Will Greece leave the Euro?

[SwordoftheVistula]

http://www.nytimes.com/2010/05/07/opinion/07krugman.html

So, is Greece the next Lehman? No. It isn’t either big enough or interconnected enough to cause global financial markets to freeze up the way they did in 2008. Whatever caused that brief 1,000-point swoon in the Dow, it wasn’t justified by actual events in Europe.

Nor should you take seriously analysts claiming that we’re seeing the start of a run on all government debt. U.S. borrowing costs actually plunged on Thursday to their lowest level in months. And while worriers warned that Britain could be the next Greece, British rates also fell slightly.

That’s the good news. The bad news is that Greece’s problems are deeper than Europe’s leaders are willing to acknowledge, even now — and they’re shared, to a lesser degree, by other European countries. Many observers now expect the Greek tragedy to end in default; I’m increasingly convinced that they’re too optimistic, that default will be accompanied or followed by departure from the euro.

In some ways, this is a chronicle of a crisis foretold. I remember quipping, back when the Maastricht Treaty setting Europe on the path to the euro was signed, that they chose the wrong Dutch city for the ceremony. It should have taken place in Arnhem, the site of World War II’s infamous “bridge too far,” where an overly ambitious Allied battle plan ended in disaster.

The problem, as obvious in prospect as it is now, is that Europe lacks some of the key attributes of a successful currency area. Above all, it lacks a central government.

Consider the often-made comparison between Greece and the state of California. Both are in deep fiscal trouble, both have a history of fiscal irresponsibility. And the political deadlock in California is, if anything, worse — after all, despite the demonstrations, Greece’s Parliament has, in fact, approved harsh austerity measures.

But California’s fiscal woes just don’t matter as much, even to its own residents, as those of Greece. Why? Because much of the money spent in California comes from Washington, not Sacramento. State funding may be slashed, but Medicare reimbursements, Social Security checks, and payments to defense contractors will keep on coming.

What this means, among other things, is that California’s budget woes won’t keep the state from sharing in a broader U.S. economic recovery. Greece’s budget cuts, on the other hand, will have a strong depressing effect on an already depressed economy.

So is a debt restructuring — a polite term for partial default — the answer? It wouldn’t help nearly as much as many people imagine, because interest payments only account for part of Greece’s budget deficit. Even if it completely stopped servicing its debt, the Greek government wouldn’t free up enough money to avoid savage budget cuts.

The only thing that could seriously reduce Greek pain would be an economic recovery, which would both generate higher revenues, reducing the need for spending cuts, and create jobs. If Greece had its own currency, it could try to engineer such a recovery by devaluing that currency, increasing its export competitiveness. But Greece is on the euro.

So how does this end? Logically, I see three ways Greece could stay on the euro.

First, Greek workers could redeem themselves through suffering, accepting large wage cuts that make Greece competitive enough to add jobs again. Second, the European Central Bank could engage in much more expansionary policy, among other things buying lots of government debt, and accepting — indeed welcoming — the resulting inflation; this would make adjustment in Greece and other troubled euro-zone nations much easier. Or third, Berlin could become to Athens what Washington is to Sacramento — that is, fiscally stronger European governments could offer their weaker neighbors enough aid to make the crisis bearable.

The trouble, of course, is that none of these alternatives seem politically plausible.

What remains seems unthinkable: Greece leaving the euro. But when you’ve ruled out everything else, that’s what’s left.

If it happens, it will play something like Argentina in 2001, which had a supposedly permanent, unbreakable peg to the dollar. Ending that peg was considered unthinkable for the same reasons leaving the euro seems impossible: even suggesting the possibility would risk crippling bank runs. But the bank runs happened anyway, and the Argentine government imposed emergency restrictions on withdrawals. This left the door open for devaluation, and Argentina eventually walked through that door.

If something like that happens in Greece, it will send shock waves through Europe, possibly triggering crises in other countries. But unless European leaders are able and willing to act far more boldly than anything we’ve seen so far, that’s where this is heading.

My thoughts are that for the rest of the EU, options 2 & 3 are politically more likely than allowing Greece to leave the Euro. The Euro is the cornerstone to EU integration, which they seem dead set on.

It appears that it will come down to whether they allow a political breakdown or an economic breakdown of the EU, and I'd bet on them allowing an economic breakdown before they allow a political one.

[Cato]

The ship of state is sinking, back to the drachma for you!

[Absinthe]

I think this is very likely to happen, as the austerity measures aren't going to be accepted by Greeks and there's only gonna be more riots and protests until the government is forced to default and go back to the drachma.

[Arne]

I hope so !!!!!
When it´s Time , it´s the time..

[Absinthe]

We all kind of hope so because nobody likes the current situation (neither Germans nor Greeks). Only the stock market benefits from this, not nations...

[ikki]

I think this is very likely to happen, as the austerity measures aren't going to be accepted by Greeks and there's only gonna be more riots and protests until the government is forced to default and go back to the drachma.

problem with that is tho that the loans are in euros... so a dropping drachma would cause the loan amount to increase, and thus intrest too, measured in drachmas.

I dont think they will let bygone loans be bygone, no matter abuot defaulting, the money will be extracted one way or the other. One popular technique is to seize ships and shipments, and thus ruin all trade.
Along with any and all bankdeposits abroad.

[Absinthe]

problem with that is tho that the loans are in euros... so a dropping drachma would cause the loan amount to increase, and thus intrest too, measured in drachmas.

I dont think they will let bygone loans be bygone, no matter abuot defaulting, the money will be extracted one way or the other. One popular technique is to seize ships and shipments, and thus ruin all trade.
Along with any and all bankdeposits abroad.
I never said it's gonna be easy and the total outcome will be the same for Greeks (going back to living like 100 years before, either way).

When you're broke, you're broke. The only difference is that with a loan you feel more secure whereas you're actually more broke than before because now you owe even more money...

[Loki]

Only the stock market benefits from this, not nations...

Actually, the stock market doesn't benefit from it at all.

[Absinthe]

Actually, the stock market doesn't benefit from it at all.
I meant it benefits from Greece staying in the Euro, not leaving it

[Eldritch]

Actually, the stock market doesn't benefit from it at all.

This past week in the Helsinki stock market has been nothing short of catastrophic.

[Liffrea]

Originally Posted by SwordoftheVistula
My thoughts are that for the rest of the EU, options 2 & 3 are politically more likely than allowing Greece to leave the Euro.

Some senior German politicians have suggested that Greece should consider leaving the Euro as an option.

However, legally, Greece cannot leave the Euro without consent of the other member states, it would breach the Maastricht Treaty. In the short term it would probably break Greece more to leave the Euro than to stay in (the moral of the story? They should have stayed out in the first place, UK be warned).


The Euro is the cornerstone to EU integration, which they seem dead set on.

True but Greece is a relatively insignificant and poor member state (no offence but facts are facts) the richer and more powerful states (Germany and France particularly) are better served by having a solid foundation to build from. If that means shedding excess baggage and picking it up later on……sometimes you have to take a step back to take two forward. I suspect the Euro project will survive the loss of Greece, maybe even Spain, Portugal and Ireland..... as long as France and Germany stay in the game, if either of them bail, then it’s dead.

[Cato]

The death of internationalism is looming on the horizon. Woot!

[ikki]

Actually, the stock market doesn't benefit from it at all.

It was known that unstable southern economies would be causing trouble. The argument was tho that those were smaller than the german, uk, benelux et al, and thus any instability would be but a tiny undercurrent.

That argument however failed to notice its own flaw. It stated that aslong as the share of economy, or more preciesly, the sums would be small... the damage would be neglient.
430 billion isnt small anywhere, 60 of which has to be met soon, the rest following soon after. Or do the banks dare call in those?

[poiuytrewq0987]

There is no real benefit in having the euro as the national currency if your economy is still developing. The only time you will see actual benefits from using a strong currency is when your economy is on par with countries like Italy or the UK.

[ikki]

There is no real benefit in having the euro as the national currency if your economy is still developing. The only time you will see actual benefits from using a strong currency is when your economy is on par with countries like Italy or the UK.

on the opposite, a developinmg economy needs a stable currency, and the euro watches inflation.

Keynesianism has never worked anywhere, the sole evidence for the theory comes from the polish-soviet war, wherein expanded spending caused growth in poland. Problem just was, they were also under wartime austerity, wherein prices were fixed and most products werent available anyway.

And besides, every economy is developing, exceptions being the soviet 1960-> which just stagnated and thus rusted away.

[tired]

The drachma was not worth much ,so it was cheaper for tourists to go to Greece

[poiuytrewq0987]

The drachma was not worth much ,so it was cheaper for tourists to go to Greece

When I last visited Greece four years ago, I met a couple of Greeks who talked about living standards being much cheaper when Greece used the drachma. They said that adopting the Euro caused the price of goods and basic necessities to skyrocket.

[tired]

A lot of Greeks were returning to Greece in their old age,not any more

[Loki]

Even better, I hope this episode is the beginning of the end of the EU. Germany can't keep on funding the rest of Europe for love and charity. Each to their own.

[Vulpix]

Germany can't keep on funding the rest of Europe for love and charity.

Fixed.

The euro and the EU are doomed. It's only a matter of when, not if. It has never been any clearer.

[Liffrea]

Originally Posted by Mayhem Vixen
The euro and the EU are doomed.

All things are in the end, but I don’t expect the EU to disappear anytime soon, there are far too many vested interests as well as the “weight of history” behind it. They will shed the dead wood; the Franco-Belgian-German triangle will probably remain intact, they can afford to lose the Greeks and Iberians, expect to become contracted more towards its northern European heartland but I wouldn’t expect anything momentous, not yet.

[Cato]

The euro and the EU are doomed. It's only a matter of when, not if. It has never been any clearer.



Both will rot and stink up the place like the US has been doing for the past few years. As much as I love the US, I'm probably not far from the mark when I say her that best days are well behind her. :grumpy:

[SwordoftheVistula]

More:

http://www.bloomberg.com/apps/news?pid=20601087&sid=agwHp5N5FXA8&pos=1

Romano Prodi recalls how he persuaded Germany to allow debt-swamped Italy into the euro: support our membership and we’ll buy your milk, he said.

When Prodi toured Germany’s agricultural heartland after becoming Italian leader in 1996, he pitched “a big milk pipeline from Bavaria,” pointing to a three-year, 40 percent plunge in the Italian lira that was hurting dairy sales. “To have Italy outside the euro, a huge quantity of exports from Germany would have been endangered,” Prodi, now 70, said.

Germany got the message, allowing entry rules to be bent to create a 16-nation market for its exporters. Now, German taxpayers are footing the bill for that permissiveness as Europe bails out divergent economies lashed to a single currency with little control over national taxes and spending.

The consequences are an 860 billion-euro ($1 trillion) bill for a debt binge led by Greece, sagging confidence in the European Central Bank’s independence and mounting speculation that a currency designed to last forever might break apart.

“You have the great problem of a potential disintegration of the euro,” former Federal Reserve Chairman Paul Volcker, 82, said yesterday in London. “The essential element of discipline in economic policy and in fiscal policy that was hoped for” has “so far not been rewarded in some countries.”

German-led northern Europe, with its zeal for budget discipline, is attempting to fix the mistakes made by the euro’s founding fathers in the 1990s. It is squaring off against the governments of the south over who will control the euro and the ECB; whether the currency will be used to promote growth or squelch inflation, and ultimately, whether some countries should be disbarred from the monetary union.

European Club

What was conceived as a club for Europe’s strongest economies was expanded for political reasons, leaving the currency union with minimal powers to police deficit spending and no safety net for dealing with countries, like Greece, that veer toward default.

“There was no discussion of that at all, of a crisis mechanism,” said Niels Thygesen, a retired Copenhagen University economics professor who served on the 1989 group led by European Commission President Jacques Delors that mapped out the path to the euro. “It was believed that if countries adhered more or less to prudent budgetary policies, that would not or could not happen.”

Kohl’s Role

Former German Chancellor Helmut Kohl, seeing the euro as the capstone of Europe’s economic integration and Germany’s return to the European family after two world wars, opened the door to the deficit-prone southern European countries that the Bundesbank, haunted by the memory of hyper-inflation, wanted to keep out.

Returning from the December 1991 summit in Maastricht, the Netherlands, that kicked off the euro project, Kohl told the German parliament that he wanted “the greatest possible number of countries” in the euro. That gave Italy, Spain and Portugal the encouragement to meet the economic targets to join in 1999 and Greece to follow two years later.

Defenders of the German economic model knew the threat posed by countries such as Italy, whose budget deficit was 10.2 percent of gross domestic product in 1991, when they forced European leaders to set 3 percent as the limit for euro members.

“A well-known German financial leader told me: Fortunately for Germany, Austria is between Italy and Germany,” said Alfons Verplaetse, who oversaw the Belgian central bank from 1989 to 1999. The reckoning was that only Germany and its immediate neighbors would pass the economic tests, limiting the euro to a handful of countries, Verplaetse, 80, said.

Nobel Laureate

Today’s euro is far from what economists like Nobel laureate Robert Mundell call an “optimum currency area.” Gross domestic product per person ranges from 69,300 euros in Luxembourg to 18,100 euros in Slovakia, debt from 14.5 percent of GDP in Luxembourg to 115.8 percent in Italy, and unemployment from 4.1 percent in the Netherlands to 19.1 percent in Spain.

“A currency without a state is difficult to manage,” said former Italian Prime Minister Lamberto Dini, 79, who also served as the nation’s finance and foreign minister. “The decision to create a single currency in Europe was an eminently political decision. It was supposed to bring about greater European integration not only at an economic level, but at a political one.”

Europe’s multi-state structure leaves it without a U.S.- style federal tax and financial-transfer system to smooth discrepancies between richer and poorer regions. The EU’s budget, mostly for farm aid and infrastructure projects, represents barely 1 percent of the bloc’s GDP, compared with European national budgets that average 47 percent of GDP.

The Blueprint

Signs of a mismatch between strong and weak economies and a loose coordination of fiscal policies were noticeable in the earliest blueprint for a common currency.

“In view of the marked divergences that persist between member states in realizing the goal of growth and stability, there is a risk of surging disequilibriums unless economic policy can be harmonized,” Luxembourg Prime Minister Pierre Werner wrote in the 1970 report that introduced Europe’s first bid for a single money.

Four decades later, Werner’s prophecies are coming true, as euro-region governments prioritize domestic needs to pacify voters after the deepest recession in a half century. The EU Commission estimated May 5 that the overall economy will grow 0.9 percent in 2010, not enough to create jobs, after shrinking 4.1 percent in 2009. It predicts unemployment will climb to 10.3 percent in 2010 from 9.4 percent in 2009.

Euro Rejection?

German officials are already debating what was unthinkable to the euro’s architects: that a currency union designed in its founding treaty to be “irrevocable” might not be. Finance Minister Wolfgang Schaeuble said March 12 that expulsion from the euro may be the ultimate penalty for serial violators of debt rules.

Under current EU law, ejection is “legally next to impossible,” the ECB said in December. Changing the treaty requires unanimity among the EU’s 27 governments, so the euro’s current lineup -- likely to be joined by Estonia next year -- will have to find a way of making do.

Markets have rendered a mixed verdict on the euro’s resistance to the crisis. The currency’s decline below $1.24 for the first time since November 2008 from a record high of $1.60 in July 2008 still leaves it above the starting rate of $1.17. The euro is about 11 percent overvalued against the dollar, data compiled by Bloomberg of purchasing power parities show.

Maastricht Treaty

Greece’s ability to get into the euro illustrates what is wrong with Europe’s uncoordinated economic management. Greece, the EU’s poorest country at the time of Maastricht, set about cutting its budget deficit from 16.3 percent and persuading the Germans that it was serious about being fiscally prudent.

By 1996, with Greece’s deficit at 7.4 percent of GDP, Finance Minister Yannos Papantoniou was confident enough of making the grade that he pleaded for the euro’s paper money to feature the name “euro” in the Greek alphabet.

The German reaction wasn’t encouraging. Theo Waigel, Germany’s finance minister at the time, responded by saying he had “enough trouble in Germany trying to sell this idea of giving up the mark, and now you want me to put funny letters on it as well,” said Ruairi Quinn, then Irish finance minister, recalling the altercation at an April 1996 meeting in Verona, Italy. Waigel added that “it’s all irrelevant because you’re never going to qualify,” according to Quinn.

Greek Letters

The global economic boom of the late 1990s enabled Greece to meet the targets for deficits, debt, inflation, interest rates and currency stability. Greece joined the monetary union in 2001 and a year later, banknotes featuring generic architectural symbols and embossed with Greek lettering went into Europe-wide circulation.

Waigel started with a “very negative position,” said Papantoniou, 60, the Greek finance minister from 1994 to 2001. He responded to the German’s outburst in Verona by offering him “an appointment in two years’ time to check this out and you’ll change your mind.”

“Once we entered the euro, we forgot about the necessity of carrying on this structural effort and we now pay the price,” Papantoniou said. Waigel, now 71 and a lawyer at GSK Stockmann + Kollegen in Munich, wasn’t available to comment for this article.

What Societe Generale SA economist Dylan Grice dubs a “Greek tragedy” dates to 2004, when the new Conservative government of Costas Karamanlis accused its predecessor of fiddling the budget numbers to pass the euro test -- a charge Papantoniou denies. EU records now show that Greece has never brought its deficit under the limit.

‘Greek Drachma’

“Investors had always regarded the euro as a de jure German mark,” Louis Bacon, founder of the $15 billion hedge- fund firm Moore Capital Management LLC, wrote in an April 16 letter to investors who have made an annual return of 20.5 percent from his flagship fund during the past two decades. “It’s dawning on the world that it is becoming, de facto, a Greek drachma.”

Greece’s credit rating was cut to junk by Standard & Poor’s on April 27, making it the first euro member to lose its investment grade.

The nation’s slipping competitiveness was masked by an economic expansion buoyed by the euro-driven drop in bond yields to 3.23 percent in September 2005. Growth peaked at 5.9 percent in 2003, topping the euro zone that year. Unit labor costs that bounded ahead by as much as 10.2 percent in 2002 put Greece at a disadvantage to countries like Germany, where wages declined in 2004, 2005 and 2006.

‘New Odyssey’

Greece’s fiscal crisis was exposed after another change in government, from the conservatives back to the socialists last October. Prime Minister George Papandreou, elected on a promise of higher wages and benefits, is now on what he calls a “new Odyssey” that may end with the dismantling of the welfare state built by his father Andreas, Greek leader from 1981 to 1989 and 1993 to 1996.

Italy’s journey to the euro followed a similar script to Greece, from German opposition to reluctance to acceptance. Then the paths diverged. Italy kept its deficit under the limit five times in the euro’s first 11 years. Deficit-obsessed Germany has only done so six times.

Led by Prodi, Italy snuck under the deficit ceiling in 1997, the test year for the first group of euro aspirants, helped by a one-off “Eurotax” and a yen-denominated swap. Italy wasn’t alone in coming up with one-time savings and accounting dodges. France transferred pension funds from France Telecom SA to graze the 3 percent limit.

Bundesbank Bid

Even Waigel made an ill-fated bid to get the Bundesbank to boost the paper value of its currency reserves to reduce Germany’s debt.

Germany’s tight-money faction dictated the rules for the euro, yet it lost out when Waigel’s call for automatic sanctions on countries with deficit overruns was rejected by other governments in talks that culminated in Dublin in December 1996.

Prodi, who served two stints as Italian leader and ran the EU Commission from 1999 to 2004, said the “crisis isn’t unexpected. It came much later than I thought.”

The euro project is “half baked,” he said in an April 20 telephone interview. “You cannot have a monetary policy without coordination in fiscal and economic policy, because otherwise you will have problems.”

The budgetary lapses cloud EU efforts to quell Greece’s crisis and prevent a stampede by speculators against Portugal as well. Germany, for example, is again pressing for curbs on deficits as long as its own economy escapes closer oversight.

‘Fractious Mobilization’

Bickering over Greece, exacerbated by Germany overruling French opposition to making the International Monetary Fund part of a rescue, contributed to the euro’s slide this year against the dollar. Moody’s Investors Service cited the “fractious mobilization” of EU support as a reason why it cut Greece’s credit rating on April 22.

Spain, France and Germany have scoffed at a May 12 EU Commission proposal for more coordination of taxing and spending plans before they are voted on by national parliaments. The commission also urged more “expeditious” enforcement of the deficit rules, without calling for tougher fines on violators.

“The old idea that you discuss with peers your budgetary plans before they’re announced is very difficult to implement,” said Jean Pisani-Ferry, a Maastricht-era EU economic adviser who now runs the Bruegel research institute in Brussels. “It runs up against the politics.”