Euro zone exit might be best of bad options for Greece

ROME — The Globe and Mail

The euro symbol is reflected in a puddle on the cobblestone pavement outside the European Central Bank in Frankfurt. (Kai Pfaffenbach/Reuters/Kai Pfaffenbach/Reuters)

The real question is not whether Greece will leave the euro zone. The real question is why any of the distressed countries – Greece, Ireland, Portugal, Spain, Italy – would want to guarantee more years, even decades, of torture by staying put. For them, the euro zone has become an economic and fiscal pressure cooker with no release valve. They are getting boiled alive like lobsters in a pot.

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The potential economic collapse of any number of euro zone countries is built into the region’s structural DNA. A country minus its own currency loses its main economic engineering tool. It cannot raise or lower interest rates on its own, depriving it of its ability to control inflation. It cannot print money. It is almost impossible for a country that borrows in its own currency to default and go bust. The United States’ debt load, as a percentage of gross domestic product, is worse than the euro zone’s, collectively speaking. But an American bailout is unimaginable.

Austerity is only ratcheting up the torture for all the euro zone countries, plus a few in the wider European Union (note that Britain is back in recession, yet Prime Minister David Cameron refuses to take his foot off the spending brakes in spite of near zero interest rates). Spending cuts and tax hikes in the absence of growth are proving murderous to Greece. Canada’s austerity program in the 1990s is the exception that proves the rule. Austerity might work in the absence of austerity in neighbouring countries. But when everyone is slashing with alacrity, the result is a transborder suicide pact.

Greece and the other dying economies, in other words, have no way to make themselves competitive. They can’t depreciate their currency because they don’t have one of their own. They can’t adjust interest rates (not that Japanese-style rates at zero would help them at this stage). They have been told by Berlin, Brussels and the International Monetary Fund that they have to keep austerity intact or risk losing bailout loans and the allegiance of sovereign bond investors.

Hold on. What about internal devaluation, where wages and costs get crunched to the point that the economy can attract foreign investment and ramp up exports? Nice idea on paper, but it’s not working. Greece, and to a lesser extent Spain and Italy, have erupted in demonstrations, strikes and riots, some fatal, as wages and benefits fall and unemployment soars.

Youth unemployment in Spain and Greece is already 50 per cent and rising. Let’s hope the budget cuts don’t destroy fire departments, because another round of internal devaluation could turn their cities into smoking rubble. During the February riots in Athens, about 40 downtown buildings were damaged or gutted by fire.

Another option is whacking private bond investors, as Greece did in February, when a bond swap reduced the net present value of those bonds by about 70 per cent. Greece’s national debt load, as a result, fell by about €100-billion. Spain and Portugal, perhaps even Italy, might be tempted to pull a similar stunt and it just might work. But the repercussions could be dire, because bond “haircuts,” as they’re known, might trigger a retaliatory bond buyers’ strike down the road. For them, one trip to the barbershop might be pain enough.

Add it all up, and you can see why Greece might see no way out of the quagmire, save endless bailouts. But even more bailouts are not really an option. Eventually the money will run out or political pressure in Germany, the main sponsor of the emergency loans, will prevent more loans from being doled out. In any case, bailouts don’t make an economy more competitive; they just buy time in the hopes an economic miracle restores growth.

By definition, then, the pressure cooker’s safety valve is an exit from the euro zone, rebooting the national central banks and reprinting the old currencies, such as the drachma. Of course, any exit is bound to be messy. In Greece’s case, it could destroy the banks. The country would default on external debt denominated in euros, making it incapable of selling sovereign bonds. Lack of funds could close the government, shredding social services such as hospital care and police forces. Chaos and violence could shatter civil society.

But if Greece’s international paymasters could find a way to ease the country out of the euro zone without utterly destroying the economy, a euro zone exit would emerge as an attractive option. And if Greece pulls it off, why wouldn’t Portugal and Spain attempt to do the same? The sad truth is that a euro zone exit is emerging as the best way to take the lid off the pressure cooker.

Follow on Twitter: @ereguly

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