Blackmail by Athens?
One year ago, the Greece lost the confidence of the financial markets, interest rates rose dramatically, and the Greek government asked for help from other euro area countries. Since then, the Greek state has been dependent on capital supplied through the European rescue package. The loans are conditional on a significant fiscal consolidation. Moreover, structural reforms to modernise the countries are demanded. So far, the very unpopular fiscal consolidation has been ‘broadly on track and has made further progress towards its objectives’, as stated by the European Commission in February 2011. Therefore, the rumours of a possible euro exit were quite surprising. Of course, with a national currency Greece could easily depreciate against the euro to gain competitiveness. But what would a euro exit really mean for Greece and the euro area?
Let us suppose Greece tried to exit the euro. What would happen? First, just after the announcement of an exit, investors and private savers would transfer their euro-dominated money out of Greece or would hold cash in euros. This capital flight to prevent an anticipated depreciation loss would immediately make all banks in Greece illiquid and insolvent. Moreover, the depreciation would increase public and private debt (which would still be denominated in euros). Within days or weeks a large part of the private sector and the Greek state would default on their debt. That could potentially drag the euro area as a whole into recession and would almost certainly threaten the stability of the euro area banking system. The costs of a euro exit by Greece would be immense and would be borne by all euro area countries. Thus the exit option is certainly not in the interest of the euro area.
So, how did the exit rumours start? Greece is probably preparing to renegotiate the conditions of its loans because the Greek deficit will certainly not decrease as proposed one year ago. More loans will be necessary and for a much longer period. As official documents of the European Commission tell us that everything is ‘broadly on track’, it seems that either the rescue programme was not the right way to help Greece (see my blog post from May 2010: ‘Euro stabilisation plans are flawed’) or Greece is not doing enough fiscal consolidation. In this context, is raising the possibility of exiting the eurozone effectively blackmail from Athens to increase financial support from other members?
If yes, it is poor blackmail, particularly if one considers further the effects of exit on the Greek economy. I wonder who would accept the new drachma, which has no credibility and is issued from a country that has just defaulted. The new drachma would heavily inflate after depreciating against the euro and many Greek citizens would probably continue to use the euro, as it is the more valuable currency (there are already signs that Greeks are withdrawing euros from their bank accounts). Banks or foreign investors might only provide loans (if any) in euros to prevent the high exchange rate risk. To a large extent, Greece would be ‘euroised’, and accordingly such a blackmail strategy is not credible.
Exiting the euro looks at first glance like a simple solution that solves almost all the problems of the now euro-trapped Greece. But the costs for Greece and the euro area would be immense, while the benefits would be minor. Greece should therefore stick to its fiscal consolidation programme. A restructuring of the debt might also help. However, more important are structural reforms to increase labour market flexibility and untangling free markets to promote private enterprise, innovation and economic growth.