Thursday 29 September 2016

A Grexit would be disastrous and could signal disintegration of euro

Another week, another crisis in the eurozone, but don't be fooled into thinking this won't affect Ireland

Published 28/06/2015 | 02:30

GREECE IN CRISIS: People wait outside a closed branch of the National Bank in Athens, Greece yesterday. The bank did not open at 10:30am as usual but remained closed while dozens of people lined outside to withdraw cash. Photo:Yannis Behrakis
GREECE IN CRISIS: People wait outside a closed branch of the National Bank in Athens, Greece yesterday. The bank did not open at 10:30am as usual but remained closed while dozens of people lined outside to withdraw cash. Photo:Yannis Behrakis

Whatever the outcome of the weekend crisis meetings on Greece it has been another dreadful week for the European Union. Greece could fall out of the common currency even before the referendum planned for next Sunday and financial markets are set for a turbulent opening tomorrow. Seven years into the crisis this kind of thing simply should not be happening. There must be senior politicians in France and Germany, the principal architects of the common currency, beginning to wonder if the game is worth the candle.

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The design of Europe's single currency was the fruit of intense deliberations from the mid-1980s onwards. The blueprint in the Maastricht treaty was fleshed out in the construction of the European System of Central Banks and the new common currency was finally launched in January 1999. A central feature in the design was the so-called 'no-bailout' clause: if a member state got into trouble there was to be no financial rescue, never mind three-in-a-row, from other members or from central European institutions.

A logical corollary of the no-bailout clause was that eurozone members with excessive debt would default on foolish private lenders. This prohibition of rescue from partner countries' public funds implied, and should have been understood to imply, that losses would end up elsewhere: not with European taxpayers, not with the IMF and not with Greek taxpayers either.

When push came to shove in Greece in the spring of 2010, the no-bailout clause was sacrificed and a 'no-sovereign-default' doctrine was substituted. Thus was committed the original sin of eurozone mismanagement. Greece was lent money to repay undeserving sovereign and bank creditors. The holders of Greek sovereign debt included French and German financial institutions and they were vulnerable also through exposure to the Greek banking system.

Creditor interests were placed ahead of the interests of Greek citizens and of the coherent management of the common currency. This view is not an alternative to the view that successive Greek governments stretching back to the 1970s had been guilty of egregious economic policy errors, including the decision to join the euro. They stand guilty as charged, but the people who financed the errors were repaid via the May 2010 deal, with the debt transferred to the Greek Treasury.

This violation of the no-bailout clause was accompanied by a deflation of the Greek economy as a condition of the 'rescue' and an inevitable default in 2012. This too was botched - the default was not big enough. At no stage was a process initiated which was likely to lead to Greece's debts becoming sustainable, even had there been full and vigorous implementation in Greece.

The two Greek programmes, of 2010 and 2012, failed not because, or not only because, they were poorly implemented in Greece. They were poorly designed by Greece's saviours.

If there is another deal for Greece over the next days and weeks, it is most unlikely to be a good one. Greece needs a solution, not another temporary fix. The European common currency has yet to be transformed into a functioning monetary union, as the bank run in Greece attests. Regional runs against solvent banks should not happen in a well-designed system. The week's tsunami of summits in Brussels (the eurogroup, the Council of finance ministers, the European Council) was diverted, yet again, into the minutiae of the Greek pension system and VAT rates.

Meanwhile, the UK prime minister struggled to gain attention for the rather more important matter of whether his country will stay in the EU at all. No sane person any longer denies that the common currency has been a disaster for the European project. There has rarely been such public recrimination between member states' politicians since the first steps were taken in 1958 and never such an absence of solidarity.

There are three courses of action open to Europe's leaders. The first is to admit the error and try to devise the least damaging route back to national currencies. The second is to construct, through a new European treaty, a proper monetary union designed to endure. The third is to blame someone else (anyone will do: Greeks, Marxists, Anglo-Saxon financiers, America) and muddle onwards.

The EU would survive a return to national currencies although the mechanics of dismantling the euro would be daunting. Constructing a fully articulated monetary union would work too but requires major treaty change. Of the three options, the onward muddle is the greater threat to the cohesion of the EU, the defining political success of the post-war continent.

The muddle option is, however, the clear preference of the current European political leadership: it avoids any acknowledgement of previous errors and it defers (or conceals) embarrassing decisions about the allocation of the costs arising from those errors. The objection to this course is not just that it is cowardly, although it certainly is. The real problem is that the costs of unresolved policy errors do not sit still. They go forth and multiply. Whatever the costs of a planned dissolution of the common currency, a disorderly break-up would threaten the world financial system and risk a worldwide depression. The involuntary ejection of Greece would be seen as the first instalment, even if Greece could successfully be blamed.

The Irish Government has, rather gratuitously, chosen this past week to add a curious and quite ahistorical footnote to the proceedings. The narrative was by way of a Homily to the Greeks: behave yourselves as we have done, accept the Troika programme, and all will be well. As the IMF team have pointed out repeatedly, the roadmap for Ireland was already in place when the programme commenced. It has been precisely this absence of domestic political ownership that has hampered the reform efforts in Greece. It is impossible to micro-manage somebody else's reform process either technically or in terms of political legitimacy, a lesson entirely lost on the IMF's European partners.

Ireland faced a serious bank run in late 2010 and had little option but to seek official lender support, as Central Bank governor Patrick Honohan reminded everyone again last week at the Banking Inquiry. But the budget consolidation programme was already in place, and crucially in process of implementation, at that stage. Agreement with the Troika on a three-year adjustment programme was straightforward, since substantial tax increases had already been imposed and spending cuts started as far back as July 2008. There are no sound-bite lessons for other countries in the Irish experience.

Should Greece end up outside the euro, and regardless of blame allocation, the common currency becomes a temporary little arrangement and the markets could embark at any time on a re-run of the 2012 sovereign debt crisis.

This financial version of Spot the Weakest Link would see deposit runs and rising bond yields emerge somewhere else and further ingenious sticking plasters applied after yet more long weekends in Brussels. It is always possible that some version of muddle through will avoid a disintegration of the currency zone. But the costs have been horrendous and will rise further with a Greek exit. Has it all been worth it?

Sunday Independent

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