Thankfully, last Friday’s Der Spiegel article (as I had imagined it would [1]) opened a Pandora’s box of views on the state of the eurozone. Why thankfully? Because, until now, Europe has been living in denial, imagining that the crisis could be dealt with by a mix of expensive loans, deep austerity and tighter fiscal discipline. It is now clear that this mix only accelerates the crisis and multiplies its eventual cost. A new tack is, therefore, of the essence.
Recalling that the ball started rolling when Der Spiegel inaccurately reported that Greece was contemplating a heroic exit from the euro, the past few days saw a candid debate on the pros and cons of such an exit. Mark Weisbrot weighed in with a piece in the New York Times entitled Why Greece should reject the euro. While his take on the impossible situation that Greece is now in is spot on, and he demonstrates a touching sympathy with the Greeks’ predicament, he errs in the same manner that Hans Werner Sinn (an austere critic of Greece who believes that Greece has laid its own procrustean bed) erred in calling for Greece to exit the euro as the best of all evil scenaria. And what is their shared error? To imagine that leaving the eurozone is equivalent to being kicked out of a club for misbehaviour.
Watching this debate unfold reminded me of another interesting split within the group of commentators who like Weisbrot, and unlike Professor Sinn, express sympathy with Greece’s plight. On the one hand, there is the American perspective from which things appear as relatively straightforward: Countries caught in a debt-recessionary spiral which cannot inflate their way out of debt have no alternative but to default. And if default is not allowed within a eurozone that refuses to finance the debt (by means of low interest loans), then the country in question must consider leaving. Nuriel Rubini’s point the other day was precisely that, namely that Greece’s exit from the euro is one of the few feasible strategies available to Athens. However, those who understand the profound difference between a currency union and a fixed exchange rate also understand what I call the Eagles-doctrine.
The Eagles-doctrine? In their hit Hotel California, the Eagles’ last verse was: “You can check out any time but you can never leave”.[2] Thus the… Eagles-doctrine for a currency union (like the eurozone). How exactly does this doctrines hang together, preventing a checked out (i.e. insolvent country like Greece) to leave? In two ways: First, by ensuring that any such move will return the country to the Stone Age. Secondly, by guaranteeing a series of cascades that will cause the whole union to collapse. Let’s take these two ways in turn.
Suppose the Greek PM were to announce that tomorrow morning he will be tabling a piece of legislation in Parliament that paves the way to (a) an exit from the euro, to be effected by next week (an extremely short space of time in which to organize a new drachma issue capable of financing economic activity nationwide), and (b) a default on Greece’s debt (which would be essential given that Greek debt is denominated in euros and a new drachma would devalue to such an extent that the debt mountain would be impossible to scale, even in theory). I submit to you dear reader that within minutes all ATMs in Greece would dry up, as Greeks withdraw all the cash they can. Within an hour, banks will have to shut shop, overwhelmed by the queues of customers demanding their savings (and if the announcement is made after hours, the banks will simply not open the next morning). In short, all economic activity will cease for at least a week. For a country already in recession, this would be tantamount to collective suicide.[3]
But let’s for argument’s sake assume that the Greeks decide to risk such a catastrophe, and that our German partners are only too happy to see the back of us. Soon, I suggest, their joy will turn to despair. Why? Consider the chain reaction that will begin with the collapse of the Greek banks. The ECB will have lost more than €110 billion in one instant (money owed to the eurosystem by the Greek banks) plus up to €40 billion of the Greek bonds that it has purchased on its own account since May 2010. Someone (call me Germany) will have to recapitalise the ECB. Moreover, the eurozone’s private banks will start falling like sad dominoes not only because they are owed serious money by the Greek state but also because they are owed money by others who are owed money by the Greek state. Again, someone will have to prop up the remaining eurozone’s banks at a cost that is better left uncontemplated. And as if this were not enough, the money markets will start betting on who will follow Greece into the wilderness. I am prepared to bet many months’ salary that the punters will put much money on Ireland coming (or leaving) next. These bets will, by themselves, increase fears within Ireland (and in the mind of Irish asset-holders) that Ireland’s euro membership may be in peril, thus liquidating their real estate holdings and taking every euro they have off the Emerald Isle.
There is no need to continue to drive my point home: Once these events occur, the markets will turn to the next exit prospect and then to the next until Germany will decide it has had enough. At that point it will bail itself out of the eurozone and the common currency will perish. Could that be a good thing? Why should Germans fear such a prospect, especially if they can then forge a new currency union with ‘like-minded’ nations, like Holland, Austria and Finland? Because, the simple answer is, if they do this, the new currency (an NDM?) will skyrocket, propelled by the collapsing economies around this new union and, importantly, against the backdrop of a global currency war that will ensure a massive drop in the demand of Germany’s exports.
In the United States Paul Krugman seems to understand this, [4] even though he is tempted by the thought that a desperate government may adopt the desperate exit strategy. In Europe, with the exception of some German austerians (like Professor Sinn, who seem unaware of the hideous truth that producing gleaming products which foreigners want to buy is no guarantee that they buy them), almost everyone understands that a Greek exit from the euro is a catastrophe of the highest order not just for Greece but for Europe as a whole (even for the global economy, one might add). Wolfgang Münchau, as reported by eurointelligence.com today, impresses upon his reader the crucial point that “monetary union has some state-like characteristics” and that, as with any state, its disintegration is fraught with dangers and traps.
Having said all that, Mark Weisbrot’s concerns (as well as Roubini’s Krugman’s etc.) remain in force: “Greece” he writes poignantly “cannot afford to settle for any deal that does not allow it to grow and make its way out of the recession. Loans that require what economists call “pro-cyclical” policies — cutting spending and raising taxes in the face of recession — should be off the table”. Unfortunately, not only do they remain on the table but new loans made conditional on fresh, harsher pro-cyclical policies are imposed as well. So, is there an alternative?
The obvious alternative that anglo-american pragmatic minds (including Nuriel Rubini and Martin Wolf, see his piece in the Financial Times today) immediately think of is a default. Indeed, if Europe is unwilling to finance a burgeoning Greek debt forever, and an exit from the eurozone is ruled out, default within the eurozone is the only option. Now, there are those who argue, with some justification, that a Greek default within the eurozone will trigger a series of similar defaults that may end up being as devastating in their effect as that of a series of exits (beginning with Greece) from the euro area.
First and foremost among these anti-default polemicists is Lorenzo Bini Smaghi, the ECB board member (who uniquely manages to retain a modicum of independent thinking while still an ECB functionary). In a recent talk he rounded up his narrative by quoting from David Marquand’s book The end of the West: “The economic crisis itself, like its predecessor in the 1930s, is political, not technical… The world’s economic blocs will have to find painful answers to urgent problems; and the allocation of the pain will be a supremely high-political matter. It will raise profound questions of distributive justice… the proper balance between the claims of poor and rich nations…But for the Union’s leaders to opt out of the global search for answers would be a betrayal of their citizens. And they will be unable to opt in if they cannot speak with one voice and lack the democratic legitimacy to carry their people with them.” [Emphasis added.]
This conclusion to an important talk sounds all too cryptic at first. But soon enough the message shines through: High interest loans, austerity and denial are jeopardizing the European Union’s democratic legitimacy, both with German voters (who are exasperated by the vicious cycle of throwing good money after bad, and end up concluding that the Greeks et al must be kicked out) and with Greek, Irish etc. voters (who feel that they are assigned a Sisyphean task by a heartless Goth taskmaster).
What might a new path look like? What do we put in the place of new expensive loans for insolvent eurozone nations, in exchange for destructive austerity? Stuart Holland and I have suggested one such path (click here for our Modest Proposal and here for a more recent rationale for it). Others may come up with alternatives. The one option we do not have is the one that the European Union is, currently, insisting upon against all rhyme and all reason.
[2] Click here and jump to 5’ 32’’ if you are too young to remember that 70s hymn. Thanks are due to my friend and colleague Gary Dymski, of the University of California, for bringing up the significance of this line (in the context of California’s deficit woes).
[3] Weisbrot writes: “You can be sure that the European authorities would offer Greece a better deal under a credible threat of leaving the euro zone. In fact, there are indications that they may have already moved in response to last week’s threat.” Sure. The only problem, of course, is that the threat of an exit from the Europe is hardly credible, if my analysis is correct.
[4] He, correctly, writes: “Argentina had a supposedly irreversible peg; it still had peso notes in circulation, so the mechanics of exit from the peg were much easier than exiting the euro would be. And the mechanics matter a lot; they could make all the difference between a brief period of shock and an extended financial breakdown.”
