Will the Greek exit be voluntary or involuntary?
Ever more voices are talking about the possibility of Greece leaving the euro zone despite the fact that there is no formal mechanism for a euro are member country to exit the single currency and the fact that most European voters want the euro zone to stay intact. This talk of a Greek exit, however, makes sense because Greece’s situation is untenable economically and politically. I wrote a trio of posts on the likelihood of a unilateral Greek exit in February: Running through unilateral Greek exit scenarios, How and why Greece will leave the euro zone, The political economy of a Greek default (and euro zone exit). I plan on updating my thinking here with a member post later today or tomorrow. However, I just want to outline some of the critical points here first,
The political economy surrounding the Greek issue has deteriorated as expected. There is no political will in Greece itself or in the euro area for the kinds of repeated haircuts and bailouts it will take to see Greece through the current crisis. Here’s how I put it in February on the issue (highlighting added):
For the time being, European policy makers must continue down the present path of austerity/non-default defaults because they are deathly afraid of committing policy mistakes given the weak financial sector and high private sector indebtedness. Most importantly, if things go pear-shaped, they know they will be blamed because they have no mandate to break up the euro zone (yet).
Eventually, however, the populace will grant this mandate to break up the euro zone. In the core, bailout fatigue will set in and Greece will come to be seen as expendable even if it means significant costs to prevent contagion and to recapitalise the European financial sector. In the periphery, the deflating economy that accompanies austerity will cause such social unrest that nationalist and extremist politicians will take prominence, giving a green light for a euro zone exit as well. Their mandate will be to throw off the ‘German yoke’ by any means necessary and that means default and/or exit to stop the debt deflationary spiral. Finally, it is clear by now that private sector participation will not be near unanimous. And so the likelihood of ECB participation in writedowns and a credit default swap triggering default will increase over time. To me that means default and exit – come what may.
There are five issues I highlighted on the political economy surrounding Greece in this passage:
- Euro banks are undercapitalised, not just in Spain where we are seeing this build to crisis proportions but generally. French banks in particular are very exposed to Greece and a Greek re-default/euro zone exit would render some of the biggest banks there insolvent.
- Private sector indebtedness is high in many euro area economies within the core as well as the periphery. This means the deflationary policy response has/will hit these economies hard.
- Bailout fatigue is building in places like Germany where the CDU were crushed in the Landtagswahl in Nordrhein-Westfalen. The reigning center-left/Green party coalition has now moved from minority to majority rule. The last 11 state elections have been miserable for Chancellor Merkel’s coalition government’s parties. But German politicians still have no mandate to break up the euro zone.
- Bailout fatigue = Greek expendability = Euro bank recap.
- Austerity fatigue means nationalism and political extremism as we have seen in Greece and France. Spain, Ireland and Portugal are outliers in this move but politics in Italy, Netherlands, Belgium and France can also become strained the longer austerity and recession dominate the headlines. For Greece, austerity fatigue does not mean politicians have a mandate to exit the euro area though.
- The ECB capital issue will become a political event if monetisation losses are crystallised, requiring euro area governments to pony up more ECB capital. How this affects policy is as yet unpredictable.
I believe Europe can ‘handle’ a Greek departure from the euro zone. It will be painful but the politics of such an exit increasingly favour it. My view for some time has been that it is a question of when and how not if i.e. now or after bailouts and crisis have slowed to simmer and by the Greeks or by mutual consent. My view in February was that the exit would be by mutual consent after crisis had died to a simmer, because voters do not want the euro zone to be broken up. However, I did write my posts to look at what a unilateral and immediate exit would look like. Since then, the possibility of a more near-term or unilateral exit has increased. And so I will update you with how changes in the six issues above affect the European situation and the likelihood of that exit.
I will be on BNN’s headline with the Paul Waldie and Brian Milner of the Globe & Mail at 1240ET today. We will talk about Greece as well as JPMorgan Chase, yahoo, and the Bill Ackman battle with Canadian Pacific. Tune in.