Blog Post

The balance of financial terror

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. […]

By: Date: May 22, 2012 Topic: European Macroeconomics & Governance

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.


Republishing and referencing

Bruegel considers itself a public good and takes no institutional standpoint. Anyone is free to republish and/or quote this post without prior consent. Please provide a full reference, clearly stating Bruegel and the relevant author as the source, and include a prominent hyperlink to the original post.

Read about event More on this topic
 

Upcoming Event

Sep
1
12:30

The EU recovery fund - state of play and outlook

Bruegel Annual Meetings, Day 1- In this session we will discuss the EU recovery fund, its state of play and outlook.

Speakers: Nadia Calviño, Karolina Ekholm and Guntram B. Wolff Topic: European Macroeconomics & Governance Location: Bruegel, Rue de la Charité 33, 1210 Brussels
Read about event More on this topic
 

Upcoming Event

Sep
2
10:00

Conversation on the recovery programmes

Bruegel Annual Meetings, Day 2- In this session, we discuss the recovery programmes.

Speakers: Maria Demertzis, Henry Foy and Tadeusz Kościński Topic: European Macroeconomics & Governance Location: Palais des Academies, Rue Ducale 1
Read about event
 

Upcoming Event

Sep
2
13:00

European banks: under global competitive pressure?

Bruegel Annual Meetings, Day 2 - European banks have lost stature and remain generally low-profitability, low-valuation in comparison to their global peers. Is that a problem? If so, what can EU policymakers do to address it?

Speakers: José Antonio Álvarez Álvarez, Mairead McGuinness and Nicolas Véron Topic: European Macroeconomics & Governance, Finance & Financial Regulation Location: Palais des Academies, Rue Ducale 1
Read about event More on this topic
 

Upcoming Event

Sep
2
15:45

Blending physical and virtual: shaping the new workplace

Bruegel Annual Meetings, Day 2 - This panel will cover the changes the COVID-19 pandemic made to our workplaces, and what to expect in the near future.

Speakers: Nicholas Bloom, Michael Froman, Mario Mariniello, Sara Matthieu and Luca Visentini Topic: European Macroeconomics & Governance Location: Academy Palace
Read about event More on this topic
 

Upcoming Event

Sep
3
10:15

Conference on the Future of Europe: envisioning EU citizens engagement

Bruegel Annual Meetings, Day 3 - Panellists will discuss different options and what they may entail while revisiting the debates on the future of Europe at national and EU-level that have been conducted thus far.

Speakers: Caroline de Gruyter, Kalypso Nicolaïdis, Niclas Poitiers and György Szapáry Topic: European Macroeconomics & Governance Location: Palais des Academies, Rue Ducale 1
Read about event More on this topic
 

Upcoming Event

Sep
3
09:00

The role of the EU's trade strategy for an inclusive and sustainable recovery

Bruegel Annual Meetings, Day 3 - We are delighted to welcome Valdis Dombrovskis, Executive Vice President of the European Commission for An Economy that Works for People to talk about Europe's trade strategy.

Speakers: Valdis Dombrovskis, Alicia García-Herrero and Guntram B. Wolff Topic: European Macroeconomics & Governance Location: Palais des Academies, Rue Ducale 1
Read article
 

Blog Post

Will European Union recovery spending be enough to fill digital investment gaps?

The recovery facility will boost digital transformation, but questions remain whether it will be sufficient to achieve Europe’s digital ambitions.

By: Zsolt Darvas, J. Scott Marcus and Alkiviadis Tzaras Topic: European Macroeconomics & Governance, Innovation & Competition Policy Date: July 20, 2021
Read article Download PDF
 

Policy Contribution

A new direction for the European Union’s half-hearted semiconductor strategy

The EU needs a more targeted strategy to increase its presence in this strategic and thriving sector, building on its existing strengths, while accommodating its relatively low domestic needs.

By: Niclas Poitiers and Pauline Weil Topic: European Macroeconomics & Governance, Innovation & Competition Policy Date: July 15, 2021
Read article More by this author
 

Blog Post

Fit for 55 marks Europe’s climate moment of truth

With Fit for 55, Europe is the global first mover in turning a long-term net-zero goal into real-world policies, marking the entry of climate policy into the daily life of all citizens and businesses.

By: Simone Tagliapietra Topic: Energy & Climate, European Macroeconomics & Governance Date: July 14, 2021
Read article More on this topic
 

Blog Post

Fair vaccine access is a goal Europe cannot afford to miss – July update

European countries must do more to tackle the vaccine uptake gap. Vaccination data should be published at the maximum granularity level so researchers and local decision-makers can monitor progress.

By: Lionel Guetta-Jeanrenaud and Mario Mariniello Topic: European Macroeconomics & Governance Date: July 14, 2021
Read article More by this author
 

Blog Post

SPACs in the gap

Special-purpose acquisition vehicles could fill a gap in European equity markets and lure risk-averse investors off the sidelines.

By: Rebecca Christie Topic: European Macroeconomics & Governance, Finance & Financial Regulation Date: July 13, 2021
Read article More on this topic
 

Blog Post

A breakdown of EU countries’ post-pandemic green spending plans

An analysis of European Union countries’ recovery plans shows widely differing green spending priorities.

By: Klaas Lenaerts and Simone Tagliapietra Topic: European Macroeconomics & Governance Date: July 8, 2021
Load more posts