Can Greece Survive?

Randall Wray takes a bearish view of the Greek situation, the capital position of European banks and the future of the Euro.

By L. Randall Wray

(Cross-posted from

It was obvious to those who understand Modern Money Theory that the set-up of the European Monetary Union was fatally flawed. We knew that the first serious financial and economic crisis would threaten its very existence. In a sense, it was from the beginning much like the US in 1929, on the eve of the Great Depression—with excessive lender fraud, household and business debt, and a boom that had run on too long. Anything could have set off the crisis that followed—just as discovery that Greece had been cooking its books sealed Euroland’s fate. And like the US post-1929, Euroland has struggled to understand and to deal with the crisis. Meanwhile, it is slipping into another great depression.

Many economists and policy-makers—even fairly mainstream ones—have come to recognize that the barrier to resolution is the inability to mount an effective fiscal policy response. And that is because there is no Euro-wide fiscal authority. Hence, the half-measures undertaken by the ECB and other authorities to put band-aids on the debt problem.

To be sure there is a conflict among authorities over the solution—given absence of a fiscal authority. Many want to impose austerity—equivalent to medieval blood-letting. These argue that the real problem is the lack of self-discipline in the periphery countries. Note that this view is shared by the elites in those countries! Many of them would be happy to throw their countries into deep depressions that wipe out all resistance to wage-cutting and slashing of all social programs that benefit working people. That is always the preferred solution of unenlightened elites. Through this method, wage costs in the periphery nations can be cut, making production more competitive.

This of course is also the position of the most powerful member of the EU. Prudent Germany had held wages in check over the past decade while ramping up productivity. As a result, it became the low cost producer in Europe and can even go toe-to-toe and win against Asia. Mind you, not in the production of cheap labor intensive output, but where it really counts in the high value added export sector.

And this view is also common among working classes in the central countries—that share the view of periphery populations as lazy and over-rewarded. While untrue, what is most shocking about this attitude is that if the blood-letting and crushing of wages in the periphery actually does work, the factories will be moved out of Germany seeking lower cost workers. In other words, success in the periphery would shift the burden back to Germany’s workers, who would have to accept lower wages to compete. That will be fueled by job losses if Germany cannot find sales outside the EU that will be lost as the periphery nations fall farther into depression. The result will be a nice little rush to the bottom, benefiting Europe’s elite. How nice.

To be sure, I do not think there is a snowball’s chance in hell that the EU will squeeze sufficient blood out of the Greeks (and Spanish and Italians and Irish and Portuguese) for this to work. What actually makes far more sense is to raise German wages—to achieve competitiveness within the EU by leveling up. But that snowball does not have a chance, either, because Germany is looking far outside the borders of Europe—and mostly in an eastern direction. As a result, it will remain focused on cutting its own labor costs—so the periphery nations will never catch Germany on the way down.

That leaves two alternative approaches. First, continued debt restructuring, ECB purchases through the back door (allowing central banks to buy the debt), guarantees, and lending. The hope is that the financial institutions holding all the periphery government debt can either move it off their balance sheets, or use the American method of “extend and pretend” to avoid recognizing the institutions are insolvent. The problem is that almost all the economic data in recent weeks are bad—almost globally—and that makes it likely there will be some financial hiccup somewhere that will spread as quickly through financial markets as it did in the Global Financial Crisis of 2007.

Many European banks will be recognized to be hopelessly insolvent—with PIIG government debt only adding to the problem. Further, the ECB legitimately worries about the “precedent” and “incentive effects”. This is not really a matter of rules governing what the ECB can do—it has leeway much as the Fed has to intervene in a crisis to essentially buy or lend against virtually any type of asset. It has to do with what the ECB sees to be its independence. Markets would view a US-style bail-out of the European financial system (and by extension, guaranteeing individual government debts) as a loss of its independence. In truth, the ECB already gave that up, but clings to the hope it can somehow get its virginity back.

The third approach is to create the necessary fiscal authority. This would allow the ECB to stick to monetary policy, while giving a European Treasury the purse strings to deal with the crisis. I’ve been arguing since 1996 that is really the only way to make the EU project viable. The economics behind that is simple, adopted in developed countries everywhere. Indeed, the US is effectively an American Monetary Union (AMU) but one properly set up with both a central bank and a treasury. However for political reasons, that ain’t going to happen in the EMU. We are actually further away from that than we were in 1996 because the crisis has increased hostility among the members. No one wants to cede power to the center.

Well, none of those is going to work. What is left? Exiting the union.

  1. David Lazarus says

    Greece can survive but not in the eurozone, unless and it is totally dependant on a significant writeoff of Greek debt. If that is done and Greek liabilities are manageable then it can work. If the objective is to save the euro that must happen. It will mean that core nations banks fail along with greek banks but that was always on the cards. if they push the austerity route much longer Greece will soon have no option but to default, and the core nations banks fail at a later date. Either way there has to be write offs of greek debt, and core nations banks will fail. The easy route of default is being blocked by Geithner to protect US banks, but they will only drag down the bigger core nations banks who they probably also insure but are definitely not providing enough capital to protect themselves against a default.

    1. Andrew says

      It seems the problem is easier to deal with if Greece leaves the EU monetary union and goes back to the Drachma, then they could inflate their way out of this with a massive devaluation. In the EURO, I don’t see how austerity, combined with monetary policy designed primarily for Germany can lead to the growth required to service their debt? Though ramming the tranches through to service the huge yields on their 2year may be good for some players involved.

      Are there any good estimates on whether or not the rest of the EURO zone can withstand the sovereign debt default write downs with an insolvent Greece?

      China has offered assistance, but to my mind, it seems another insane move. It’s a continuation of the same Western credit / Asian mercantilism relationship that is dying a slow death.

      1. David Lazarus says

        They do not need to inflate their way out of trouble. With their own floating currency they can get that to take much of the strain. It will put import prices up but that will help it balance its trade deficit. Iceland has actually done quite well since they walked away from the banks. They can do that in Greece. The issue for France is avoiding the embarrasment of a French bank collapse. I do not sit and analyse the ECB balance sheet but a greek default will technically bankrupt the ECB.

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