Greece: Exiting the Euro Or Not?

The Greek general election on January 25th looks like a referendum on Greece’s membership of the euro.

If the Greeks vote for radical left-wing Syriza and its leader Alex Tsipras, a new anti-austerity government could eventually take Greece out of economic and monetary union. Alternatively, it could catalyze a series of anti-creditor steps that may lead to Germany and the main creditor countries leaving.

The Greek people don’t like the idea of further cuts in living standards but are equally against being treated as international pariahs.

Expect protestations from international creditors that, if the Greeks vote for Syriza, they will be ‘committing suicide’, cutting themselves off from foreign loans, sacrificing all previous reform efforts, and so on.

Tsipras himself will do his best to sound some diplomatic notes as a man with whom Angela Merkel and others can do business.

The outcome will be messy

The Greek electorate may pull back from the brink and water down support for Syriza. We can expect another coalition. Whatever happens, we face much debate and hand-wringing, a lot of it self-serving and hypocritical, about whether the Germans should live up to their historical pro-European sympathies, relax insistence on orthodoxy and allow a further rescheduling of Greek debts in another deal to keep the euro intact.

The Germans don’t appear too keen to throw good money after bad. So far, there’s been little ‘contagion effect’. Yields on Greek debt have shot up, yet the spreads between long-term interest rates in Germany and in the main debtor countries Spain, Italy and France remain very low. I do not expect that to last.

There will be a lot of talk about Greece being a ‘special case’. Sure, Greece is special. We all are, some more than others. I anticipate other weaker countries, led by Italy, will sooner or later get sucked in.

Split from the euro area?

Greece could split itself off from the rest of the euro area with fewer repercussions than three years ago – as the German government now seems to admit.

Private bondholders and foreign banks have largely got their money out of Greece. Greek government debt (more than 170% of GDP) is now overwhelmingly in the hands of European public sector lenders, whether the European Central Bank, individual governments or the myriad European rescue funds.

‘Grexit’ would lead to political turbulence, exchange controls and a concerted effort by the creditors to make life difficult for the Greeks (‘pour décourager les autres’). But it would not bring a run on the banks and a financial crisis.

Let’s be clear. Whether Greece is in or out, the Germans and the other big creditors within EMU, led by the Netherlands, will not get their money back.

Pity Greece

In a financial restructuring, which is what the euro area requires, everyone feels the pain – debtors and creditors.

Everyone feels sorry for the debtors. No one is too worried about the creditors, especially if the largest one is Germany, generally believed to be a country big and able enough to look after itself that should not have lent the Greeks all that money in the first place.

It’s slightly depressing that we have been here before. In July 2011, I suggested that Greece should hold a referendum on whether its citizens were willing to pay back the debt. ‘That should concentrate minds,’ I wrote then in the OMFIF Bulletin.

At end-October that year, George Papandreou, then prime minster, seemingly took my advice and called a referendum, which was to take place on 4 December. He (and the rest of the European Union, led by German Chancellor Angela Merkel) then got cold feet.

Papandreou scrapped the idea just a few days later and stood down in favor of a government of national unity that knuckled down to austerity and reforms in exchange for debt relief.

This was agreed in February 2012 and involved rescheduling of €206bn worth of Greek bonds owed to largely private bondholders. Taking into account the total amounts, this was five times bigger than the previous largest sovereign restructuring in history (for Argentina in December 2003).

The restructuring was supposed to reduce government debt to an allegedly sustainable 120% of GDP by 2020. Instead, it’s gone the other way.

Observers predicting a favorable outcome forgot about the ‘snowball effect’ under which the relative size of a country’s debt automatically rises when the interest rate is higher than the annual increase in nominal GDP (which in Greece’s case has been contracting).

2015 will be different

This time round, there will be less alarm about Greece leaving. The European Central Bank and (especially) the ever-alert Bundesbank will be dusting down emergency plans that were held in place during all the ups-and-downs of recent years.

Angela Merkel is older, wiser, more tired and more cynical. She will be advised by Jens Weidmann, the Bundesbank president, who now has come of age, with nearly four years of ECB crisis management under his belt. Weidmann is only 46 but looks like a man more willing to suffer a bust-up rather than submit to blackmail.

Ahead of the Greek vote, and with Tsipras speaking openly about debt write-offs, the last steps the ECB wishes to take is to wade into the market and buy government bonds in anything except token amounts.

If anyone is to supply ‘shock and awe’, then it must come from the politicians, not the central bank. I’m sorry to say that I expect more shock than awe.

Editors Note: This piece was originally published as an OMFIF Commentary.