Grexit

I never subscribed to the idea that Greece was going to be expelled from the euro zone in 2012. However, my view on Greece is more pessimistic than most. Most policy makers in Europe would have you believe the euro crisis is over. It’s not.

Here’s what I wrote to subscribers in November and what I still believe is true:

The flip-side of being too optimistic is being too pessimistic. And here I am talking about a Grexit and eurozone breakup… I do believe that eurozone policy makers are committed to the euro. And given the lack of euro zone exit mechanisms, I do not believe that a Greek exit is possible in the near to medium-term.

Now, the worst case scenario would be a disorderly default and exit by Greece, followed by copycat defaults and exits elsewhere in the periphery that would lead to the euro’s collapse. Bt this kind of Armageddon scenario would mean the end of one of the world’s leading exchange and reserve currencies. It would mean a complete about face by a number of leading European policy makers. And it would also mean opening up the European and world economies to an enormous wave of economic and political unpredictability. I see this as very far-fetched. It won’t happen.

The most likely scenario for Greece is that we continue on the present path of varying levels of austerity and reform in exchange for bailouts. Along the way, the economic and political situation in Greece will become extreme, making an eventual Greek exit from the euro zone possible – and in my view probable. This exit would occur only after the general crisis had ended and Greeks understood that Greece still wasn’t prospering economically within the euro zone. I wrote three posts on the likelihood of a unilateral Greek exit last 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). Read these for a fuller perspective on Grexit scenarios.

Bottom line: in Greece, austerity is going to be the policy of choice for the EU for some time to come. Eventually, after the contraction in GDP this engenders, we are going to understand that Greece’s public debt burden is still unsustainable as part of the euro zone. At the same time, Greece’s economy won’t exactly be firing on all cylinders. Faced with a choice of an interminable adjustment process or Grexit, I believe the Greeks will eventually choose Grexit, the key word being eventually.

Nouriel Roubini isn’t wrong. He’s early. I put it this way to subscribers last May:

I think the Europeans are now actively preparing for a Grexit because to not do so would be folly. However, Europe wants Greece to stay in for now because the EU is not yet prepared for a Greek euro zone exit. Instead, we are more likely to see the Greek memorandum renegotiated, get a Spanish bank recap and see a push toward tighter fiscal integration with penalties for ‘free riders’ including explicit mechanisms for euro zone exit.

This is exactly what has happened except the only one bit remaining – explicit mechanisms for euro zone exit. If and when this language appears in euro zone treaties, a Grexit will be on the table, not before.