Germany Mistakenly Believes The Euro Could Survive Greek Exit

As part of the verbal and political sparring leading up to the coming Greek elections, we see that various Germans are now saying that the euro, the eurozone, could survive Greek exit from it just fine. My own opinion is that this is mistaken: but not for the reasons usually thought of. Sure, if Greece did exit then there may or may not be a spike in interest rates in, say, Portugal and or Ireland. Maybe the ECB would be able to deal with any such outbreaks if they did occur. But that’s not the dagner to the euro at all, that someone else is forced out after Greece leaves. Rather, the danger is that if Greece leaves and it works for Greece then other people are going to start asking, well, why don’t we do that?

The specific point being made is this:

Accepting Greece’s exit from the euro area would mark a reversal of Merkel’s position throughout the currency bloc’s debt crisis, which erupted in Greece in 2009.

The threat of contagion has since diminished, Spiegel cited the government officials as saying. They pointed to the recovery in Ireland and Portugal, two euro nations that sought bailout assistance, as well as the strength of the currency area’s backstop fund and the establishment of a bloc-wide banking union, the magazine reported.

Entirely willing to accept that so far as it goes. Ireland isn’t going to leave, they’ve definitively turned the corner. Portugal is unlikely to as well (and I speak as someone writing from that country). Along with Spain they’ve taken their punishment, adapted their economies and don’t actually need to leave the euro to avoid much further pain.

Depending upon how good your German is you can read the original piece here. Or a bit more of a translation here:

Worse, a Grexit now would mean all hopes of ECB QE would be put on indefinite hiatus until the legal framework of not only funding sovereign deficits but also monetizing bonds from an imploding Eurozone is justified. It also means that peripheral bonds, which have priced in well over 100% of a European QE, would go bidless overnight, leading to market crashes across the continent, then to bank runs first across the periphery then the core, and ultimately lead to a full-blown European depression.

But that’s not what I think the danger is. I think that the ECB can and will, if necessary, purchase enough sovereign bonds to make sure that rates don’t spike to unsustainable levels. Thus it’s not that if Greece leaves then others will be forced to follow.

Rather, what I think will happen is something very different. The standard solution to Greek woes all along has been a renegotiation of the debt and a devaluation of the currency. It was the devaluation (off the gold standard) that aided so many in the 1930s. Devaluation would also be standard IMFprescription in such cases. Not having a devaluation is the non-standard policy that has been forced on the country by membership of the euro, meaning that that internal deflation had to happen instead. So, what then happens if Greece does follow what most economists should be the standard solution to the country’s problems? Greece leaves the euro, the banks fail (likely, if not entirely certain) and then? Sure, the first 12 months will be pretty hairy but our standard solution then predicts that we would see significant and sustained growth in the Greek economy. It wouldn’t be a surprise to see several years of growth in the 5-10% of GDP sort of range.

Then what happens? Does Italy, already in the beginnings of a terminal debt spiral, then say, well, we’ll go for that internal deflation route? Or do they start polishing the lira printing presses and leave the euro? What about France that is getting sclose to such problems? Belgium which is already over the hill and well into this area?

Don’t forget, the standard IMF prescription for a devaluation rather than internal deflation is there for a reason. It inflicts a great deal less pain upon the populace that way. And people do get to vote these days, whatever the bureaucrats in Brussels think about technocratic rule. Does anyone really believe that internal deflation in Italy would be politically possible (Hi! Beppe Grillo, yes, we are talking about you here) if Italians could see that Greece had had a hairy year on leaving the euro but everything seems to be getting better now?

And that’s what I think is the danger to the euro. Not that Grexit, Greece leaving it, would make the euro blow up. Rather, that Greece leaving, Grexit, would actually work for Greece and that means that other countries would follow that example. After all, standard economics, the way we’ve all thought about these problems for the last 80 years, does indeed state that devaluation is the solution here. Whatever the political desires of those arguing for greater European union, it is still the answer that will work.

http://www.forbes.com/sites/timworstall/2015/01/04/germany-mistakenly-believes-the-euro-could-survive-greek-exit/