Greek euro exit: 'not if but when'

Greece seems to be heading towards the eurozone exit door: the real challenges are managing an orderly default and ensuring Europe's firewalls are big enough, argues Europe Economics consultant

It appears ever less a question of if Greece will exit the euro and ever more about when, on what terms, and with what effects this will occur. While leaving the euro would be unprecedented, factors internal and external to Greece edge us, on unchanged policies, inexplicably towards this.

The factors internal to Greece are the misery that it has been reduced to and the vanishing possibility that this can be ameliorated within the euro on present policies. Possibly in contrast to the United Kingdom, the Greek population are in no doubt about the depths of their predicament.

It might not be obvious to everyone in the UK that we are living through a more sustained period of contraction in national output than was experienced in the notoriously grim 1930s. This may be because the causality between foregone output and unemployment is not now as pronounced as it was then. If it were, we would be looking at something like four million unemployed. A recession, as Ronald Reagan famously said, is when your neighbour loses their job and a depression is when you lose yours. We are statistically close to depression but fewer P45s have been delivered than we'd expect to be associated with this.

Nothing veils Greek eyes from the extent of their calamity. It is a visceral, desperate and inescapable reality: a quarter of all businesses bankrupted since 2009, nearly half of under-25s unemployed, and an increase in the suicide rate of 40 per cent in the first half of 2011. If a depression is when your neighbour loses their job, what is it when your neighbour's business collapses and they kill themselves? "We've been robbed of our dignity, we've been humiliated," said George Karatzaferis, leader of the right-wing Popular Orthodox Rally political party. He insists that his country "could do without the German boot". Framing the country's problems in such provocative terms is migrating from an unsayable to a worryingly commonplace view in Greece.

The factors external to Greece that tend towards their euro exit also involve previously unsayable things being increasingly said, if only privately for now. Publicly, European Union leaders have appealed to high European ideals in insisting that default within and exit from the euro area are impossible. Privately they may concede that they've done so for the sake of lower motivations: fear of what Greek default would mean for their own public finances and bank balance sheets. Publicly those high ideals continue to be parroted. But, privately, they are increasingly confident that Greek default and exit will not result in contagion to their banks and sovereign bonds.

The intolerability of Greek life invites the rejection of the extreme austerity that the troika – the European Commission, the International Monetary Fund and the European Central Bank – demands, while confidence that impregnable firewalls between Greece and the rest of Europe have been erected discourages ardent resistance on the part of the troika to this rejection. In spite of everything, most political leaders in Greece continue to believe that they are better off in the euro. If their equivalents in the core euro states were more prepared to will the means of keeping the euro together, rather than simply the end, then this might be true. Such means would have to involve some mix of fiscal transfers closer to the scale of the United States dollar area and activism by the ECB nearer to that of the Bank of England. In other words, the substance of euro solidarity, not empty homilies.

Unless and until this substance materialises, and it seems ever less likely to, completion of the Reagan analogy in the Greek case would seem to be that recovery occurs when the troika lose their job and Greece exits. This recovery would not be painless for Greece. It would require temporary exchange controls and complex restructuring of its public and private debts, as well as soaring inflation as a new drachma plummeted in value. But with this new currency Greece would gain an exchange rate at which it can export its way to recovery.
There would be a sting in the tail of Greek exit if the firewalls that European leaders think are erected prove less substantial than they believe. Given the warning from Moody's that it may cut the credit rating of 17 global and 114 European financial institutions, it's hard to discount this possibility.

As much as tensions are more exposed on both sides of the Greek firewall, there is a mutual interest in ensuring that if Greece is to exit and default that it does so on as orderly terms as possible. It is to be hoped that sufficient trust remains to act upon this interest. Otherwise the extent of the problems emanating from Greece will continue to belie the puny 2 per cent of eurozone gross domestic product that it is responsible for.

Jonathan Todd is a senior consultant at the London-based Europe Economics