Tuesday, May 15, 2012


Being an econo-lawyer super-monster creature thing, I feel a sustained moral obligation to have an opinion about Greece's potential exit from the Euro. The only problem is, I don't really have one. Part of the reason for that is that I am actually a pretty decent economist. (Even if I do say so myself.) In that capacity, I once added the following proposition to my Ph.D. thesis:
 6. An economic truth consists of a proposition that is deducted by sound logic “from simple assumptions reflecting very elementary facts of general experience.” Cf. Robbins (1932), p. 104. Whether such a proposition is useful is an entirely different matter.
or, in the main text:
 Because of the complexity of human society, the social sciences always provide many different explanations for the relationship between any two variables. While many of these hypotheses might be true [meaning, here, that they are correctly deducted from Robbins' "simple assumptions"], even when they contradict each other, inevitably some will have greater explanatory power than others.
Thinking about economics as a vast web of competing theories, each true but with varying explanatory power, is obviously not the best way to end up with clear, decisive conclusions. That is not always a problem; sometimes eliminating the faulty and the weak propositions is enough to arrive a at a clear conclusion (see: my posts on austerity here, here, here, here and here). But in the case of Greece & the Euro, there are just too many unknowns and too many variables. To begin with, the arguments I've made about austerity in general - and in the Netherlands in particular - absolutely positively with bells on do not apply to Greece. They simply have no alternative to DEFCON 1 levels of austerity. That is true not because the EU says so, but because the capital markets say so. (And, within the capital markets, it's not the evil ratings agencies, but the actual bond traders. There is actually very little evidence that sovereign bond downgrades - as opposed to corporate bond downgrades - have had a significant effect on interest rates during this crisis.) The next concentric circle of reasoning encompasses not just Greece, but also the other PIGS (one I, because Ireland is not included). Sustained competitiveness differential between the core and the southern periphery = sustained current account deficit for the latter = sustained borrowing by the latter (or, theoretically, other forms of FDI, but that is hardly going to cover the entire CA deficit). Combine that with: single currency ≠ rebalancing through devaluation, and you arrive at a serious problem. This is the wider Eurozone crisis, and it needs to be fixed somehow, not just for the benefit of Greece, but for the sake of the entire Eurozone. Analytically, there are two solutions:
  1. The Eurozone can be broken up, with the periphery countries leaving (or having their own common currency). This SEURO can then be periodically devalued relative to the NEURO, thus preventing a scenario where Germany owns every piece of Portugal, Spain, Italy and Greece, up to and including the Azores and some chunks of Cyprus.
  2. Instead of lending or investing their current account surplus, the core countries can simply give that money away. The problem is, of course, that we're talking serious money here. Greece alone had a 2011 Current Account deficit of € 21 bn, and adding Spain (€ 37,7 bn), Portugal (€ 11 bn) and Italy (€ 50,3 bn) to that adds up to a total hypothetical bill of € 120 bn which needs to be covered somehow. In an intact and healthy Eurozone, part of the solution would be a realistic interest rate for all things PIGS, which would have the effect of making it harder for these countries to import (or to spend full stop), because of increased financing costs. But at the end of the day, a large portion of that sum would have to be covered through pure transfers, and there aren't enough Greeks working abroad to do that through private sector remittances alone. Either through the tax bill or through the inflation tax (i.e. central bank printing press), the public sector will have to make up the difference. In the long term, the only way out of this is an inflation target that is higher than 2% and (politically) sustainable for all EU countries. Having an average inflation rate of 2% is not very interesting if the spread around that mean is too high. It is better for Europe to have a slightly higher rate if that is what it takes to reduce the inflation differential within the Eurozone.
However, as noted, all of this is about the Eurocrisis in general, not about Greece in particular. Rephrasing these points to concern Greece alone:
  1. A Greece-only SEURO is not a SEURO but a Drachme. And such a currency would not be devalued, because it would be quite capable of plummeting without central bank help. Which brings us to major uncertainty no. 1: Plummet by how much?
  2. Greece has zero bargaining power vis-à-vis Germany and the other core countries to push for a permanent annual gift or for a higher inflation target. Both are absolute no-go's for Germany. The best they can hope for is to hang on by their fingernails until the crisis subsides through economic growth elsewhere. More German tourists on Greek beaches = Greek economic recovery. Major uncertainty no. 2: How much longer until the EU average GDP growth is back at pre-crisis levels? And major uncertainty no. 3: What will be left of Greece when it is?
Technically, Greece does have one bargaining chip: When they go down, so do any number of core country banks. The problem is that no one really seems to know how many, or how badly. Which is major uncertainty no. 4: How heavily are German and other core country banks invested in Greek debt? We know, by the magic of arethmetic, that that debt has to be held somewhere outside Greece, but by whom? And how well is it hedged, when viewed in the aggregate? (Bank A holding € 100 bn in Greek debt and € 100 bn in Greek CDS doesn't do the country as a whole much good if those CDS contracts are simply held by a few other big banks.) And so the only thing that is certain is the law of the thing. As a lawyer, I can assure everyone without doubt or reservation that it is impossible to throw Greece out of the Euro without its consent. It cannot be done. No way José. Only a Treaty amendment duly ratified in Athens and in the 26 other EU capitals will do the trick. However, given recent precedent, getting 27 ratifications shouldn't be too difficult as long as everyone is properly motivated. The economic conclusion is that Greece is damned if they do and damned if they don't, but the exact extent to which they will be damned in each case is impossible to predict with any great amount of confidence. (Which hasn't stopped some people, but OK.) My preference - if I were a Greek politician or citizen - would be to stay, but only because this is a once in a lifetime opportunity for Greece to get rid of all the rotten apples at once. Even here in Italy the crisis has given us Sunday shopping, and in Greece it might even go so far as to allow people to start an on-line olive business without giving a stool sample. Greece urgently needs to fire half its civil service, get people to actually pay their taxes, repeal 2/3rds of their pointless regulations, etc. Staying will give the politicians the political cover to do all that, the only problem is that they're having a little difficulty getting re-elected at the moment. (As an aside, unlike many talking heads, I'm not saying that these reforms will help Greece survive the current crisis. On the contrary, in the short term they will only make things worse. Instead, I'm saying that Greece needs them on ethical grounds and - more pragmatically - because they will bear fruit in 10-20 years.) Were I a German politician, I would be inclined to rip off the band-aid, to get it over with. Putting it off only makes it worse. Throw them out as soon as you are confident you can get those 27 ratifications, cauterise the wound, and move on. There is no dispute that Greece should never have been let into the Euro, so good riddance to them. Just get it over with. (Here, the objective argument for what is essentially a character preference is that the uncertainty is deadly for economic growth everywhere. Kicking Greece out will reduce uncertainty, once the waves have settled.) So there you have it. Should Greece leave the Euro? That depends on who you ask. Where you stand depends on where you sit. (And if you happen to be François Hollande, you will kick the Greeks out too, because a) you can't afford to displease the Germans over something that doesn't matter to France directly - France's exposure to Greek debt is by all accounts extremely low - and b) France doesn't have the kind of money it would take to put up their share of any further major bailout, that is to say: it has the money but a Socialist President would rather spend that money on French croissance rather than Greek bailouts.)

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