Is it a Greece Choice?


What is the end game for Greece? I wrote yesterday that this was the endgame for Greece. How is it likely to play out?

• The big fear in the markets – the “nuclear option,” as it were – is that Greece defaults on its debt, abandons the euro and reinstates the drachma. This would of course cause chaos in Greece and huge losses among the other European countries that own Greek debt, directly or indirectly (through the ECB, etc.). To make matters worse, citizens in Spain, Portugal and maybe even Italy might worry that their country is next and send their savings en masse to Germany. That would be the biggest bank run in history and could cause the banking systems in those countries to collapse. Moreover, investors in other European countries holding stocks or bonds of those countries would suddenly have to hedge the currency risk. That could cause a huge flood of money out of the euro. The combination of the internal and external pressures could cause the euro to break up.

• Greek officials have been fanning the fears of the nuclear option. They reason that if it’s a choice between the nuclear option and a bail-out, the EU will go with the cheaper and safer option and come up with the money if they are scared enough.

• However, the EU seems to have a third possibility in mind. They seem to be slowly starving Greece of money by withholding funds and limiting the amount of Emergency Liquidity Assistance (ELA) that the ECB supplies to the banks until it finally capitulates and agrees to the EU’s demands. The next step may be to increase the haircut on the collateral that Greek banks have to put up for ELA funds, thereby further squeezing the banking system and the Greek economy.


• So what’s to prevent Greece from defaulting, leaving the Eurozone, reinstating the drachma, and carrying on with a clean slate and no debt? Several things:

1) Legally, Greece can’t leave the Eurozone without leaving the EU. That is the only way that a country can legally leave the euro. However, the government does not have a mandate to leave the EU. If they try, they may be voted out of office.

2) As long as they remain in the Eurozone, then European law only allows the euro as legal tender. The government would have to pay all wages, debts, pensions and bank deposits in euros.

3) Unfortunately, the country doesn’t have the money to do that. In 2014 Greece ran a small primary budget surplus (that is, revenues minus expenses not including interest payments) of 0.4% of GDP. When they started negotiating with the EU earlier this year, they expected a much larger primary surplus for 2015 of 4% of GDP. In that case, Greece could afford to default and alienate the markets, because it wouldn’t need to borrow any money so long as it didn’t have to pay any interest. However, the economy has slowed considerably since then and tax revenues have fallen, pushing the budget back into a primary deficit.


4) With a primary budget deficit, default and an exit from the euro would be worse for the Greeks than the hated austerity program. The government would not have the money to meet its campaign promises and would have to default to its own citizens, cutting pensions and public services while probably redenominating bank deposits into a much weaker currency.

• If either or both of those events happened, no doubt support for the government would collapse and the government would be voted out. I expect that once PM Tsipras and his colleagues realize that, then they will reluctantly agree to whatever demands their creditors make. My guess is that this will involve a referendum so that they can get public approval to renege on their campaign promises. At which point the party may split up and a new government form that in fact will have policies much like the previous one, after all is said and done.


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