Sunday, January 25, 2015

Grexit: it is not the debt, it is the future.

A follow up to my previous post now that we know that the Syriza party has won the election. What comes next will not be easy. And it is not because the policies proposed by Syriza are that radical or unreasonable and certainly they are not worse that what has been done in Greece since the crisis started. The real issue is that this is a wake up call for the Euro area (and possibly the European Union). A wake up call that without a consensus on what is the purpose and processes of a monetary union, this will be a failed project. The reality is that so far EMU has been built in an asymmetric way: the ECB was designed as a strong anti-inflation central bank with the Bundesbank in mind and that served a purpose (for everyone including Greece). The strict criteria to enter into EMU (low inflation, low budget deficits) were a great excuse for politicians in some countries to do policies that otherwise they could not have done internally. There was no doubt who was in charge and what was the ideology that prevail when it came to define policies. And that model worked well in times of economic growth when everyone, including Greece, enjoyed the benefits of stability and growth.

But the crisis made everyone realized that the model was not perfect, that there was no consensus around economic policy and, more fundamentally, that for monetary policy to function properly we needed some amount of risk sharing, something that no one had been willing to discuss before.

And the elections in Greece yesterday have made it even more clear that the consensus is gone. That the model that worked well until 2008 is being challenged by several countries. And without a minimum level of consensus, EMU cannot work. The problem is not that anti-austerity policies might stop in some countries. This is likely to benefit everyone in the short run including Germany. The problem is not that we might need to restructure Greek debt again, that is feasible from an economic and political point of view. The real issue is how to move forward, what will be the way in which the European Commission will deal with future budgetary plans of Euro members, how will the ECB treat sovereign debt in the future, how will markets perceive the risk of future default.

From the perspective of Germany (and other countries that share the same view and economic situation), any agreement with Greece that signals to the market that this would be the solution for any future crisis, would be a disaster. Germany needs a strong commitment from Greece and others that this would be the last time that this happens. But that is unlikely to happen. There could be promises but I cannot imagine how to make those promises credible.

So either Germany gives up and runs the risk of having similar negotiations later in the year with Ireland, Portugal, Cyprus, Spain and Italy. And it accepts the fact that we will be starting a new cycle of accumulation of government debt until the next crisis. Or it throws the towel. And I see this happening in two ways, either it refuses to be flexible in the negotiations with Greece and the ECB holds its promises that liquidity will stop unless there is an agreement, which will push Greece out of the Euro. Or Germany decides to leave the Euro and leaves the other countries to manage what is left. Both of these scenarios are likely to cause a crisis. The first one could potentially be more contained assuming the other Euro countries support Germany. The second one would be a major economic disaster for Europe and the world.

No, Syriza's policies are not that radical, crazy or absurd but the negotiation that starts today is between parties that are either scared by what has happened so far or are not willing to be members of a club that cannot commit to not doing this again. I still do not see how they will agree on a model to move forward.

Antonio Fatás
on January 25, 2015 |   Edit