Greece: Out of the Frying Pan and Into the Fire 

The choice that Greece faces is not between happiness and misery; it is between different versions of hardship and how the suffering is to be distributed.

The train to a better destination has already left the Greek station – it can no longer get there from here. What is at stake now is the kind of pain Greece prefers to bear. Is it the kind of pain and humiliation that comes from succumbing to the demands of its creditors for more austerity? Or alternatively, is it the pain associated with a shredding of the social fabric amid a further lurch lower in the economy and an additional rise in unemployment?

The creditors’ choice is to either try to organize the debt relief for Greece or to accept a more freewheeling form of debt relief as its default cascades and the banking system lies in ruins. They either risk turning Greece into a failed state or trying to manage the process and extract concessions.

Similarly, Greece’s choices are terribly limited as well. The idea suggested by some that the “No” victory in the Greek referendum is a democratic rejection of austerity will be shown to be unfounded. Whether inside the monetary union or outside of it, Greece’s standard of living is going to fall. The basket of goods they get as citizens is going to be reduced or will come at a higher price, most likely both. This is unavoidable now. Greece can influence to some extent how the suffering is going to be distributed. It can be negotiated with the official creditors or it can be left to the disorderly breakdown of civil society, where the burden is borne by the elderly, young, poor, and sick.

The many critics of monetary union blame the euro for Greece’s woes. It shaped the crisis and frames the choices, but Greece was a weak link prior to joining the monetary union. It used deception on an audience that wanted to be deceived to meet the requirements. The critics exaggerate the degrees of freedom to conduct the monetary policy of a small economy with Greece’s economic structure.

The main reason to introduce a new currency is to allow the devaluation that being in the union denies Greece. It is advanced as a way to stimulate the economy through exports. However, the root problem is that Greece is relatively closed and does not have an export sector of any note. It is not simply that Greece is not competitive, though that is a big part of the problem. It does not have the capacity. Without export growth, the currency devaluation raises the costs of imports, fuelling inflation just as the economic contraction deepens. Domestic demand evaporates and there is no foreign demand.

Greece’s banking system is on the verge of collapse. It will need to be recapitalized, whether Greece is part of EMU or not. Depositors are at risk in either event. Business failures are going to increase without economic growth regardless of the particular monetary system.

Outside of the monetary union, Greece’s new money would be immediately suspect. Introducing a currency for the sole purpose of devaluing will not strike investors as a compelling business proposition. Imagine the ruinous consequences on the value of Greek savings and pensions. It is possible that a new currency would not be accepted, and the economy could remain euro-ized. If Greek officials think they are being choked now, imagine the monetary asphyxiation on the other side of the Rubicon. Would many of those blaming the monetary union for Greece’s woes be willing to buy a new Greek government bond if it introduces its own currency?

The choice that Greece faces is not between happiness and misery; it is between different versions of hardship and how the suffering is to be distributed. Greece may have greater nominal sovereignty outside of the EU and EMU, but it will find that it is difficult to exercise, and it comes at a steep price. The creditors would force Greece to live within its means. The circumstances Greece will find itself outside of the monetary union will force the same fate onto the Greek people.

Events are moving very quickly in Greece, and every day the combination of capital controls and bank holiday are becoming more disruptive and destructive. Commercial activity is grinding to a halt. Private businesses are already reportedly issuing scrip. In addition to the further souring of loan book, Greek banks will also be hit hard by a sovereign default. The ECB cannot raise the ELA ceiling but may still tighten the rules of access. In order to preserve its limited options, the Syriza government may have to do two things. First, it needs to challenge the ECB’s ELA authority. It does not arise from the execution of monetary policy. It seems to emanate from its position as a backstop. However, the exposure is not on the ECB’s balance sheet or the Eurosystem as a whole. Only Greece bears the risks. Second, Syriza may choose to replace the Governor of the Bank of Greece. It will violate the principle of the independence of the central bank, and anger other countries in Europe. However, from a strategic point of view, Tsipras needs to control the bank, especially if Greece were to leave the monetary union. It would also give the Syriza government access to the 5 bln euros of reserves (according to Bank of Greece figures) and the 3.6 bln euros of gold.