In many ways, renewed talk of Greece renouncing the euro mirrors fevered discussion on the fate of Lehman Brothers in 2008. The bank’s chaotic bankruptcy came six months after the rescue of Bear Stearns, prompting anguished debate as to whether Lehman too would receive a bailout or go bust. The US authorities refused to save Lehman, triggering a storm which brought the world’s financial system to the brink of collapse.
As Greeks prepare for a snap election on January 25th, it appears increasingly likely that the European authorities will soon be confronted with a question of similar magnitude. Narrowly ahead in the polls is the hard-left Syriza party, whose charismatic leader Alexis Tsipras may repudiate Greece’s bailout arrangements with the international community. German leaders are in uproar at the prospect, saying they will not be blackmailed into renegotiation. So a battle of wills between Athens and its sponsors looms. At issue is whether the debt-addled country receives yet another reprieve or whether it is finally cut loose from the single currency.
This uncertain scenario is of no small relevance to Ireland, whose EU/IMF programme in late 2010 came in the wake of the first Greek rescue. Ireland broke free of its bailout shackles after three years, making a return to private debt markets in 2014 and taking the benefit ever since of a steady decrease in borrowing costs.
With Ireland’s rate of economic growth the fastest in Europe, investors perceive the State to be well down the road to recovery. Yet the lesson learned in Europe’s sovereign debt crisis of 2010-12 was that the weakness of one country in a currency union is the weakness of all. Ireland cannot be impervious to disruption and turmoil elsewhere in the euro zone. The danger remains that reverberations from a Greek exit could turn the heat up again.
But would European leaders really force Greeks back to the drachma? What are the risks? And what would it mean for us?
Greek departure
Such questions returned to the fore at the weekend when Der Spiegel reported that Berlin no longer opposed a Greek exit from the single currency. The article suggested German chancellor Angela Merkel and finance minister Wolfgang Schäuble believed the euro zone could cope with a Greek departure from the single currency.
Although German officials backed away from the report, the magazine said Berlin considered a “Grexit” almost unavoidable if Syriza prevails in the elections. It was enough to raise the electoral stakes for all Greeks, raising the prospect of another tense game of wits between a new concession-hungry government in Athens and euro zone benefactors who might say that the drachma is the only alternative to the hated diet of continued retrenchment and full repayment of all debts.
Exit talk used to be anathema in Europe, where there are no legal provisions for a country to leave the currency. But Germany and other currency members are known to have flirted with the notion when Greeks went to the polls twice in two months in 2012.
The election of a centre-right government under outgoing premier Antonis Samaras, who was more or less wedded to the bailout programme, was sufficient to put the matter to rest back then. Syriza’s continued advance – together with demands to reverse cutbacks, introduce a big stimulus plan and cancel debt – has put the question back to the top of the agenda.
A lot has changed since the debt debacle was at its very worst, when halting, ad-hoc measures only added to the pervasive sense of crisis. Having pledged to do “whatever it takes” to save the currency, the European Central Bank has since developed a programme to act as lender of last resort to stricken countries.
Adding to the safety net is the European Stability Mechanism permanent bailout fund, a partial banking union and the prospect of separate ECB action to introduce a programme of quantitative easing to boost demand and inflation in the euro zone.
Grounds for talks
The theory is that Europe’s anti-crisis firewall is strong enough now to withstand any outburst of contagion from a Greek exit. While there are concerns that this would lead to speculative attacks on other other weakened countries, the reply comes that no private market participant would be able to outgun the ECB if it came to it.
There is always the possibility of compromise, that Tsipras would need coalition partners to form a government and that they would insist on taking the edge off some of his more hardened demands. That might provide grounds for talks with Europe on a new deal, but the fact remains that the interest rate on its existing bailout loans has been cut right back already and the maturities prolonged radically.
It is also the case that Greece’s biggest creditors are fellow euro zone member states, so any further forbearance would face big political tests in other capital cities. Any failure to muddle through, however, could precipitate the country’s departure from the currency.
Time pressure is also acute. “It is worth noting that Greece’s current bailout programme expires at the end of February, leaving very little time for a new Greek government to agree on a follow-up programme,” says Citigroup economist Ebrahim Rahbari. “It is possible the current programme will be extended again for another couple of months, but it is also possible that the current programme will expire without a new programme in place, which would likely, at least temporarily, restrict the eligibility of Greek assets for ECB [funding and outright purchase] operations.”
Exit remains a “definite” possibility, says Prof Alan Ahearne, head of economics at NUI Galway. “Where the rubber hits the road is with their banking system. If there are concerns that they’re not going to work with the EU, people will start withdrawing money from the banks and the only thing that would prevent the banks collapsing then would be support from the ECB. If that support is not forthcoming, then the Greeks can’t remain in the euro.”
This would present an abundance of risk within Greece itself, although the act of currency devaluation could act as a economic spur in its own right. There would be large potential gains for the Greek tourist industry and for the country’s exporters, which would gain a price advantage over competitors. There would no escaping economic volatility, however, and ordinary Greeks could be faced with very high inflation before a new currency stabilises.
“The short-term consequences for the Greek economy would be devastating – and that itself would be a big disincentive,” says Ahearne.
The real burden of the Greek national debt would multiply, as it would remain denominated in euro. The very process of leaving the currency, however, implies Athens would default on that debt. Finding a way back to international respectability in that scenario would be very difficult.
Contagion
What all of this might mean for other euro zone countries such as Ireland is another matter. If the technical task of printing and circulating new bank notes is not insurmountable, the challenge in any exit from a currency union such as the euro zone is to avoid contagion.
“So far, the markets have remained sanguine about all this,” says a note by Jonathan Loynes, chief European economist with Capital Economics in London. “Greek government bond yields are a long way below the levels reached when ‘Grexit’ fears surged in 2012, while other peripheral yields have remained very low. And while the euro has fallen to a nine-year low against the US dollar, this appears primarily to have reflected the prospect of QE [quantitative easing] by the ECB.”
Still, Loynes argues it would be too complacent by far to conclude that Greece’s problems present no dangers to other countries. The lack of contagion thus far provides no comfort as the original outbreak of crisis followed isolated developments in Athens before spreading inexorably.
What happened in the Irish bailout in 2010 is clear enough. So how deep is the threat to Ireland from contagion if it happens?
“It varies between countries,” says Loynes. “I would have thought Ireland would be down the list in terms of potential contagion countries, given its improved economic provenance over recent quarters and the fact that it should benefit more than other countries by the drop in the euro given its openness and strong trade links outside the currency union.”
While Ireland’s current growth is being pulled along by the strengthening of the US and British economies, the danger remains that any upsurge of turmoil in the euro zone would lead it back to outright recession. That would be bad news, for the standstill in Europe is already holding back Ireland’s recovery.
Things were bad enough in the euro zone before the Greek election was called. That alone might give pause for thought before anyone in Berlin or elsewhere advocates a repeat of the Lehman experiment.
