The Chinese water torture that is the euro zone debt crisis
Here’s the video from last night’s capital Account with Lauren Lyster and Demetri Kofinas. Since we’re sick of the euro crisis, everyone keeps acting like this crisis is about to boil over and take the world economy with it. It certainly could. At least then, it would be over. More likely though, we will continue to get these repeated cycles of crisis, bailout, and liquidity infusions. Remember the Italian crisis? Same thing there. And this is about the third time that a Greek exit from the euro zone has been imminent. See, we’ve been here before.
I’ll let you in on a secret: Greece was never going to hit its austerity targets anyway. Moreover, who says an anti-austerity Greek government could be elected and then go out and reject austerity? If you listen carefully, no one is saying they reject fiscal consolidation in Greece outright. No one. They may be saying they want some stimulus on the side or they want the timetable to be backloaded. But that’s a different story. Even so, Greece could default and stay in the euro zone. Eurozone default is not synonymous with breakup. I know people like Nigel Farage and Geert Wilders are talking about breaking the euro up. But, they’re on the fringe. Show me a mainstream politician talking this way. Most of Europe is still very committed to the euro. Even the most anti-austerity Greek politicians are telling you this. Why do you think Grexit is imminent then? We’re not there… yet. I’m betting on extend and pretend. And remember I’m a eurosceptic. I’m just reading the tea leaves.
As always, my concern is bank runs. That’s how a depression turns into a Great Depression.
Grexit is not definite no matter what EU leaders say about how irrelevant Greece is. They know that once Grexit is fact, that Portugal and Ireland will be targeted by speculators as the next likely candidates. I think that Spain and or Italy will be targeted once they appear weak enough. Though with the problems at Bankia today the problems for Spain will make it look very vulnerable depending on what they decide to do.
As for bank runs I am not worried. Europe’s banks are over extended and this is one way to accelerate the deleveraging of banks debts. For small depositors all that we need to know is that there is a deposit protection scheme. When look at the depression I see that the massive clear out of debts under Hoover actually meant that when stimulus was applied it was not siphoned off to reflate bubbles, which is what happened during the 2008 crisis. If there is a mass run on the banks it will eliminate many banks but also their political influence which may be more important than the depression. Unless you have a political clear out then you will not be fixing problems, just protecting vested interests.
Since they have defaulted and are still in the Eurozone, I’m going to agree with you that it is possible for Greece to default and remain in the Eurozone.
Exactly. They did it once so I think they can do it again.
Greece defaulted to its private creditors, while official creditors were given super-duper über-seniority. This is a problem now since the debt held by other governments and the ECB is so dominant that a further default on its privately held debt would make little to no difference. It’s a really big problem because if Greece defaults on its official debt then the ECB will basically be forced to turn off the TARGET2 Euro supply. It would no longer be able to pretend that it is simply supplying “liquidity” to Greece when the country is in open default on the bonds that it is holding.
What happens if Greece can no longer access ECB money is anybody’s guess, but a likely scenario is as follows: the country would no longer be able to pay public sector worker in Euros, so it starts issuing Euro-denominated IOUs instead. Since there would be a chronic shortage of Euros, these IOUs would start being traded as money (at some discount to face value) and the country would almost certainly be forced to accept them for taxation (at face value). At that point it would be very tempting for the Greek government to pass legislation forcing the trade of these IOUs to happen at their face value (i.e., demand that traders and banks accept them 1:1 for their Euro value). At this point, Gresham’s law would kick in and there would basically be no Euros circulating in the economy at all. Externally, where Greek law is irrelevant, these IOUs would of course trade at a massive discount to their face value. So even if the country maintains the Euro as its “official” currency, in a practical sense the fiat notes issued by the Greek government would be the only thing in use in the economy and they would have a floating exchange rate with Euros which would only be traded outside Greece. Nobody in their right mind holding Euros would exchange them inside Greece where the law would demand a 1:1 exchange rate, so Euros would not circulate in Greece at all.
This would continue until the pain of trying to maintain the facade that the country was still in the Euro became too painful, at which point Greece would declare that the IOUs are the new official currency and any Euros left in the country (anybody who was too stupid to move their savings to Germany) would be redenominated into this new currency.
If the ECB turned off the finances the greeks would migrate en masse all across Europe. Don’t forget that they are highly educated and hard working. So the UK is already talking of raising the drawbridge to EU migrants if Greece forced out of the eurozone. This could be replicated across the Schengen area, destroying that institution. Secondly anti German feeling in Greece will rise immensely especially with the internal meddling of Merkel in the latest election. Expect serious social disorder within Greece, most of which can now be laid at Merkel’s door. The problem is that austerity has deepened the banking crisis all to save German banks. Greek banks are now probably insolvent and the fact that the Troika are willing to turn Greece into a failed state to protect the German banks will create panic in other weak countries, especially amongst its citizens. All that it will do is cause mass migration from those countries and increase the debt burden on its remaining citizens. So the periphery could suffer a multi decade or even multi generational stagnation.
Also while Greece is a special case with its corruption, the EU mistakes will be replicated in Spain. Destroying the sovereign to save the German banks when it is a EU wide banking crisis. Edward on Capital Account said that he thinks that policy will continue until they make a mistake. In fact the fatal mistakes have already been made. All we are waiting for is the fall out. You can throw a lot of money at a problem before it collapse. That is where we are now.
I can see the possibility that things could turn even more surreal.
If the ECB eventually cuts off Greece, it’ll be the final act of an escalating trail of spats and acrimony (failure to comply with bailout conditions, suspension of bailout funds, hard defaults on Troika debt). At such point it isn’t hard to contemplate that the Bank of Greece might be tempted to just go alone, and (electronically) print its own euros. Technically it would be a pretty simple step to take: the infrastructure is still there, and it doesn’t really matter what you call a currency, the electronic handling is just the same. At the same time there would be no shortage of paper currency, since the Greeks are drawing it from the banks and hoarding it.
Someting appears to be breaking down in euroland. No one over their wants to face the facts. But the facts are what they are. In the end the euro will fall because the present system for sustaining it is totally unsustainable.
I wish Rogoff and Reinhart had never written that book. Everyone and their uncle mentions it as if it was the final proof of the evil of government debt, when it’s anything but. I even wonder if any of them have ever actually read it. The theme of the book is an interesting theory at best, and the arguments are hardly fool-proof.
I did see an interesting video on INET about total levels of debt, not just government debt. It proposed total debts (public and private) of no more than 100% of GDP. The problem is that the UK already has total debt approaching 585% of GDP. The government are overall laggards at only 90%. It is private debt that is the problem. So unless any model includes private debt just looking at government debt is ideological claptrap. Shrinking the fiscal deficit does not help the fact that banks are in trouble. Longer term we should have bank reforms that cap total lending so that excessive fiscal deficits crowd out the private sector. That will create long term stability. There will also need to be capital controls to stop banks lending abroad and getting into trouble as is the case with German banks all across Europe. It will take many years to unwind such positions.