The relationship between Greece and the rest of the euro area are increasingly reminiscent of the Cold War’s balance of terror. We are speaking of financial terror only and Greece is no USSR, but the mechanics are strikingly similar.
Start with the options for Athens. It is important to distinguish between budgetary and external aspects. Greece is forecasted to record a slight primary budget deficit in 2012, so should it default, forcing European partners to unplug assistance, it would have to tighten more (although only marginally). More importantly, the current account deficit is still expected to be close to 8 per cent of GDP this year. Without assistance and in the absence of significant private capital inflows, this deficit could only be financed by the ECB increasing its exposure even further. Should it refuse, as likely, Greece would be forced to close its external deficit precipitously – either within or outside the euro area. If forced into an exit, what remains of the economy would instantaneously fall into chaos. Financial disruption would be massive, resulting in a chain of bankruptcies. Currency depreciation would substantially overshoot, especially as policy institutions have no credibility whatsoever. Foreign goods and equipment would become unaffordable. Eventually, but eventually only, depreciation would help rebuild competitiveness. In the meantime the damage would be massive.
Turn now to the euro partners. A unilateral Greek default would undoubtedly be costly for them. Euro-area official exposure to Greece through assistance loans, ECB claims on the central bank and ECB holdings of government bonds amount to more than €250bn. To this sum must be added private sector exposure through bank loans and equity, roughly another €100bn. Additionally, a Greek exit would signal that there is nothing irrevocable with participation in the euro, turning the European currency into a sort of magnified fixed exchange-rates system; equally importantly, it would force to set rules for converting euro-denominated claims into the new currency, thereby indicating to every business or household what their assets and liabilities would become in the case of a euro break-up. No doubt this would trigger massive precautionary moves and undermine the rest of the euro area, starting with the weakest countries within it.
So each side can do major harm to the other one. The question is: will it happen?
Greek public opinion is adamantly in favour of remaining in the euro area while alleviating the austerity burden. But this is an inconsistent proposal. A Greek threat to default within the euro is not be credible if the ECB is ready to stop extending liquidity. The next government could wish to renegotiate some aspects of the programme or give priority to certain reforms. But it will still need a conditional assistance programme, until it completes the largest part of its adjustment.
The EU official line – no renegotiation of the programme, no exit at any price – is not credible either. First, it is hard to see how to object to changes in domestic priorities proposed by a newly elected government. For example, why should the EU rejects proposals to tax more and spend more, if this leaves the deficit unchanged? Second and more importantly, the EU cannot deter Greece from making use of its leverage if the price it puts on exit is infinite. To strengthen its hand and make its tough line credible, it has to be ready to contemplate a forced exit. But the EU can only do that if equipping itself to limit potential damages. This means beefing-up firewalls and speeding-up preparations for further integration of the euro area through banking union and the issuance of common bonds. Here, it is Berlin that lacks consistency. Signals that it is close to reaching the limits to the price it is ready to pay to keep Greece within the euro are only credible if accompanied by willingness to consider bold moves to preserve the common currency.
A lesson from the Cold War is that ultimately, rational behaviour proved to be the best insurance against disaster. Today also, both partners have a common interest in behaving in cool blood. They have to set red lines credibly and unambiguously, as well as to indicate where there is room for discussion. This can only happen after June 17, when a new coalition emerges from the election and forms a government in Athens. In the meantime, we are bound to live dangerously.
Comments
Subscribe to posts' commentsErich 22nd May 2012
In 2011 the huge amount of about 50 Billion (Mrd) Euro was spent for Greece by the northern tax payers (government deficits + Target2 + direct EU projects). Only a minisculous part of that actually arrived in Greece. Most of that was spent to substitute private credit by public credit, and to finance the capital export from Greece to other countries. This was a ridiculous efficiency for our tax money, and I don\'t think we could change that within the Euro system. Only after a reset with a new currency, and, of course, direct support for Greece (think about medicine, food, and money for oil) will there be any hope for Greece. Of course most of the previous credits are lost, but thats the result of a bad policy to put new money into a failed system.
Reply to Erich
Tasos 23rd May 2012
This is the most sensible article on euro and the Greek drama. It should be complemented by some clear cut advice for politicians. EU should suggest Greeks that if they want to stay in the Eurozone they should put in government only those that clearly accept the terms of the Memorandum. Hopefully this is now starting to become a universal stand. But if a stable government emerges, it has to be fully supported. The EU should stop pushing on further salary cuts and increased taxation –with all the consequences – and insists on immediate structural reforms in all protected or under supervised sectors of the economy and particularly in the liberal professions. All reforms need to be scrutinised at every detail and be implemented with direct and detailed EU supervision. The EU may become the new Thatcher for trade Unions but it will be a panacea for the economy and the grand majority of the population. All mechanisms for that are already in place. When people realise that implementation of the reforms has started, the country will immediately turn to a place of opportunity with a potential of 10% or more growth. That was the growth of the country experiencing in the early 60s. At that time -despite the heavy military burden of more than 5% of GDP - the country was one of few in the world with no deficits or debts. All should understand that Greece has huge potential – hundreds of billions of funds abroad waiting for the opportunity to be invested inside - and was always a fast reacting economy. It is a mistake to think about the Greek economy in the same way as we think about the German economy or that of any other industrialised country.
Reply to Tasos