The word on everybody’s lips these days is Grexit — Paul Krugman, for one, reckons it could be here as early as June. But how would such a thing happen? The FT, in its otherwise excellent Grexit explainer, fudges that bit:
Exit would occur because, without disbursements of additional loans, the government would run out of money to pay social security and public sector wages. In addition, the ECB could withhold needed funds from Greek banks, bringing them down. At this point Athens would need to pass a new currency law, redenominate all domestic contracts in a new drachma, impose exchange controls, secure the borders to limit capital flight and take steps to introduce a paper currency.
It’s true that Greece is currently running a substantial fiscal deficit, which is being funded by the EU. If the EU stopped disbursing loans, Greece by definition could not meet all of its obligations. But the thing that happens when you can’t meet your obligations is known as a default — and as we’ve already seen, Greece is more than capable of defaulting on its obligations without exiting the euro.
So the question is: given that leaving the euro would be political suicide for any Greek politician, why would any such politician go ahead and do it anyway?
Luke Baker has the beginnings of an answer:
The rules would appear to leave the decision largely in the hands of the departing country. But when asked if that were the case during a meeting in Brussels last week, German Finance Minister Wolfgang Schaeuble said it was not necessarily so.
According to a source present at the meeting, Schaeuble said contingency plans were being drawn up and indicated that life could be made so unpleasant for Greece that it would be left with no other option but to ask to leave.
That could involve shutting off all Greece’s official financing, not just from the euro zone’s EFSF bailout fund but from the European Central Bank too. Already there are signs of that sort of pressure being applied to Athens.
It seems obvious to me that if Greece were not receiving any money from the EU and the IMF, and the relationship there turned highly adversarial, with the EU effectively trying to force Greece out of the Eurozone, then Greece would feel no particular need to pay the EU what it is owed. And if Greece were to default to the EU, then at that point it would gain little from staying current on its other debts, too. It might still pay the IMF, and try to maintain some kind of decent relations there, but my guess is that Christine Lagarde would be foursquare behind Brussels, and the Greeks would see little point in paying her either.
Up until now, only pariah countries have defaulted to the IMF, but Greece is the exception to many rules. And given the choice between default and devaluation, it seems to me that Greek politicians — and the Greek population as a whole — clearly prefers the former to the latter.
Once you strip out Greece’s debt payments, the country’s primary deficit is pretty modest — just 1% of GDP or so. So could Greece make one more round of cuts, default on all its debts, and remain within the Eurozone?
I think the answer is no — and the reason is the banks. If the ECB were to stop funding the Greek banks, and if Greece were to default on its debts, all of Greece’s banks would be insolvent. And you can’t have a functioning economy without banks. Basically, Greek depositors need to be able to withdraw something from their checking accounts. And if the EU stops supporting the banks, that something can’t be euros any more.