Is Greece finished?

11/09/2011 by

In one sense Greece was finished the moment the Great Recession cut its growth rate (in the second quarter of 2009) from among the highest in Europe to almost zero.

Given its high, and increasing, debt-to-GDP ratio, not to mention the preceding run on Dubai’s private-cum-sovereign debt, Greece’s stalled economy precipitated a run on Greek bonds. The writing was on the wall: The huge bailout could only ever delay the inevitable default, especially so in view of the swinging government expenditure cuts that were the condition for the bailout; cuts that have led to a precipitous collapse of demand, a subsequent run on Greek banks (and a flight of deposits to Switzerland and Germany), a wholesale investment strike, and the overarching recession which has already pushed Greek GDP down by 15% since 2008/9. Add to the mix the 21st July 2011 EU Agreement, and in particular the sad reality that that Agreement was not worth the paper it was scribbled on, and what you get is the logical conclusion that Greece is about to default.[1] And since default within a highly financially integrated eurozone is unthinkable, the same train of thought takes its ‘passengers’ straight to the junction where Greece decouples and parts ways with the eurozone.

In another sense however, and even though most of the above analysis is correct, the conclusion reached in the previous paragraph misses the most crucial of points: Greece cannot exit the eurozone without setting in motion a brief sequence of catastrophic moves which will cause Germany to bail itself out of the eurozone before it itself loses its triple-A rating. Why and how is something that I have explained on a previous occasion when Greece’s exit from the eurozone was touted. If I were forced to state my arguments again, I would have struggled to come up with new phrases. So, read that piece again (if you are interested in my explanation that is).

Of course, none of this means that the present path is sustainable. Greece’s debt will be downsized, if not liquidated, one way or another. A hard Greek default can only be prevented by means of steps (like those we advocate in our Modest Proposal) that the current European leadership seems determined to avoid, even if the price of such avoidance is the euro’s collapse. So, the big question is whether the eurozone can survive with a member-state in a state of chronic default. In theory, as in the US, it could be possible to have a member-state of a currency union that cannot meet its obligations to creditors and, thus, remains in some form of receivership until it can climb out of its hole. In practice, however, such a scenario is pure fiction when such a destabilising event occurs within a currency union lacking all institutional mechanisms for recycling surpluses in a manner that might restore stability.

We hear that Mr Schauble is preparing Germany’s banks for the shock of Greek default. Do not believe a word of it. He cannot pull this off and he knows it. At some point he thought that time would allow Germany’s banks to work out ways of insulating themselves from a Hellenic shock. Instead, they seem more vulnerable today than ever. So, what on earth is going on? What is Mr Schauble really doing? What plans is he trying to hatch?

As I have consistently argued, Greece will not be allowed to default before Germany first puts in place a decent plan for splitting Greece’s monetary system from that of the surplus countries. But if I am right that such a plan cannot involve the mere expulsion of Greece from the euro, as it will kick off a chain reaction that will eventually knock France out for a sixer before returning to Frankfurt and Berlin to haunt the ‘planners’, the only logical conclusion that I can come to is that, behind all the talk of a German plan to contain a Greek default or to push Greece out of the euro, lies the groundwork for a pragmatic plan that sees Germany bailing itself out; a plan according to which Germany will round up countries it truly deems worthy of sharing its new currency with (the other three surplus countries of the existing eurozone plus perhaps Poland, the Czech Republic and even Estonia) and exiting in the most orderly manner possible; offering, for example, to the eurozone countries that will be left behind (fretting France in particular) a few gifts (e.g. Germany may choose to foot the bill for existing bailouts), an illusion of unity (e.g. suggesting that the new Germanic currency is also minted and administered by the ECB – which will now be responsible for more than one currency at once), and some vague promises (of possible fusion of these currencies, once the ‘right’ discipline has been knocked into the hearts and minds of the undisciplined).

To sum up, when I hear that Germany is planning for a Greek exit from the eurozone, even for a Greek default, I immediately suspect that Germany is planning a controlled disintegration of the eurozone and, at once, I fear that it will only manage to achieve an uncontrolled disintegration whose end result will be massive recession in the European north and gargantuan stagflation in the European periphery. Or as the bard might have said:

For in that sleep of debt what dreams may come,

When we have shuffled off this Greek coil,

Must give us pause…

[1] The ongoing saga of whether the banks will or will not participate in the by now infamous swap as envisaged by the Agreement is utterly irrelevant. The said swap was but a nice little earner for the banks that, even if it were to go according to plan, would make next to no difference to the Greek debt dynamic.

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