As European finance ministers last week converged on Wrocław in Poland for a meeting of the economic and finance grouping of EU member states, the so-called ECOFIN meeting, many analysts and commentators were talking more openly about the modalities of a Greek default. This is still vehemently denied by most governments in Europe, not least by the government in Athens, but it is worth considering how exactly it should be done.
The first question is which should come first for Greece: exit from the Euro or default on its debts (thanks to Klaus Giesen for first raising this). Looking at the commentary in the financial press, most assume that a default will come first, either by necessity or simply because defaulting might not automatically mean Greece has to leave the Euro. In its weekend edition, the Financial Times considered the option of a Greek default, followed by a more favourable assessment by private creditors of its growth outlook paving the way for Greece’s return to international loan markets. It seems also clear that default would come first, simply because of the difficulties of preparing to introduce a new currency without anyone finding out. Were it to emerge that Greece was secretly printing a new Drachma somewhere, there would be a run on its banks and any existing loans would dry up.
If a default occurred, and this put a stop to the money currently entering Greece via the European Central Bank and the IMF, the government would be unable to pay its everyday bills. It would not have enough money to pay its civil servants or to meet its welfare obligations to its citizens. At the same time, Greece’s banks are heavily exposed to its own government’s debt: a default would leave the banks high and dry. In this respect, the economy would grind to a halt. Greece would be left with two options: exit the Euro and begin issuing its own currency in order that it can start paying its own bills and recapitalize its banks; or sit in limbo, hoping that some kind of help will come from outside, whilst on the ground in Greece the cash economy gives way to a temporary bartering arrangement and the creation of quasi-currencies in the search for some kind of medium of exchange.
Putting all this into some perspective, and if we remember that Greece’s economy accounts for only a tiny proportion (less than 3%) of the overall Eurozone economy, the most likely scenario would be for Greece to default and – assuming that wasn’t enough to convince private creditors that it could return to growth in the medium term – it would exit the Euro but in a way that saw it tided over by loans from the EU. The difficult period between default and a new currency winning some kind of international credibility could be made easier by help from other European governments.
What makes this orderly default and exit from the Eurozone unlikely? Everything hangs on the problem of what analysts are calling “contagion”. In fact, contagion is the wrong word. The problem is simply that if Greece’s default were to work in Greece’s favour, it would make it seem attractive for other crisis-stricken countries like Spain, Portugal or Italy to follow, raising the prospect of a mass default that would be incredibly expensive for those banks exposed to government debt in those countries. But if Greece’s default were to be a complete mess, that would also spook the markets, making it seem as if there was no alternative to keeping the Eurozone together, putting the spotlight on the political problems faced by Merkel, Sarkozy and others. So for a Greek default, both success and failure would cause problems: damned if you do, damned if you don’t.
Much of the concern about the Eurozone thus rests on the nebulous idea of “contagion”, a term which gains its force from its implication that events can develop randomly and in unexpected ways, a little like the spread of an epidemic. In fact, there are strong reasons to suppose that a Greek default and/or exit from the Eurozone could be contained. Greece is not Italy or Spain. The underlying basis of these economies is quite different, with the fundamentals in Italy in particular being much stronger.
What prevails in contemporary analysis is as much an overwhelming pessimism with the ability of democratically elected representatives to tackle contemporary economic problems as it is a clear-headed assessment of economic fundamentals. It is this lack of faith in democracy that is making the Eurozone crisis so intractable, not the objective and relentless laws of the markets.