January 17, 2012
What would be the most disruptive effect of a country – Greece for example – leaving the Eurozone?
Greece itself is a pretty small country. Nobody expects Greece to pay its debt anyway, so that is all in the market. In and of itself, the disappearance of Greece from the single currency would not be in any way a traumatic event. In all truth, if Rhode Island were to leave the United States, the United States would go on.
But if Rhode Island were to leave, people might say, “What next?” Greece is a very, very small country, but people would say, “If Greece leaves, what would that mean?” Nobody is absolutely sure, but it probably would mean that the debts of the Greeks that had been contracted inside Greece would be re-denominated in a new drachma. Their value would collapse perhaps 50% to70% depending on what happens to the exchange rate. The banks would almost certainly implode and have to be taken over all by the state. It would immediately be a huge crisis in Greece. Of course, those Greeks who still had money in Greece would be the less-savvy people, who would lose enormous value in real terms. Those companies who borrowed outside Greece would be bankrupt because of the balance sheet effects.
In other countries – Italy, Spain, perhaps even France – people would ask if their money is safe in the banks. Should they keep their euros in the banks, or should they move them to Germany or Switzerland or to the Netherlands? The likelihood is there would be an accelerated flight, not just of wholesale funding, but even of deposits. There would certainly be a flight from the government debt of those countries, probably further collapses in prices, and possibly difficulty rolling over the debt of these countries.
This would create a general financial crisis across the Eurozone.
How could the ECB deal with that?
If the ECB were willing to recycle all the money that came out of the weaker countries, for example what was then deposited in German banks, they could certainly transfer it all back, but that would imply taking an ever-increasing risk on the balance sheet of the ECB. That might be politically very difficult. The Germans on the ECB’s board might say we are exposing ourselves too much to these very large risks.
The major consequence of a Greek departure would be to generate a pan-Eurozone financial crisis, because the banks are so important. They are very big global players that would certainly affect other economies, including the US, through the financial channel predominantly. There would also be trade effects, but the loss of confidence in the financial channel would be the most important.
You could argue that the chance that Greece will leave is in increasingly the market. You can also argue that it is increasingly clear that the ECB will act to support the system, so in the event of a crisis, it might not be quite as severe as I have described. But this is the danger, that suddenly you realize that what had previously been unthinkable is now thinkable, and it might include the breakup of the Eurozone.
While on the subject of Greece, much has been made of the austerity that is being imposed on them. It is fair to characterize those measures as “austerity”?
Greece started with a huge fiscal deficit, and they still have a huge fiscal deficit. They started with a huge current-account deficit, and they still have a huge current-account deficit. So somebody is still giving them lots of money, and none of that is being financed in the market. So there is a huge external support operation.
As a result, the Greeks are enjoying a much higher standard of living as a nation than they would otherwise. In that sense, it may be worse than they thought it would be before the crisis, but it is a hell of a lot better than it would be without all the support.
At the same time, the Greek economy is progressively shrinking. A lot of the burden is being imposed not on the Greek public sector, but on the ordinary Greek citizens who are not getting what they used to expect and are being required to pay more tax. There is a certain amount of pain being felt in Greece, and a very important aspect – which you must be familiar with from the American experience – is that this pain is very far from equally borne.
There are extremely wealthy people in Greece who have certainly taken all their money out, and they are not suffering at all. Most of them don't pay much tax. Many of the upper-middle-classes don't really pay tax. In the extreme case, famously so, there are public servants who continue to enjoy relatively privileged positions, and then there are ordinary people who are genuinely squeezed.
There are real losers here because the economy is shrinking dramatically, because some public spending programs have been dramatically cut. Many of those programs are for the weakest and the most vulnerable.
It is fair to say that Greece is being more than adequately cushioned, in some sense, against the worst of the crisis. But, in a very unequal and unfair way, there are lots of losers.
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