DIVORCE IN HASTE, REPENT AT LEISURE / THE FINANCIAL TIMES COMMENT & ANALYSIS

June 16, 2015 5:56 pm

Divorce in haste, repent at leisure

Martin Wolf

Neither Greeks nor their partners should imagine a clean break if they leave the euro

 

The outbreak of the first world war was, we are told, greeted with confidence and jubilation by the peoples of Europe. Something similar seems to be happening after years of economic crisis and political turmoil in Greece. A growing number of people feel that enough is now enough.

 

The strident views expressed in these pages by the Italian economist, Francesco Giavazzi, are shared by many in high office. Meanwhile, Alexis Tsipras, the Greek prime minister, accuses Greece’s creditors of “pillaging” his country.

 

Olivier Blanchard, the International Monetary Fund’s sober chief economist, indicates that a deal might still be reached. But many are beginning to long to see the knot cut. Whatever game the Greeks thought they were playing, their government may now just desire an end to the humiliation. Similarly, whatever game the eurogroup may have been playing, it may now just want an end to the frustration. If so, Greek default, exit and devaluation could be fairly close.

 

Would euphoria then last? I fear not. The assumption of some in the eurozone is not only that the Greek case is unique, but that the disaster those sinners so deserve would improve the behaviour of everybody else. But the currency union would also no longer be irrevocable. New crises will occur. When they do, confidence in the union would be less than complete after a Greek exit. The programme of Outright Monetary Transactions, announced by the European Central Bank in 2012, might need to be implemented, to calm nerves. But it could fail. Self-fulfilling speculation could force even more divorces.

 

Some argue that Greece at least would be far better off after a default and exit. It is indeed theoretically possible that a default to its public creditors, combined with introduction of a new currency, a big devaluation (accompanied by sound monetary and fiscal policies), maintenance of an open economy, structural reforms and institutional improvements would mark a turn for the better. Far more likely is a period of chaos and, at worst, emergence of a failed state. A Greece that could manage exit well would have also avoided today’s plight.

Neither side should underestimate the risks. It is also crucial to avoid the contempt so characteristic of the frayed nerves caused by failing negotiations.

Fecklessness may be a grievous fault, but grievously have the Greeks answered it. As the Irish economist, Karl Whelan, points out in a blistering response to Mr Giavazzi, the Greek economy has suffered a staggering collapse. From peak to trough, aggregate real gross domestic product fell by 27 per cent, while real spending in the economy fell by a third. The cyclically-adjusted fiscal balance improved by 20 per cent of GDP between 2009 and 2014 and the current account balance improved by 16 per cent of GDP between 2008 and 2014. The unemployment rate reached 28 per cent in 2013, while government employment fell by 30 per cent between 2009 and 2014. Such a brutal adjustment would have shredded the politics of any country. (See charts.)

 

 

Europeans are now dealing with Syriza because of this calamity. But they are also dealing with Syriza because of the refusal to write down more of the debt in 2010. This was a huge error, made far worse by the subsequent collapse of the Greek economy. Indeed, the vast bulk of the official loans to Greece were not made for its benefit at all, but for that of its feckless private creditors. Creditors, too, have a duty to take care. If they are careless, they risk big losses. If governments want to save them, their own taxpayers should be told to pay up.

 

Greece has also already made significant reforms, including to its pension arrangements and business environment. But backtracking on such reforms would indeed be a huge mistake, as the eurogroup and IMF argue.

Given all this, it is tragic that the breakdown might occur now, after so much pain has already been suffered. It is not too late to reach agreements aimed at promoting reform, minimising additional austerity and making debt manageable. That would also be in everybody’s long-term interest. The parameters of such a deal are also clear: a small primary surplus in the short run, a decision by the eurozone to pay off the IMF and the ECB, accompanied by long-term debt relief, and a strong commitment to bold structural reforms by the Greek government.

Whether it likes it or not (understandably, it does not) the European Central Bank is a central player. It will have to decide when it can no longer treat the credit of the Greek government as collateral against emergency liquidity assistance to Greek banks. If Greece cannot reach a deal on the release of funds, the ECB seems likely to cut the banks off. That would then trigger controls on withdrawals. This might be accompanied by a scheme for circulation of deposit receipts, or ultimately by messy introduction of a new currency.

 

 

Right now, however, the aim must still be to cool down and secure a deal. Yet, in the current mood of anger and recrimination, reaching one now seems ever more unlikely. That would not be the end of the story, however. Europeans will be unable to walk away. Whether Greece stays inside the euro or leaves, much the same challenges will arise. The Europeans would still have to admit that they would not get much of their money back; and they would still have to help avoid a Greek collapse.

It might be a relief to divorce a difficult partner. But the partner will still exist, even after this monetary marriage is over. Greece will remain strategically located and even inside the EU.

Neither the Greeks nor their partners should imagine a clean break. The relationship will continue. It will just be poisonous. If, tragically, that fate cannot be avoided, it will have to be managed for a very long time.