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Greece and the Euro: A trial separation?

By Daniel M. Ryan
web posted March 1, 2010

The comparisons to early 2008 invite themselves. The government of Greece is in the midst of a debt crisis, in part prompted by enforcement laxity of the 3% debt-to-GDP limit; it seems to have bailout or default as the only ready solutions. Either the EU or the IMF steps in and injects cash into Grecian government coffers, or else the Greek government will default on some of its debt. Credit-default swaps on Grecian sovereign debt shot up to record levels, and the Euro has taken a serious tumble - so serious, the amount of speculation against it reached a record level as of last Tuesday. That record surmounted two previous records made on the previous two weeks. Currency speculators, whether large or small, don't think much of the Euro's future vis-à-vis the U.S. dollar.

Many analyses have focused upon bloated public payrolls and high government expenditures as the cause of the Greek government's woes. Some others have pointed to the fact that there are a suspiciously low number of high-taxable-income taxpayers in the nation. Put these all together, and a picture emerges of a government that's dependent upon deficit financing to function. The recent scandal involving Goldman Sachs covering up part of the Grecian government's fiscal deficit adds certain detail to the picture. To all appearances, permanent deficits are not just fiscal-stimulus measures; they're a standard operating procedure of overall policy.

There have been comparisons made between Greece's deficit-to-GDP ratio and the U.S.', mostly aimed at ribbing the U.S. government, but the two are qualitatively different. Granted that the U.S. government's current 9.9% deficit-to-GDP ratio is in the same zone as Greece's 12.7%, but there's no evidence that the U.S. deficit ballooned for any other reason than economic policy. There's no evidence at the federal level, and little evidence at the state level, that permanent and large deficits are a tool of statecraft. Greece doesn't exactly have the best record of Euroland in the preserving-democracy department. From 1967 to 1974, the government was controlled by a military junta. The other Euroland nation demanding austerity may hear that current Greek co-operativeness is contingent upon the unspoken expectation of a bailout. The possibility of a new coup hasn't been hinted at, let alone seen, but governmental instability may be. In terms of political stability, Greece and the U.S. are far from being in the same league.

What happens if the Greek government turns to the EU and says that the required austerity measures will threaten the government? They're likely to be disbelieved in the current clime, particularly amongst Germans who seem to have pegged Greece as a beggaring nation, but the EU may have no choice if the Grecian officials force the issue. It makes for a good trump card, although one that would bring the U.S. into the game. Who else winds up disbursing valuta enorme in order to preserve freedom and democracy in the world? What other nation has an established tradition of using fonds graissage for statecraft purposes?  At the very least, the same Grecian politicians who've proven to be quite nimble in a certain way can use the possibility as a negotiating tool.  

It Might Come Down To… 

The three options presented by Niall Ferguson are austerity, bailout or default. The fourth option, which has been presented as the doomsday button, would be Greece withdrawing from the EU entirely and going back to the drachma. That would allow the Grecian government to implement the policy that the Eurozone prevents: devaluation. The trouble is: once Greece is out of the EU, it's out. There are no provisions for withdrawing from the Euro without withdrawing from the EU itself. Once out of the EU, a nation no longer qualifies for adjustment payments. More fundamentally, more viscerally, its citizens and businesses are no longer integrated with EU economies. They'd be on the other side of the paper divide, which would have profound dislocative effects on the Grecian economy. Should the drachma be restored in this way, it would fall hard before the dusts settles. So would the Grecian economy.

Moreover, there's a domino problem. The Grecian economy is only a small part of the EU's, but there are other nations resorting to deficit laxity that are beginning to look like Greece. The largest is Spain, whose GDP is about 20% of the Eurozone's. Greece leaving may prove to be fissiparous.

That's why there's been so much anger and agony over the issue. The obvious solution – Greece withdrawing from the Euro but staying in the EU itself – isn't permitted by the Lisbon Treaty. Austerity may be politically impossible, and the consequences of it may lead to a kind of government that would disqualify Greece from EU membership. A bailout would create a free-rider problem that would balloon as soon as Portugal, Spain and Ireland got the news. A partial default seems to be the least unfeasible option.

Unless…a trick from American bankruptcy law is adapted to Euroland circumstances. That tool is prepackaged bankruptcy. It adaptation is prepackaged readmission.

It's not mandatory to join the EU and accept the Euro. Nor is it mandatory, according to the Copenhagen criteria, for an applicant to exhibit fiscal restraint. That's only required for admission to the Eurozone. A prepackaged readmission would be Greece leaving and concurrently re-applying. It takes two years to leave the EU. If the re-application process is expedited, Greece could be let back in on the same day it left. Needless to say, the process would be eased by the fact that Greece is currently a member of long standing. It would be a novel procedure to pre-approve Greece, but it's not explicitly forbidden.

During the brief interstice between ex-member and new member, Greece need only reintroduce the drachma. Then, it's back in the EU but with its own currency again. If the same structural-deficit problem arises, then drachma devaluation would take care of it.

Doing so is, of course, easier written than done. It would require a triple time co-ordination: making sure that the drachma was ready to go on the same day as the withdrawal and re-admission, which also require simultaneity. If this course is taken, then the drachma had better be ready to go months in advance of the day.

This procedure, if successful with Greece, could be used for any Eurozone country whose fiscal house becomes disordered. It means a step backward for the Euro, which may render it beyond the pale of the possible, but it also reduces an overcrowdedness that is clearly shaking the Euro (and the EU) in entirety.

Of course, there's always default instead...along with its consequences, including to German banks. ESR

Daniel M. Ryan is currently watching The Gold Bubble.

 

 

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