to bail them out.