No exit?

The economic drama unfolding in Greece has an uncanny resemblance with Jean-Paul Sartre’s existentialist play, No Exit.  The similarities go beyond the elements of absurdity and irrationality.  Sartre’s most famous play is actually based around three dead characters condemned to live together for eternity. Many of Greece’s fellow Eurozone members could probably identify with this situation and especially with one of the characters when he says “l’enfer, c’est les auters.” [“Hell is the other people.”] But are the other Eurozone members really forced to live with Greece forever and are they economically as good as dead, not least because of this predicament?

The Greek politicians who believe they can force Europe to change significantly the conditions of the bailout because Europe cannot afford to let Greece out should think again. The Eurozone and the rest of the financial system would probably be able to handle the Greek exit without truly existential consequences. While such an exit would be very costly to everyone, its potential effects are often overrated, particularly by those who claim that they would be of several orders of magnitude higher than the impact of the collapse of Lehman Brothers.

Most of the reasons why the departure of Greece from the euro would not wreak such a havoc in the financial markets as the Lehman event have to do with uncertainty. The collapse of Lehman Brothers created a massive panic in the financial markets largely because of the tremendous amounts of uncertainty and unpredictability that were associated with it. Few people expected such a fast downfall of this mighty bank. In addition, there was a tremendous amount of uncertainty about who Lehman’s largest counterparties were and therefore who would be most affected by its collapse directly and indirectly. A departure of Greece from the Eurozone would be anything but unexpected. It has been considered as at least theoretically possible for almost two years  by the markets and was acknowledged as such even by some of Europe’s most powerful political leaders more than six months ago. During this time bought dearly by the Eurozone governments, ECB and the IMF, the structure of Greece’s creditors has become widely known. They all had time to prepare for large potential losses stemming from their Greek exposure, which they duly did. In fact, Greece has already de facto defaulted on its debt, which led to the largest sovereign debt restructuring in history. As a result, the private sector currently holds a little over 100 billion EUR of Greek bonds, which amounts to less than 40% of the total Greek debt. One should not forget that we had been repeatedly warned by many market participants, including the ECB, that if ever Greece were to conduct a debt restructuring that would not be fully voluntary, it would have catastrophic consequences on European and international financial markets. In the end, Greece did precisely that, but no financial Armageddon followed. This was largely because the restructuring was quite expected and actually decreased uncertainty about the future development of the remaining Greek sovereign debt.

The first order negative effects of the Greek exit would therefore be limited. The biggest risk are the indirect effects, particularly the impact on the borrowing costs of other vulnerable Eurozone countries, especially Spain and Italy. If the markets took the Greek departure as a sign that now any country can leave the Eurozone, this could lead to a massive sell-off of the Spanish and Italian bonds. This could in turn increase the refinancing costs of these countries to such an extent that they would no longer be able to stay in the Eurozone without an external financial support. However, with strong support from the Eurozone and IMF, such a shock could be handled. For one, since the no-Eurozone-exit taboo was publically breached last November, the financial markets have already partly “priced in” the possibility that Italy and Spain could move back to their old currencies. Still, if Greece really left the euro, a clear and convincing communication from the rest of the Eurozone would be absolutely essential to stem a massive panic elsewhere. The Eurozone would have to convince the markets that the Greek exit really was a one-off event, precipitated solely by Greece and its repeated failures to abide by reasonable and mutually agreed conditions of its bail-out. The economic, social and political catastrophe that would start to unfold in Greece right after its move back to the drachma would probably be the best guarantee that no other Eurozone government would be foolish enough even to question the terms of their financial rescue package – no matter how tough these terms might be.

The cards held by Greek politicians are not as strong as they may believe also because the European and IMF negotiators know that Greece would gain very little from departing from the euro. History shows us, that the costs of leaving even a virtual currency union – such as the ending of the Argentinian peso’s peg to the dollar – are massive. In the case of Greece, they would be even larger and the benefits even smaller because of its peculiar situation. The new and weaker currency would help the competitiveness of its exports. However, without the required structural reforms, this benefits would be limited and short-lived– not least because in the whole EU Greece is one of the least open economies to trade. Moreover, Greece cannot simply do what other “defaulters” have done: stop repaying its debt without an agreement with its major creditors. These creditors are the IMF and EU partners. Not repaying IMF loans would be quite unheard of, as virtually all IMF loans have always been repaid in full. Should Greece unilaterally stop repaying the loans from its Eurozone partners, it would cause such serious domestic political problems for many of them, that they would likely look for an exemplary punishment for Greece, maybe even creating a pressure for expelling it from the EU. For Greece, this outcome would be a political catastrophe of historical proportions, even without the large losses of people’s savings, mass riots and the martial law that would probably have to be introduced at least temporarily in order to save the Greek banking sector from total collapse.

It is therefore above all in the interest of the Greek people to keep the euro. This can only by achieved if the Greek economy returns to growth, which in turn requires first and foremost ending the uncertainty and bringing a sense of normalcy to the economic life in Greece. Nobody spends their money when the state does not pay its bills and the salaries of its employees, when people do not know what will happen to their savings, and when investors do not know whether the value of their investments will not decline dramatically if the country switches to a much weaker new currency tomorrow. With such uncertainty, growth is simply impossible. So the key to ending the crisis and unlocking growth lies mainly in the hands of Greece’s politicians. They should finally realize that the rest of the Eurozone is really not condemned to live with Greece forever. For the rest of Europe, the Greek exit may be risky and costly, but by no means the worst imaginable outcome – it would certainly be much less of a catastrophe for us than for Greece.

Martin Bruncko is Slovak government’s plenipotentiary for knowledge economy. Until recently (April 2012) he was a member of the board of directors of the European Financial Stability Facility and of the Eurogroup Working Group, which prepares and partakes in the regular meetings of finance ministers of the Eurozone countries, the Eurogroup. He was named Young Global Leader by World Economic Forum in 2012.