Tuesday, 20 September 2011

The Real Risk Of Leaving The Euro

The calls for Greece to default on its mountain range of debt and leave the Euro for the perceived safety of its native Drachma are growing louder. Nouriel Roubini’s column in The Financial Times gives several very good reasons why such a move would make sense for Greece. Roubini acknowledges that the extensive ‘collateral damage to Greece’ of leaving the eurozone, but says it can be contained.

Other analyses, however, verge on the ludicrous. Costas Lapavitsas, a professor SOAS and a member of Research on Money and Finance writing in The Guardian, recommends default and departure from the Euro because of the ‘errors’ of the organizations charged with giving Greece enough money to pay its bills.

“Greece is facing an economic and social disaster, the results of so-called rescue by the ‘troika’ of the EU, the International Monetary Fund, and the European Central Bank. Greece must change course to avoid a grim future for its people: it must default on its debt and exit the eurozone,” opines Lapavitsas.

Noticeably absent from his analysis is any recognition that the real culprit in the Greek tragedy is the very structure of Greek economic and political life over the last several decades. The international organizations he blames had nothing to do with the out-of-control political patronage, corruption, bloated state sector, stagnant economic structure, and unpunished tax evasion that brought the country to its knees. Undoubtedly the international organizations could have responded faster and more effectively, but it is risible to blame them for Greece’s sharp descent into the third division.

Collateral Damage

Roubini is right about the collateral damage to Greece if it leaves the Euro. Banks would probably have to be nationalized, there could well be a bank holiday for a few weeks while the drachma was re-introduced, inflation would soar, savings would be at risk, and the value of the drachma would drop like a stone.

Lapavitsas blithely says such a development would give Greek companies a chance to increase exports and recapture the domestic market. What is he talking about?! Perhaps he hasn’t noticed that the Greek industrial infrastructure has been eroded to the point of extinction. Every ounce of steel, every drop of oil, every car, every electronic product, much of its food is imported. What exactly does he think Greece will export? Most Greek companies rely heavily on imported raw materials and machinery. Exactly how are they going to pay for these with a rapidly depreciating Drachma?

Greece does have certain industries, like ship yards, that could benefit. But years of union intransigence and government incompetence have reduced this industry to a shadow of its former self.

Pressure For Reform Must Continue

But the real risk of returning to the Drachma is that it could remove the pressure on the political class to make the reforms necessary to put the Greek economy on the road to recovery. Right now, under the threat of bankruptcy, the ruling party in Greece is promising extensive reforms that should have been made decades ago. Opening up closed professions, shrinking the size of the state, selling state assets, collecting taxes are just some of the reforms agreed to because of the pressure of the very international organizations that Lapavitsas criticizes.

Make no mistake. These reforms are traumatic for the ruling PASOK party that blossomed on the back of a corrupt system of patronage. They spell the end of business as usual, and could mean the end of PASOK as a major party. Who is going to vote for them if they cannot deliver the jobs and pensions they used to pass out? No wonder several leading members of PASOK are resisting implementation of these reforms. The fact that this is the only way to create a sound economic basis in Greece is of little importance to them. The risk of losing their office far exceeds their knowledge of or concern about the economic well being of their country.

The only way they could continue business as usual is to remove the external pressure for reform by defaulting on Greece’s sovereign debt, declaring bankruptcy and returning to the drachma. With inflation and depreciation it could be much easier to retain the old habits that got them into this mess in the first place.

The likelihood of a Greek default increases with each passing day. The European Union is simply not able to respond quickly to anything, let alone the risk of a default by a member state. Something like that was not supposed to happen. But despite much flapping around with endless, conclusionless summit meetings Greece may be forced to default and leave the eurozone. Whether this is a disaster for Greece depends entirely on how it is done. If such a move is taken as an excuse to abandon all the reforms discussed so far the Greek economy will remain mired in deep recession without even the hope of growth. The benefits that Roubini discusses will be possible only if the difficult steps taken under duress continue when the immediate pressure is removed.

No comments: