Barry Eichengreen, Professor of Economics and Political Science at University of California, Berkeley
For faithful followers of the European economy, it feels like déjà vu all over again. Turmoil in Greece is raising doubts about the country’s continued membership in the eurozone.
The specter of a “Grexit” in turn is once again fanning fears about the stability and very survival of the single currency, with the euro plunging to a nine-year low. German politicians are playing hardball, threatening to withhold assistance unless Greece adheres to their rules.
The resulting uncertainty discourages the private investment that Europe so desperately requires. Having already endured a difficult recession, the European economy looks poised to dip again.
All this sounds disturbingly familiar. It is an all-too-depressing echo of 2010, when turbulence in Greece first ignited the crisis in the eurozone.
But not so fast. Isn’t the current situation fundamentally different? And isn’t it different in reassuring ways?
First, banks, in France and Germany in particular, are much less exposed to Greece today than they were in 2010. They have sold off their Greek government bonds. To be sure, many of those bonds have migrated onto the balance sheet of the European Central Bank. Still, if the ECB experiences financial losses from a Greek default, the institution can be easily recapitalized by its stronger members. This would not be a happy outcome, but neither would it be a disaster.
Second, Europe has a very different central bank president than five years ago. Its president then, Jean-Claude Trichet, made the grievous mistake of raising interest rates, not once but twice, in the spring and summer of 2011 when the turmoil in Greece was spreading.
In contrast, the ECB president today, Mario Draghi, is alert to the dangers of financial instability. Were Greece to default on its debt and abandon the euro, Draghi would foam the runway. He would buy the bonds of other Southern European countries big time in order to insulate their financial markets and prevent their economies from being infected.
Third, European leaders today are much less patient with Greece than in 2010. Not only are their banks and bond markets in a stronger position, but there is the perception that, by threatening to reject its agreement with the EU, Greece is reneging on promises made in return for earlier assistance, which in turn makes more assistance less likely. The left-wing, anti-system party Syriza, which is likely to head the next Greek government, has adopted a particularly hard anti-EU line. Other EU countries, in turn, will regard it with even less sympathy than Greek governments past.
The implication is, unlike 2010, when Greece and the EU were both inclined to compromise to keep the country in the eurozone, this time Greece will exit. But what happens in Greece will stay in Greece. And Europe will thus have taken a first step toward putting its crisis behind it.
These conclusions are both right and wrong. They’re right that post-2010 changes work to make Grexit more likely. But they’re wrong in thinking that the result will be positive for either side.
Most obviously, Grexit would be a disaster for Greece. It would not boost exports and get the Greek economy growing again. Greece no longer has a problem of high labor costs, having cut these radically since 2010. Rather, the country’s inability to grow its exports reflects deep structural problems: inefficient public administration, failure to collect taxes and widespread corruption. Cutting Greece loose from the European Union – for such would be the consequence of leaving the euro – would do nothing to address these problems. To the contrary, such a step would only compound them.
Nor would bankrupting the country’s banks – this being the implication of a debt default, given that Greek banks are the only financial institutions still holding significant quantities of Greek government bonds – be exactly helpful. To contain depositor flight, the country would have to impose capital controls. It would have to close down its financial markets for an extended period. These would not be positives from a growth standpoint.
The other thing Greece urgently needs, of course, is foreign investment. Grexit is the last thing one would prescribe from this point of view.
The implications of Grexit for the rest of Europe may not be as dire, but they are highly uncertain. The idea that monetary union is forever would have been consigned to the dustbin of history. The door to exit having been opened, financial markets would go into a frenzy whenever a Spanish or Portuguese politician showed the least sign of being less than fully committed to the euro. It would take a hyperactive European Central Bank continuously on call to “do whatever it takes” to contain that frenzy. Whether the ECB, with its very large governing board, influential German shareholder and restrictive mandate, is temperamentally capable of responding in this manner is, at best, an open question.
When the housing market crashed, then US Treasury Secretary Hank Paulson and Federal Reserve Chair Ben Bernanke confidently asserted that the fallout could be “contained.” When Lehman Brothers went belly up, they similarly asserted that they could limit the destabilizing repercussions. European officials today are similarly confident that they can contain the shock waves created by Grexit. They should think twice.