By The Market Mogul
In recent weeks, the tone between Greece and its debtors has sharpened again, making a potential Grexit appear more likely than ever.
In July and August, major payments are on the agenda and presently it seems almost impossible for Greece to make the payments that will be due. Even if an agreement is reached with Europe, the ECB and the IMF, its exit from the Eurozone won’t be completely off the table. A lot has been written about what would be the consequences of a Grexit and opinions vary from Greece’s dropout to be a humanitarian catastrophe to being a non-event in the global economy.
One must bear in mind that no country has ever left the Eurozone, there is no formal process for an exit and thus would involve considerable improvisation, causing vast amounts of uncertainty. The only parallel one could compare such an event to is that of the widening of the bands and breakdown of Bretton Woods.
The possible implications of a Greek dropout could result in a chain reaction. First of all, Greece would officially default on its debt (€320bn in total, Germany alone is owed €50bn) as a new, devalued currency is introduced to replace the Euro, which in the Greek case could be the drachma. This may cause a knock on effect of severe (hyper) inflation. Greece’s banks would lose access to funding from the ECB, which would, almost certainly, cause a new crisis and deep recession for the nation.
Even though a Grexit seems more likely than ever, one still has the feeling that most politicians and experts prefer Greece to stay in the Eurozone. One of the main arguments proposed is the potential danger of a contagion to other peripheral members of the Eurozone, and even the global economy.
Whilst the immediate financial impact of a Grexit would be muted, in the long-term, investors might lose faith in other struggling economies like that of Spain, Italy or Portugal, which would lead to bond yield implications for the nations. In an article for the FT, Wolfgang Münchau states:
“Those who play down the risks of a Grexit are good at counting but not at grasping the dynamics of a default”tweet
He compares the current situation with the US ‘misjudgment’ of the impact of the Lehman bankruptcy in 2008 and claims that “it was not the impact on those directly exposed to Lehman losses that mattered; what mattered were the vast global ripple effects.” In his view, a Grexit would lead to a price plunge in several asset classes across Europe, leading to negative Eurozone investor sentiment, leading to contagion. However, the opinion that all that really is a worst-case scenario and the reality will look much less dramatic. Münchau points out in his article, the (new) German view considers a Grexit to be:
“A calamity for Greece, a minor shock for the Eurozone and a non-event for the global economy”tweet
Erik Nielsen, Chief Economist at UniCredit states “disaster for Greece, but not for the wider region – because of QE.” He continues to outline that “nobody in their right mind would start shortening other peripheral debt to any significant extent so long as we have QE.” His reasoning is, that as long as the demand for government bonds is (artificially) kept high through QE, investors won’t see a danger of a collapse in prices in the medium-term. Other arguments suggesting only a minor effect of Greece’s dropout are the existence of the European Stability Mechanism, the relatively low exposure of the private sector to Greece today (€175bn in 2008 vs. €42bn today) as well as the fact that Greece’s output only represents 2% of Eurozone GDP.
Other Economic Effects
Alongside the danger of contagion, many experts have forecasted further economic effects of a Grexit. They point out that a bankruptcy of the Greek banking system may ensue, to which the government would be forced to react by printing money, possibly leading to a hyperinflation, with unpredictable social consequences. Another interesting thought from the economic perspective is whether it might cost the IMF more than its current lending to Greece to prop up the country, should a financial collapse occur.
In contrast, proponents of a Grexit put forward that the devaluation of a newly introduced currency would immediately make Greece more competitive (e.g. through cheaper exports and tourism) and therefore help its struggling economy in the long-run). However, a Grexit would not solve the underlying problems faced by the Greek economy, such as poor tax collection, the struggle to control government spending, and can therefore not be regarded as a strong argument in favour of such.
Some consider the Greek situation similar to that of Argentina, which defaulted on its foreign debt in the late 1990s and as a consequence, devalued its currency by putting an end to the peso’s fixed exchange rate to the US dollar. Some argue, Greece might experience similar benefits from such devaluation, however, there is a major difference between the two countries: Greece is not a major commodity producer, unlike Argentina, causing potential benefits from a devaluation appear significantly smaller.
Those who think a return to the drachma would be good for Greece should take a look at what happened to Argentina when it left its dollar peg. Its devaluation did little to improve the trade balance (which was largely driven by the commodity boom), but a lot to redistribute wealth to those more likely to invest it than spend it. The increase in domestic investment helped Argentina’s growth, but this is a type of recovery oligarchic Greece needs, like another Peloponnesian War.
The Political Impact
Some politicians, including German Chancellor Angela Merkel, have repeatedly addressed European values, such as solidarity, when it comes to the discussion of a member state leaving the Euro. They state that one of the pillars of a monetary union is the commitment of each member staying. If one member leaves, it would shake those pillars of mutual commitment and economic partnership.
On the other hand, leaving the Euro does not mean leaving the EU (although there are legal constraints on this statement, as EU lawyers have pointed out in the past) and therefore a Grexit would probably not call the fundamental values of Europe into question.
It may also be interesting to explore the manner by which a potential Grexit would lead to structural reforms within the EU, as countries like Germany might feel pressured to react to avoid an implosion within Europe. These reforms could include a banking union (including shared supervision and a supranational European financial system) or a fiscal union, in which at least some the debt is mutualised through jointly issued Eurobonds. Additionally, Greece could serve as an example to other countries reluctant to enforce necessary reforms, as it shows there is no guarantee to try everything to keep a country within the Eurozone.
The Social Consequences
Some people consider every debate about economic and political consequences insignificant as they see the social impact on millions of Greeks as the crucial aspect of the discussion. Former Greek Prime Minister, Antonis Samaras, estimated that the living standards in Greece could fall by 80% within a few weeks of Greece’s exit. This would mainly be due to the hyperinflation of imported goods. An almost certain bank run also carries the potential for turmoil.
However, the supporters of a Grexit have their own view on the social aspect of the issue. They argue that the current structural reforms imposed on Greece take too long to become effective and cause social backlash, which make a Grexit even more necessary.
Greece may not be able to pay back its debt – regardless of whether or not it leaves the Eurozone.
Thus one must weigh up the impact of a Grexit on an economic, political and social level. Some may perceive the arguments against a Grexit being rather qualitative in nature and based on estimates. In contrast, the Grexit supporters have tangible numbers and facts on their side. Therefore, on the basis of all the aspects discussed in this article, perhaps instance of a Grexit occurring being the most likely scenario.