Winner of the New Statesman SPERI Prize in Political Economy 2016

Wednesday 23 May 2012

Why I can still believe the Euro will survive, just

                Paul Krugman thinks that Greece will probably leave the Eurozone. It is generally foolish to disagree with PK, and what follows is a huge hostage to fortune, but here goes. It is clear that Greece wants to stay in the Euro. Their people do and so do most political parties, including Syriza. Their banks are losing money fast, but the Greek central bank will fill that gap, as long as the ECB allows them to. So a Greek exit will only occur if the Eurozone in some shape or form decides that Greece must go. (See John Quiggin here, for example.) This is the first reason why I think the Euro may survive. If the Greek people were less committed to the Euro, then in macroeconomic terms the option of Greece themselves deciding to leave would look quite attractive in all but the short term, so they might well take that option. (For a different view, see Jacob Kirkegaard here.)
                The spin being encouraged in Europe at the moment (and I broaden the scope here deliberately, because it includes the UK government) is that the next Greek election is in effect a referendum on Greek membership. The implication, given the previous paragraph, is that if Greece tries to renegotiate the terms of its existing loans, the Eurozone will force Greek exit.  The key question is whether this is a credible threat.
                The question is not whether Greece has some moral duty to honour its debts. Creditors will always use this type of language, because they want as much of their money back as possible. There will also be plenty of talk of moral hazard: if Greece is able to renegotiate terms on this occasion etc etc. But all this is just rhetoric. Greece has already partially defaulted. There seems to be no obvious moral reason why private creditors should lose some of their money, but governments who lent to Greece should not, particularly when the terms of the loans were largely decided by the creditors under duress.
                So is it a credible threat? The main plank of my flimsy optimism about the Euro is that the decision to abandon Greece is a Eurozone decision, rather than the decision of sections of German public opinion or particular European officials. The Eurozone remains a collection of national governments, acting mainly in their own national interests. Suppose Greece does attempt, after its elections, to renegotiate its loans. The Troika will have to decide how to respond. Let’s look at the costs and benefits of this choice.
                If it refuses to move from current agreements, and offers little or nothing in return, Greece will suspend some or all of its interest payments, and the ECB would be instructed to withdraw support to the Greek central bank. Crudely, it will stop giving Greece Euros. The outcome is forced Greek exit, which will almost surely mean that the Eurozone would lose everything it has lent to the Greek government, because Greece would default on these loans. So in these very specific financial terms, rather than restructuring existing loans to try and get something back, it would lose it all. So far, so bad.
                But, you may think, at least the Eurozone will have drawn a line in the sand, to discourage other debtor member nations to think along Greek lines. Exactly, which is why those debtor nations will not want to see Greece exit. If they have any sense, those governments will know that they too might find themselves in Greece’s current situation, and so they will not want to be treated in the same way. What about countries like France and Italy? The election of Hollande is clearly important in this respect: see Paul Mason here or Linda Barry here for example. In addition, I think both countries will fear the dangers of the contagion that Greek exit might bring much more than the benefits of discouraging future renegotiation of periphery country loans. See R.A. on this here.
                We should also not forget that the IMF is part of the Troika. The IMF knows that in every case where a borrower nation gets into severe difficulties, some flexibility has to be shown by creditors. This is usually difficult in practice because the creditors are many, with each hoping that someone else will take the hit and lose their money. But not in this case. As we saw at the recent G8, the pressure on the Eurozone to be accommodating will be huge.
                Now all this implicitly paints Germany as the odd one out. It is certainly possible, listening to some sections of German opinion, to believe that Germany will insist on taking a hard line. I suspect that in reality the German leadership is prepared to give ground to ensure the survival of the Euro in its present form, although electoral pressures may get in the way. However Germany is not in charge of the Eurozone or the ECB. Nor has it any obvious means of coercing the other Eurozone governments to take a hard line, even if it wanted to.
                So the threat of pushing Greece out of the Eurozone is not credible, if the decision to do so is made by the Troika, or the Eurozone as a whole. This makes the important assumption that the ECB will be prepared to continue to provide Euro’s to Greece. As far as I can see, there is no technical reason why they cannot. (See Marshall Auerback on this.)  I also strongly suspect that the last thing the ECB wants to do is to be seen to force Greek exit without clear political backing from the Eurozone as a whole. But the ECB is an independent body without any democratic control and little transparency, so we cannot be sure what it will do.
                To get a different perspective on the same issue, consider what might happen if the centre ‘pro-agreement’ parties do much better in the next Greek election than they did in the past. Problem over? Hardly. It is much more likely that in the near future the Greek government would still have to ask for the loan terms to be renegotiated, because its fiscal position has got much worse as a result of austerity and the crisis. So renegotiation is likely anyway. Are Eurozone countries really willing to risk so much just to get slightly better terms on restructured loans?
                If this analysis is right, it raises two questions. First, is it wise for the Eurozone to make threats which are not credible? Second (and this has some influence on the first), why does most of the media appear to act as if the threat is credible? (OK, I’m obviously talking about the media I see, and I’ve no idea how this is being discussed in Greece.) Is it lack of thought, or just because the more alarmist you sound the better the copy? I know it is a lost cause, but the media are an important part of this story. The Eurozone are hoping to influence public opinion in Greece by making these threats, and if the media called these threats as bluff, they would be ineffective and would stop being made. So they are complicit in this game of chicken. And the problem with games of chicken is that they can go horribly wrong, as the markets well know. In addition, politicians can get trapped by their own rhetoric. In which case my analysis above based on rational self interest may be worth very little at all.


  1. On the other hand, what if the next TROIKA quarterly review reads: "...failure to implement ... considerable delay in implementing... expected primary deficit at end 2012 above 6%..."?
    Possible scenario: <1> IMF Board decides not to authorize next tranche, (possibly) excepting amounts for debt servicing via the escrow account <2> ditto EUrogroup, <3> Greek gvrnmnt covers shortfall in payments with IOU's, <4> deposits with Greek banks vanish, <5> Greek banks are cut off ELA...
    Need I go on?

  2. Am I wrong in saying that this games of chicken has been going on for the last three years? So whilst in the one shot game one would expect players to avert the crash, the past repeated failures to do so suggest otherwise. Then it is not the media fault. Indeed, at the beginning of this crisis nobody believed it could get to this. Even back in November 2011 I believe the majority of economic agents likely to be heavily impacted by a crash weren't unprepared because they correctly understood that in a game of chicken the worst would ultimately be averted. But after a sequence of half-hearted attempts to solve this crisis, people have realised that the game of chicken has merely been postponed whilst the stakes are hightened each time because of the continued loss of confidence and momentum. So my question is: what is the rational outcome when you have a sequence of games of chicken each one more dangerous than the previous one? Is it still irrational to fear for the worst?

  3. There are a lot of variables that might give reason either to you or to Paul Krugman. Yet, this might be the first analysis I read that factors in the intricacies of European politics, and bet on what's likely instead of what people say.
    Many questions are still wide open:
    - Will Greeks really want to stay in the euro?
    - Will the Germans and the ECB really want to keep them in?
    - Even, if the answer to the two previous questions is yes, what will happen in two years if the Greek economy hasn't started to recover, and the Greek budget is not balanced?

  4. The media question may look marginal compared with the euro issue, but it might in fact be more fundamental:
    - Why do the media buy everything they're told by policymakers?
    It is a recurring question in economic blogging (Krugman constantly refers to that problem), and the one that motivated me to start blogging.
    In the French-speaking media, either from France or Switzerland, economic illiteracy and deference to policymakers reach stratospheric levels.
    It is a reason why the euro was not much debated 15 years ago.

  5. Arne Baumann (Turin, Berlin)24 May 2012 at 11:08

    I completely agree with your analysis. As much as I enjoy reading Paul Krugman's blog, I think he's wrong on this one. However, the news of a Greek exit not being very likely is only partially good news. A Greek exit, however costly for whomever, might have started a rather bumby, but speedy resolution of the current impasse (i.e. break-up of the eurozone). A Greek exit not happening implies that the stale cliffhanger of how to get out of this mess will continue for some time. Instead of exchange and interest rates taking over again, the process of slow internal adjustment will continue, accompanied by political stalemate. I think that might also be one of the reasons why the media is acting like it is. An action movie is much more attractive to watch than a CCTV tape from the geriatric ward.

  6. Interesting - I also believe Greece can default & remain in the Euro because nobody has put forth a convincing argument on why they will/should exit. The issue remains on who is pushing the austerity agenda in Germany - and here I believe its the banks (and possibly large corporate elite) in Germany.

    The question the anti-austerity must ask themselves: how to convince the German banks to change their tune? IMHO, its self evident that in a Greek default and a forced exit from the Euro, the bond holders of Greek debt will not only loose their Greek holdings (maybe they will be able to recover 50c on the € after lengthy court challenges) but there is a very good chance that the value of their other Euro bond holdings will be reduced by 20-50%.

    To sum up: bond holders of European debt may loose another €50bn-€80bn in restructuring Greek debt, or they could loose €500bn-€2tn (if not more) in revaluing all their European bond holdings within 2 months of a Greek default & forced exit. Whose the losers then?

  7. Can the ECB actually exclude Greece from the euro off its own bat? I tend to think that, legally, it cannot: the Eurosystem is established by treaty. Equally, the other members of the EU could not throw Greece out, because Greece could block a treaty change. So I don't think the Bank of Greece could be cut off from TARGET2 (incidentally, if it was, the initial result would be "euroisation", not a new drachma -- the creation of a new currency requires an active decision by the Greek government).

    What could happen is that the ECB could stop any lending by the Eurosystem (including the Bank of Greece) to Greek banks. Then they would all be bankrupt. In this situation, however, euro exit is still a choice for Greece, and it could well stay in if the other EU members are prepared to use the ESM to recapitalise its banks (as your arguments suggest that they would).

    I try to think through these issues here, if anyone is interested:

  8. Ganging up on poor Greece takes little imagination at this point.

    What we would really like to know from Krugman et al is whether small fragile economies are condemmed to loose out when integrated into a Single Market with much bigger and stronger trading partners.


  9. If SYRIZA do well in the next election, then many of the tenets would be supported by the Troika see,8599,2116075,00.html
    including a fair taxation, a asset register and enforcing the taxes on the rich, which has been promised but hasn't happened.

    However, the annullation of the agreements are unacceptable, and if the party insisted on that path then the rest could not be accepted. If on the other hand the party were to say - give us 3 months to impact tracing tax cheats, hidden assets and the black economy, that in it's way could be acceptable.

    To leave the Eurozone, Greece would have the path to leave the EU as in the Lisbon treaty, and then perforce quit the €uro. A very messy exit


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