Watching this week’s episode of This Week (a programme I greatly enjoy watching for its off-beat humour and incisive political analysis), I couldn’t help feeling that their discussion on the economic crisis in Europe and the eurozone was somewhat lacking a dose of common sense.
The first bone of contention for me was when Andrew Neil asked one of his guests whether Greece defaulting would mean a simultaneous exit from the euro. She immediately responded ‘yes’. My response would be an instantaneous “why???”.
There’s absolutely no connection between Greece defaulting and departing from the Euro. One is almost inevitable (in my view) and the other virtually impossible. Greek sovereign debt is simply a contract between the Greek government and a private individual. Greek membership of the eurozone is a much larger and intractable issue, as it is not one contract but a universal standard amongst millions of individuals.
(A quick explanatory analogy: Greece defaulting would be as complicated as asking your friend, or a group of friends, to change a previously agreed meeting time. Greece leaving the euro would be like requiring them to alter their timezone, and everyone else’s, to change the actual time of the meeting)
To clarify and underline: I believe Greek default is a certainty and it will happen within the next 12 months. Or rather, it will happen as soon as the non-interest Greek budget moves into surplus, which could be a lot sooner than 12 months away, going by reports. The Greek government would announce it would no honour its debts, institute a long bank holiday to prevent capital flight and would go through the motions of calling in the IMF and the other European leaders in to hold some sort of crisis talks. Then it would default, go back to business as usual and return to the markets within two years. The full details are written in this excellent 2002 article “How to default”.
Membership of the Eurozone is an entirely different affair. I have not seen a credible explanation as to how this would happen without causing massive currency flight, financial collapse and the destruction of the Greek economy. A report by UBS puts the potential damage to Greece at as high as 50% of GDP in one year. I do not think any government led by anyone with a sound mind would permit this to happen. Even the most ruthless of dictatorships remembered to pay their army.
Just think Greek exit through: Greece is leaving because it wants to devalue its currency. But the problem is that the currency is not going to default by a modest amount, say 20%. It is going to go through the floor and be worth say around 15% of the euro. Firstly that makes all foreign imports worth 6 times more than they did the day before. It means that every single person in Greece is going to want to make sure their savings in euros don’t turn into drachmas, meaning every Greek bank suffers a bank run large enough to bankrupt it immediately. It means Greece literally drains of money as capital flees abroad, and due to EU restrictions I suspect Greece could not impose currency controls. Greece also holds lots of debt in euros, so leaving the euro to join the drachma would increase the debt by a factor of six also.
People talk of Greece leaving the euro as if it were a possible policy choice. I do not share this view. I believe that leaving the euro is an impossible action, not least because of the suicidal implications it would have for any economy attempting to do so at a time of crisis.
So where do we go from here? Well, the European government leaders are still doing their usual dithering routine so I don’t expect them to come up with any great package to avert crisis. But here is my plan, assuming magic-wand powers:
- Greece defaults in an ‘orderly’ way, having moved into a primary surplus.
- The ECB engages in a widespread interest rate targeting regime on government debt to prevent interest rates in at-risk countries spiralling out of control in response to the Greek default. For example, the ECB would ensure Italian bond yields do not rise above 6%. (They are currently at 6.5%)
- The ECB does what it should have done 12 months ago and moves interest rates to close to 0%.
- A long-term solution to internal balance-of-payments imbalances within the eurozone is brought about. This could be greater fiscal integration, either explicitly through a central European treasury (highly improbable), or more likely through the back door via some sort of debt relief package.
The key thing here really is the ECB. The ECB lacks the full powers of a traditional central bank, so acting in the way described above is not in its DNA. However I am optimistic that under its new management it might have a fair stab at saving the eurozone.
