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Tuesday, May 15, 2012

Less Sanguine Views on Greece's Exit from Euro

...from two U.K. newspapers.

Jeremy Warner of The Telegraph warns, "Brace, brace. Dark times ahead as Greece heads for the exit" :

European policymakers are about to commit another major blunder in their handling of the eurozone debt crisis, and this time it could well be fatal. Mistakenly, they have convinced themselves that it won't much matter if Greece leaves, and indeed that it might even help resolve the wider crisis to get rid of this persistent thorn in the flesh.

Bring it on, they mutter callously; it will be a lot worse for them than for us. On one level, this is just bravado. It's an attempt to put as nonchalant a face as possible on the now apparently inevitable. But they also seem to believe in their validity of their own analysis – that they have indeed used the past two years well, and are now fully prepared for a Greek exit.
Believe it if you will. The ineptitude to date of the eurozone's crisis response strongly suggests a different conclusion – both that the likely contagion from an exit has been hugely underestimated, and that by prompting a wider breakup, thereby tipping Europe into depression, it may end up as bad for everyone else as it is for Greece.  
The Greek problem has been consistently misdiagnosed and mismanaged right from the start. First there was the suggestion a year ago from Angela Merkel and Nicolas Sarkozy that if Greece didn't buckle under and agree austerity it might be chucked out. Markets reacted logically by selling bonds in any country that looked vulnerable, thereby making it much harder for all periphery governments to fund themselves.  
This disastrous admission was compounded by attempts to underpin confidence in the financial system by forcing banks to mark their sovereign debt to market. This destroyed the concept of the "risk free asset", forcing banks for the first time to apply capital to their sovereign debt exposures. Unsurprisingly, they stopped buying sovereign bonds in the distressed countries, again making it harder for governments to fund themselves.
These mistakes were partially reversed by the European Central Bank's LTRO programme, which provided banks with the liquidity they need to resume purchases of sovereign bonds. Unfortunately, this has only succeeded in creating its own problems. The completely inappropriate austerity of Europe's Fiscalpakt has sparked new doubts about debt sustainability, which has in turn further undermined confidence in bank balance sheets now stuffed to the gunnels with sovereign debt.
And they expect us to believe that a Greek exit can be managed without further cost? Let's just briefly deconstruct the increasingly desperate position that Greece finds itself in. Greeks have voted to reject austerity but remain in the euro. They won't be allowed both.
If they don't continue with the programme, they'll be denied the remainder of the bail-out money. Unable to pay wages, pensions, healthcare costs and bills, government will quickly grind to a halt. The state could theoretically force the banks to buy its bonds, but the ECB would soon in such circumstances refuse further funding. At that stage Greece would have no option but to return to the drachma.
Hyperinflation would replace grinding deflation. The effect on living standards would be equally catastrophic. It's true that properly managed, leaving the euro does in the long term have the potential to return Greece to competitiveness and growth.
But does anyone believe Greece capable of managing such a transition well given the positively heroic scale of mismanagement to date? And is it in any case possible to have a well managed exit for a country that doesn't want to leave? In or out, the outlook for Greece looks bleak.
If Greece redominates all its debts in cut price drachmas, the ECB and its backers – in particular the German Bundesbank – will take a terrible hit, but it won't be terminal. The Bundesbank would most likely simply write off its Target 2 lending to Greece, which would certainly be a major curiosity given its abhorrence of debt monetisation but wouldn't of itself destroy either the Bundesbank or the euro.
The threat comes instead from market contagion to other eurozone countries worst hit by the debt crisis. To Germany, Greece has always been a special case, a nation which cheated its way into the euro, whose citizens are lazy and won't pay their taxes, and is in any case basically ungovernable. There is a very different attitude to Spain and Italy. Germany's determination to make the rest of the eurozone work should not be underestimated.
The trouble is that once one has left, and the principle has been established that it is indeed possible to leave the euro, it's going to be tough to impossible to contain the crippling capital flight which is certain to set in elsewhere. Greece is just the canary in the mineshaft, an outrider for the much wider problem of imbalances and divergent competitiveness.
The Guardian offers insights from three experts in "Eurozone crisis: what if … Greece leaves the single currency" :

Nick Parsons, head of strategy at National Australia Bank :
The choices facing Greece and its people are deeply unattractive. On a three- to five-year time horizon, there is no policy option that will turn a bad situation into a better one, and the likelihood is that it will become even worse for many of its people. If Greece stays in the euro it faces a long, slow depression in an effort to remain solvent. If it exits, it could see the collapse of the domestic banking system, the decimation of private savings and a crippling increase in the cost of imported goods and energy.

Greece could claw back some competitiveness through devaluation, making its exports much cheaper than they are currently. But the markets would demand devaluation, and then some. The drachma was fixed at 340 to the euro when Greece joined the single currency. But if a new drachma is introduced at parity with the old currency, then €1 would quickly buy about 1,000 drachma, or possibly even more.

Just look at the evidence of Argentina, which in 2002 decided to abandon the fixed 1:1 US dollar-peso parity, which had been in place for 10 years. A provisional "official" exchange rate was set at 1.4 pesos per dollar, but within six months the market rate had jumped to 3.90. The peso had lost almost 75% of its previously fixed value. Savings were effectively expropriated and import costs tripled. It was a far from painless transition.
Costas Lapavitsas, professor of economics, SOAS, University of London : 

The first step for Greece should be to denounce the bailout agreements and default on its debt, opening the path for aggressive cancellation. Exit will follow in short order, presenting three sets of problems: monetary, banking and commercial. The main difficulty of policy would be to keep these separate as far as possible.
Briefly put: the return to the drachma should be sudden, accompanied by a short bank holiday and immediate imposition of capital controls. For a period the new drachma would circulate in parallel with the euro and possibly other state fiat money.

There are €35bn (£28bn) of banknotes in Greece, mostly under mattresses. If they could be mobilised, a lot of problems would be made easier.

Banks would find themselves in the firing line as assets and liabilities would have to be converted. To protect depositors, but also to control credit in order to prevent a wave of company bankruptcies and support employment, banks should be immediately nationalised. The Bank of Greece should rapidly build mechanisms to generate liquidity independently of the European Central Bank.

The exchange rate of the new drachma would collapse in the open markets, making it difficult to secure supplies of oil, medicine, foodstuffs and other goods. As far as possible, the exchange rate should be managed; there should also be administrative controls to ensure that vital goods reached key enterprises as well as the weakest during the first critical months.

After the initial shock, the fall in the exchange rate would prove positive for the economy. Greece remains a middle income country with a substantial productive sector that could recapture the domestic market once imports became more expensive. There is plenty of productive potential in Greece, evidenced by the technological component of its exports, which remains higher than that of Turkey, a lauded export success story.
Ray Barrell, professor of economics, Brunel University : 
Should we stay or should we go? This is the question Greek voters must now ask themselves. Each must do a careful cost benefit analysis, looking at the gains from being in the euro and the European Union against the costs of leaving. If the Greeks leave and default on the rest of their debt, there is a good chance they may not be welcome at the European Union's tables, so they have to answer both questions. For them, and perhaps for most, the benefits of leaving are transitory, while the benefits from staying may be permanent.
On balance, the advantages would press the Greeks to stay. Some of the advantages of being in the EU could be kept with an association agreement, such as the one Norway has, but it would be much harder to influence trade and competition policy, and subsidies would dry up.
The euro raised growth in the past and hence we have more output now. Leaving the EU would mean slower growth for a period as some of the gains were reversed. Similar estimates exist for the benefits from monetary union for the core countries, but these benefits from increased flows of investment and greater competition still lie in the future for countries such as Greece.
Their potential would be lost on exit, and if there were no benefits from leaving, the Greeks would be poorer in future than if they had stayed.
The gains from leaving would be immediate, with a devaluation restoring competitiveness and raising employment. However, they would be transitory, as borrowing costs and inflation would climb and be more variable with a floating currency. The need to reform the labour market would be less pressing, and raising the retirement age from the lowest in Europe could be delayed. Pension replacement rates could remain generous.
But Greece would lose easy access to borrowing, and taxpayers would soon have to face the reality that they would have to pay for those pensions and support all the other structures that need reform.

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