Can Angela Merkel afford to be so relaxed about Grexit?

I am writing this post as a prediction and not as a warning, because I am certain that nothing I say will have the slightest impact on the outcome of the current Greek debit crisis.  However, I cannot resist putting on record my view that Grexit will be a disaster not just for Greece, but also for the Eurozone (and the world economy as well) if it occurs.

Angela Merkel relaxed about Grexit

We are told that Angela Merkel is relaxed about the possibility of Grexit, on the grounds that European banks and bond markets are much more stable than when the last Greek bailout was agreed in 2012.  As a result, if Grexit occurs, its effects will be mainly limited to Greece and there will be no contagion to other parts of the Eurozone.

Debt default would cost every Eurozone resident 700 Euros

I really cannot understand how Angela Merkel or any other Eurozone leader can be relaxed about Grexit.  We are after all concerned with 245 billion Euros of outstanding Euro debt – around 28 billion Euros owed to the IMF, and the remaining 217 billions to the ECB and other Eurozone governments.  If Grexit occurs, Greece will re-adopt the Drachma, which will promptly be devalued well below its current Euro value.  The outstanding Euro debt will no longer be just 170% of Greek GDP but something well in excess of that.  If a debt equal to 170% of GDP is too much to pay back, there will be no hope of paying back an even larger amount.  So it is inevitable that Greece will then default on its Euro debt.  This would result in a loss of 28 billion Euros to the IMF, and 217 billion Euros to the ECB and other Eurozone governments.  Based on a Eurozone population of 320 million (excluding Greece), that amounts to a loss of almost 700 Euros for every man, woman and child in the Eurozone.

Greece has achieved primary budget balance

I understand that Greece has more or less achieved primary budget balance, in that it is able to meet its current spending obligations out of tax and duty payments by Greek residents, before debt repayment.  Thus, the income of the Greek government is now sufficient to meet its current spending obligations.  If the government defaults on its outstanding debt, it would certainly have no chance of borrowing more from banks or other sources (unless Russia offers to help), but it would not need to borrow in any case to continue spending at its current level.

The Greek economy would fall into chaos for a time…but not for ever

The Greek economy would of course fall into chaos for a period of time.  Depositors would rush to withdraw their money from the banks, and some or all domestic banks may fail.  Greece might even be forced to leave the European Union altogether.  However, the country would not be entirely without resources.  Tourism could rebound very quickly, as the cost of visiting Greece would plummet – the Parthenon and the Greek islands would not disappear with the debt.  And the fall in the value of the currency would mean that Greek products would remain competitive in the EU even if import duties have to be paid.  The Greek government would have to operate for many years without access to loans from the IMF or external banks, but it has already shown that it can achieve primary balance.

The reaction of other indebted Eurozone countries

Meanwhile, other Eurozone countries with heavy Euro debt and populations resentful of never ending austerity, like Ireland, Italy and Portugal, would look on with interest at events in Greece.  If Greece manages to stabilise its economy even after an initial chaotic period, could they be forgiven for concluding that Eurozone exit and default on Euro debt may have its advantages?  And what will be the reaction of the citizens of Germany, France, the Netherlands and other creditor countries in the Eurozone, when they appreciate the massive scale of their losses?

Bluff on both sides, but is there scope for compromise?

I am sure there is a great deal of bluff in Angela Merkel’s and other Eurozone leaders’ expressed indifference to the consequences of Grexit.  I think we must also take Alexis Tsipras and his very competent Finance Minister Yanis Varoufakis at their word when they say they are determined to remain in the Eurozone and repay all outstanding debt.  There must therefore be scope for compromise, though it is hard to see how that can be achieved given the hard line being taken by both sides in this crisis.

In any event, if Grexit does occur, I predict that the resultant Euro debt default will have far more serious and unpredictable consequences than Angela Merkel and other Eurozone leaders, as well as Christine Lagarde at the IMF, appear to be allowing for.

Michael Ingle

 

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Categories: Economics, EU

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