As Greek politicians approved a tough austerity package amid fierce protests, one question dominates: is an orderly exit from the Eurozone available for Greece? And just what might be the consequences?
Recently Citibank put the probability of such a Greek withdrawal in the next 18 months at 50%. Greece is seeking to finalise a deal with bank creditors on Greece’s private sector borrowings which would cancel €100 billion euros ($A125 billion) of its sovereign debt of over €350 billion.
The other EU countries have made such an agreement with Greece’s commercial bank creditors a precondition for the bailout package that will allow Greece to meet its repayment obligations on March 20.
The haircut will be implemented by Greece issuing new bonds for one-half of the face value of its current debt, probably upon deferred repayment terms. As a quid pro quo for creditors, the new bonds will be governed by English law. The great majority of Greece’s commercial bank debt is presently governed by Greek law, making its repayment subject to the whims of the Greek legislature.
But even if this debt relief agreement is reached, Greece has a tough road ahead of it. The austerity policies being demanded by the EU and IMF are going to shrink the economy and thus make servicing a reduced debt load tremendously difficult. Wage cuts enacted to date have caused a major recession in Greece. The slashing of 15,000 public sector jobs, as required by this current bailout, will only exacerbate the recession in the short-to-medium term.
If agreement cannot be reached with private sector creditors to chop the debt they are owed in half, Greece will have to default and probably will withdraw from the Euro. However, given that a default would be very damaging to creditors, this agreement will probably be reached in the next week or two. However, even with such an agreement, whether Greece can continue to service its reduced debts for the next few years is far from certain. Austerity is no way to grow an economy.
So whether in two weeks or two years time, the issue of whether Greece can exit from the Eurozone remains important. There is no exit mechanism built into the treaties which brought the Euro into existence. This was deliberate. The politicians designing the Euro knew that any one nation’s exit was a course too painful to contemplate, so they opted to not provide for it. But this doesn’t mean it is impossible.
Treaties can, of course, be amended. The real problems lie not in printing drachma, collecting up the Euros in Greece, and exchanging one for the other. The real problem is the potential contagion – the flow-on effects of any Greek withdrawal for Spain, Portugal or Italy.
These three nations suffer from the same core problem as Greece – the Euro is for all four nations overvalued. The value of the euro is set by markets for the whole of the Eurozone and so it is undervalued for Germany, and overvalued for the less productive southern countries.
The architects of the euro strove to overcome this problem by enshrining in its founding treaties caps on budget deficits and national debt levels (and then let Greece join the Eurozone knowing it didn’t really meet these limits). However, the value of a nation’s currency is not set only by how moderate are its government’s deficits and debt levels.
These are only part of the story. The other part is productivity. The more productive a nation is, and the more competitive its exports, the more valuable will be its currency.
Southern Europe is simply not as productive as Northern Europe. Think about it. If someone said you could choose a free car, but told you nothing about it except where it was made, which car would you choose: one made in Italy, Spain or Germany?
Greece is a tiny economy. Its withdrawal from the Euro by itself will not be particularly significant. However, markets function on confidence, or its lack. The fear is that Greece’s withdrawal will make markets jittery about Portugal and Spain, driving up their borrowing costs. If this triggers crises in these countries (and Spain is none too stable today with soaring unemployment and social instability) and they are forced to withdraw from the euro, the next nation in line is Italy. And suddenly the withdrawal of tiny Greece has precipitated a crisis in the fourth largest economy in Europe.
No one knows what the consequences of a Greek withdrawal from the Euro will be, and this is precisely why Europe’s political leaders are working so hard to ensure they don’t find out. I am not a betting man. However, if I were, I’d put the probability of us finding this out at some time in the next three years, at well above 75%.
Greece is going to need much deeper reductions in its commercial bank debt than 50%, if it is going to be able to restructure its economy, and service its debts, in the long-term.