FT Alphaville
Why Greece might still choose to leave the euro
Officially, Syriza wants Greece to remain in the euro area — but the strength of this desire obviously depends on the circumstances. There is no point in avoiding the costs of exit if staying in the single currency only guarantees years of stagnation, perhaps with the added pain of unhelpful “structural reforms” imposed for ideological reasons.
The question, then, is whether circumstances favour Greece staying in the monetary union, or striking out on its own. A fascinating set of notes from Oxford Economics suggests that you would be unwise to underestimate the chance that the Greek leadership voluntarily chooses to leave the euro area.
Contrary to relatively vague polls of Greeks as a whole, there is little apparent willingness to make additional sacrifices for the sake of monetary union:
Some chinks are emerging in the popularity of the euro. In a poll on 10th May, 58% of Syriza supporters stated a preference for the drachma over implementing the Memorandum of Understanding (ie continued austerity).
More generally, it is hard to ask “a euro versus drachma” question in isolation of context. Polls frequently reveal Greeks’ willingness to compromise to preserve euro membership; but for Greeks compromise does not imply full capitulation. On May 10th, 66% responded that the government should compromise; the same poll revealed 57% thought compromises should not include much-needed pension reform, even though the pension system is bankrupt. To an outsider, reluctance to contemplate pension reform is bizarre given that retirement ages are lower than most Eurozone bailout providers.
The other important point is that the costs of exit, while potentially large at first, could soon be overwhelmed by the benefits, according to the Oxford Economics analysis.
This might seem surprising. After all, Greece’s nominal labour costs have already plunged relative to Germany’s thanks to swingeing wage and benefit cuts. Via Eurostat:
It’s not even clear what good came from these self-inflicted wounds. After all, despite the supposed improvement in “competitiveness”, the number of euros Greece earns from exports has been flat for years and is still lower than before the crisis.
On the other hand, this performance occurred in the midst of a collapsing economy. As a result, the share of GDP coming from exports has soared:
Imports, by contrast, basically fell in lockstep with overall incomes. The net effect is the smallest trade deficit in decades, as a share of the total economy.
As Professor Krugman argued recently, it would have been better to replace the nominal wage and benefit cuts with a currency devaluation back in 2010, but that path wasn’t taken. In his view, given the sacrifices that have already been made, “it’s hard to see that the risks of exit would be worth it” assuming, crucially, that “Greece can negotiate a halfway reasonable compromise”.
However, it’s possible that further reductions in relative costs could produce even bigger effects on the Greek trade balance. Those additional reductions won’t be possible as long as Greece is tied to the single currency, especially given the famous German fears of domestic wage growth.
Besides the usual trade channels, there are other benefits for Greece if it tries the time-tested recipe of default and devaluation, according to Oxford Economics.
While Greeks as a whole owe more to the rest of the world than they own in foreign assets, this picture is distorted by the government’s unusual fiscal situation. Virtually the entire public debt is owed to foreigners, which is why it makes little sense to compare Greece’s net interest burden with, say, Italy’s when thinking about the incentives for default and exit.
By contrast, Greek households own more foreign assets than they owe in liabilities to foreigners. Exiting the euro area would immediately make them wealthier, although, perversely, the stimulus would be most potent the longer the government waits for citizens to pull their savings out of the banks:
If roughly a third of the total fall [in household deposits] of €79bn reflected capital flight then households might hold a total of about €35bn of financial assets that would not be redenominated. In drachma terms, the value of these assets would increase by the amount that the currency depreciated. If the nominal exchange rate fell by 30% this windfall would amount to €10bn or 6% of GDP. Of course, this figure could rise substantially between now and any exit. A drawn out exit involving substantial deposit withdrawal can be thought of as a positive for private sector balance sheets in the event of an exit.
The picture is even better for Greek non-financial businesses:
Meanwhile, a larger proportion of the corporate sector’s financial assets are non-Greek assets that would not be redenominated post exit. In Q3 2014, Greek non-financial firms held nearly €30bn in deposits in non-Greek banks – a near record high – and around €20bn in other non-Greek assets. These assets combined were equal to just over 50% of firms’ total assets. In addition, as the chart above shows, since then, domestic deposits have contracted – if they have simply migrated to banks in other parts of the Eurozone, up to 60% of firms’ assets might now avoid redenomination.
On the liabilities side, firms have long-term loans of around €10bn with non-Greek residents which would not be converted to drachma. However, there are few other assets that would definitely not be redenominated. The big picture is that about 80% of firms’ liabilities are loans from domestic banks or shares and equity which would almost definitely be converted into drachma. On balance, then, the direct balance sheet effects of redenomination are likely to be positive.
(Note, though, that the net effect of this would be to increase the well-being of the poor and the rich at the expense of the middle classes and those with significant savings in Greek banks who lack the sophistication to convert their deposits into hard currency.)
There are even scenarios where Greek banks manage to do pretty well in a world of default and devaluation, according to Oxford, although that depends on the specifics of the Greek government debt restructuring, how the European Central Bank adjusts its Emergency Liquidity Assistance, and any changes in the non-performing loan ratio.
Fortunately for the Greek banks, they have a relatively large portfolio of assets that would stay denominated in euros and other foreign currencies. Even better, they would go into any devaluation with a (relatively) healthy capital position to endure losses on any domestic exposures.
The real open question is how the rest of Europe would react to a Greek exit. Unfortunately, this is more about politics than economics, which makes it tough to assess which outcomes are most likely.
Officials committed to preserving the single currency might think that they will serve their cause best by ensuring that Greece suffers horribly after leaving the euro, in an effort to discourage other countries from considering the option.
Greece currently receives transfer payments from the rest of the European Union worth about 3 per cent of its GDP and also enjoys relatively free trade with the other European countries. Taking that away could be devastating, especially given the expected short-term costs associated with leaving the single currency. For humanitarian reasons, Greece’s importance to European security, and its identity as the font of Western civilisation, one hopes this view doesn’t win out.
The alternative, however, could also be tricky. As Karthik Sankaran, Eurasia Group’s director of global strategy, has argued, a conciliatory response could lead to “political contagion” that increases the popularity of other anti-establishment politicians arguing that euro exit would boost their economies. That could actually be a good thing, given the apparent unwillingness of European voters for pan-European fiscal transfers, although people ideologically committed to sustaining the monetary union above all else might disagree.
The citizens of the euro area have endured tremendous suffering at the hands of a remarkably cohesive political class — much to the surprise of those who expected the crisis to resolve itself in the usual way when countries find themselves in unsuitable fixed exchange rate systems.
Presumably, fear of the unknown and the promise of an imminent recovery have been behind this Job-like pain tolerance. But every quarter of stagnation, or outright recession, erodes the consensus in favour of staying in the currency bloc. It would be rash to assume that the Greeks, and everyone else who has sacrificed for the sake of monetary union, can continue to be pushed without consequences.
ft
