Friday, May 6, 2011

Is This It?

. Friday, May 6, 2011



Der Spiegel says Greece is about to restructure its debt and leave the eurozone:

Greece's economic problems are massive, with protests against the government being held almost daily. Now Prime Minister George Papandreou apparently feels he has no other option: SPIEGEL ONLINE has obtained information from German government sources knowledgeable of the situation in Athens indicating that Papandreou's government is considering abandoning the euro and reintroducing its own currency.

Alarmed by Athens' intentions, the European Commission has called a crisis meeting in Luxembourg on Friday night. In addition to Greece's possible exit from the currency union, a speedy restructuring of the country's debt also features on the agenda. One year after the Greek crisis broke out, the development represents a potentially existential turning point for the European monetary union -- regardless which variant is ultimately decided upon for dealing with Greece's massive troubles.


And here's one political dynamic:

The European Central Bank (ECB) would also feel the effects. The Frankfurt-based institution would be forced to "write down a significant portion of its claims as irrecoverable." In addition to its exposure to the banks, the ECB also owns large amounts of Greek state bonds, which it has purchased in recent months. Officials at the Finance Ministry estimate the total to be worth at least €40 billion ($58 billion) "Given its 27 percent share of ECB capital, Germany would bear the majority of the losses," the paper reads.

In short, a Greek withdrawal from the euro zone and an ensuing national default would be expensive for euro-zone countries and their taxpayers. Together with the International Monetary Fund, the EU member states have already pledged €110 billion ($159.5 billion) in aid to Athens -- half of which has already been paid out.

"Should the country become insolvent," the paper reads, "euro-zone countries would have to renounce a portion of their claims."


In other words, now that Greece has gotten funds from the EFSF there is domestic political pressure from citizens in the Eurocore to keep them in the monetary union, if only to get their money back. Interesting.

I've blogged a lot about this recently; in the past week or so I've written about it here, here, here, and here. Near the end of the most recent of those I summarized some IPE research on fiscal crises, fixed exchange rates, and propensity to devalue/default and concluded:

Greece? Not as highly financialized, a less stable government that is unable to make credible commitments to much of anything. Not as small or dependent on trade as Iceland and Ireland, although the difference might not be meaningful. Capital flight has already happened. A long history of profligacy, and a citizenry that didn't pay taxes in the best times. Internal devaluation is likely impossible even if it were desirable. Looks like a devaluation to me.


Not exactly a novel prediction, but one supported by prior research and not just a gut feeling.

The link above is via Ryan Avent, who says:

Even as it does this, it runs a deficit, which means that absent access to capital markets (and it will lack access to markets for the forseeable future) it must continue with austerity. Fearing a potentially ugly restructuring, some depositors have been pulling money from Greek banks, threatening the system with dissollution.

As ugly as this path appears, is departure from the euro zone really going to be better? Much of this pain is unavoidable. A massive devaluation would help Greece's economy, but the short-term impact of a Greek departure is unclear and could be highly destabilising. Over the long-term, it's not certain that Greece is better off outside the euro zone.


This is pretty close to my "there will be austerity" argument that Steve Randy Waldman discussed. Avent suggests that it may be a negotiating tactic, and I've made a similar case before: so long as Europeriphery debt is held by weak financial institutions in the Eurocore, the periphery actually has quite a bit of leverage.

If this is the beginning of a new bargaining round, it opens the window for a "Hard Keynesian" agreement similar to what Farrell and Quiggin propose. The timing for a broad negotiation seems about right: Portugal just had to tap into the EFSF fund for the first time, and pressures on Spain mount. There are many difficulties in getting such an agreement through -- I believe it requires the approval of the legislatures in every EU country, which doesn't seem likely -- but if it were ever going to happen, now is probably the time.

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