Greek default does NOT equal Greek exit

18/02/2012 by

Perhaps the greatest enemy of the eurozone, at this particular juncture, is an erroneous assumption: that a Greek default is inextricably linked to a Greek exit from the eurozone. The problem with this assumption is twofold: First, it prevents Europe from escaping a trap of its own making. Secondly, it is false.

By now, reasonable people realise that the Greek Bailouts do not work. Even though the Greek government (its overall incompetence notwithstanding) has managed to reduce its primary deficit by a whopping 9% (at a time of bitter recession), a loan package worth €240 billion (even if the debt write down known as PSI is successful) will have failed to arrest the steady rise of the  country’s debt and the inexorable shrinking of its national income. It is, thus, unsurprising that the EU and the IMF are at the end of their tether. The show can’t go on (with more loans that demand GDP-killing austerity to pacify the Northern parliamentarians who must approve them).

At the same time, the notion that Greece ought to leave the eurozone is unfathomable: while almost everyone would prefer Greece to have been outside the eurozone, the actual cost of severing Greece will prove equal to that of dismantling the eurozone itself painfully, slowly, catastrophically.

The two thoughts above cause Europe to behave like Buridan’s Ass. Meanwhile the eurozone, as a whole, is moving further along the path  of disintegration and generalised recession. However, this indecision and impasse is founded on an error: the fallacious presumption that Europe is constrained to choose between the bailout route and Greece’s exit. But there is a third way which is less costly for all and gives Europe a chance, at long last, to design a new path out of the Crisis not only for Greece but for all deficit countries (as well as of the ailing European banking sector): Greece must default within the eurozone!

The Greek state, let me remind you, is quite close to a primary surplus. With judicious top-down reductions wages and pensions, plus the issue of tax-bonds, the Greek public sector could finance itself for the foreseeable future. All that is needed is that the ECB continues to provide liquidity to the Greek banks. Some say that it cannot do this because it won’t be able to accept Greek government bonds as collateral (since the Greek state will have defaulted). True but irrelevant: Greek banks have already posted whatever government bonds they owned with the ECB for collateral. That creek has dried. Nowadays they are posting domestic mortgages and other such paper titles (which are, by the way, no worse in quality to those posted by Italian and Spanish banks). All that it would take to allow Greece to stay in the eurozone, in a better state than it is today (and less austerity for that matter), is the continuation of the present ECB policy toward Greek banks. As for those who argue that the ECB will take an aggressive stance, think again: the ECB will not knowingly take steps which will destroy the eurozone.

Naturally, while a defaulted Greece can easily (and optimally, under the present constraints) remain in the eurozone, a long term resolution of its insolvency will have to be plotted by Europe. But is that not the case anyway? Is it not time that Europe deals with the various insolvencies in its midst, rather than continue to push their under the carpet (like a spolit 5-year old)?

To conclude, Europe’s optimal strategy is to let Greece default, to allow the Greek government to find ways to live within its tax take for the next year or so and, at the same time, work out the Overall Solution to the euro crisis that was promised last year and never delivered. A Greek default will provide the clarity and the time-space to do this properly. The other two alternatives (more bailouts or a Greek exit) constitute cruel, unnecessary and unusual punishment. For the whole of Europe.

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