Wednesday, January 28, 2015

Greece, EMU and democracy

One more post on Greece, possibly not the last one.

Markets are more worried about what is going on and there is more and more talk about the possibility of and exit of Greece from the Euro area. As I have argued in my previous posts, exit will not be the choice of the Greek government, it will be the only solution for Greece as the ECB refuses to provide liquidity to Greek banks as depositors run to avoid capital losses on their Euro deposits in the scenario of Greece leaving the Euro.

Let me start by repeating (as I have expressed many times in this blog) that I find that the economic policies followed in Europe have been a disaster, that the suffering that countries such as Greece had to go through during the last years should not have taken place. And I am convinced that in many of these countries, austerity has produced higher debt-to-GDP ratios, as opposed to lower ones. A real disaster.

But this is not what this negotiation is going to be about. The reality is that the crisis has had an impact on the way we all see the experiment of sharing a single currency, the experiment of EMU. While in the early days we all talked about optimum currency areas, the synchronicity of business cycles, the absence of a fiscal transfer mechanism, what we now realize is that the real issue is how to handle a full-blown crisis that puts governments at the edge of default and creates bank runs among Euro countries (something that many l thought it was impossible). The role that the ECB plays in those circumstances is not the typical role a central bank plays and one cannot ignore the political aspects associated to the difficult decisions they face.

And while it is true that Syriza has been chosen by the Greek voters and as such it is a victory of democracy, there are also voters in other countries that also feel they want their say heard by their governments.

And here is the question that I think is fundamental: if voters had a choice now, would they choose to join the Euro area given its current membership? What if they were allowed to change some of the members? There is no doubt that in some countries voters would like a different configuration of the Euro area. No doubt that Germany would be happier with fewer countries, in particular the "trouble makers".

And this decision will not be just based on economic arguments, some of it will be about the emotions generated by the crisis and some of it will be generated by the first statements of the Syriza government (and proposing a rethinking of the sanctions to Russia does not help).

So if the current membership does not work anymore, what do we do? There is no explicit process for this. Countries can opt out of the Euro if they do not like what they see. But the current negotiations with Greece will be seen by some as an opportunity to change who is in and who is out of the Euro.

If (big if) contagion can be avoided, Germany and Brussels have all the power in these negotiations. Greece does not want to leave the Euro.

Can contagion be avoided? The answer to this question three years ago was a clear no. And that's why this was not an option. Today I am not so sure. Three years ago Spain or Ireland or Italy were facing very difficult economic conditions that looked similar to Greece. Today that's not the case. Growth is very low but deficits are under control, debt to GDP ratios decreasing in some countries and interest rates are low and not reacting much to the Greek elections. The possibility of contagion today could come more from the political side. If voters in other countries decide to elect similar parties, we might repeat the same scenario in a few months in Spain or Italy. But will voters do this if they see that exit from the Euro is a possibility? Remember these political parties do not want to leave the Euro. Most citizens even if they are critical with European policies do not want to leave the Euro. My guess is that an exit of Greece from the Euro area will change political outcomes in European countries relative to what we see in the polls today. And this will limit the possibility of "political contagion".

Interesting times. More to come.

Antonio Fatás
on January 28, 2015 |   Edit