Don’t call it a comeback
Stop worrying about Greece leaving the euro. It won’t happen.
I know that because Jean-Claude Juncker, head of the EuroGroup of eurozone finance ministers, said so.
“I don’t envisage, not even for one second, Greece leaving. This is nonsense, this is propaganda”.
He assured us that the EuroGroup “will do everything possible” to keep Greece in the euro and had an “unshakeable desire” to do so.
Phew, so that’s all right then. And yet, and yet…I wonder.
Is Angela Merkel really willing to saddle her electorate with the burden of funding the welfare states of neighbouring countries which are more generous than anything found in Germany?
Are the Greeks really willing to keep cutting pensions and public sector pay and, occasionally, raising taxes at Berlin’s command?
If the answer to both of these questions is ‘no’ then Greece will exit the euro and it wont matter a damn what Mr Juncker says.
It could play out like this.
Greece could elect an anti-austerity government in the elections due on June 17th. They would refuse to enact the cuts demanded of them in return for the next tranche of bailout money. At this point the Germans could cave in and sacrifice their wealth for the greater good of the euro. But, assuming they don’t, Greece’s aid would be stopped.
The Greek government would now be faced with liabilities it couldn’t meet. Payments to bondholders or payments to employees and pensioners, one would go unmade. It seems reasonable, since this would be an anti-austerity government, that it would be the bondholders who lost out.
This would be default. Greek borrowing costs, high enough to effectively bar Greece from capital markets and which would have risen even further on the withholding of the bailout, would skyrocket.
The Greek government, unable to borrow at any price, would be faced with the task of paying out in euros when it can no longer get hold of euros to pay out with. This is impossible. It would need to convert its liabilities into a currency it could get hold of, one it could produce at will. The drachma would be back and Greece would be out of the euro.
Without the restraining hand of the European Central Bank, the newly empowered Greek central bank would run the printing presses to produce the drachmas to pay its bills generating high inflation. The value of the drachma would tumble.
Some suggest that the drachma could plummet 40% below the euro before stabilizing. But the example of Britain’s recovery following its exit from the Exchange Rate Mechanism in 1992 is not an exact one; Britain replaced one monetary rule (exchange rate stability) with another (price level stability). It is not clear what Greece’s new monetary rule would be or if it would have one.
Let’s assume that Greece did adopt some new monetary rule following the devaluation of the 40 to 50 percent generally believed to be necessary to make Greek industry competitive again and get its economy moving. What would the effects be?
The wealth of Greeks held in euros would be reduced by 40 percent almost overnight. Ordinary Greeks would be impoverished on a massive scale. But the same would also happen to anyone who held Greek assets denominated in euros and this is where things could get nasty.
Foreign banks hold about €1trillion of Greek assets. If these were converted to drachma their value would fall by 40 percent. This would blow holes in the balance sheets of banks around Europe, particularly in France and Germany, but also in Belgium. Already short of capital these core country banks would hoard it, cutting back lending, triggering a new credit crunch.
There would be a new round of bailouts direct from euro member governments putting their already pressed finances under fresh pressure. Ironically, at a lower level, the Germans would find themselves in the position the Greeks find themselves in now. Renewed calls would be made for the ECB to be given the power to act as lender of last resort.
There is no guarantee it would stop there. As in 1992 the exit of one nation could prompt market speculation that others would follow, speculation that has a habit of becoming self-fulfilling. The prime candidate is Portugal whose borrowing costs would rise and Germany would be faced with the same question it had faced over Greece: whether to pay up.
After Portugal, Spain, Italy, Ireland and even France could all follow.
What are the chances of this coming to pass? The Greeks, for all the protesting and voting for anti-bailout parties, actually want to stay on the euro, the centre-right pro-bailout party is currently ahead in the polls.
And while the average German may not be keen on the idea of funding the early retirement of Greeks, leaders in the EU sometimes claim to be acting in the interests of some quasi-mythical entity called Europe rather than their national electorates.
Often this is just a cover for the most brazen kind of nationalist politicking but not always, the Germans sacrificed the Deutschemark after all.
It is possible that Merkel, who came under pressure at the G8 Summit to hand over billions of euros of German wealth to their neighbours, might just do so.
But what are we worrying about? After all, Jean-Claude Juncker says it can’t happen.
This article originally appeared at The Commentator