Friday, 1 June 2012


I wrote in February that the Greek bailout couldn't and wouldn't work, linking to commentators who pointed out that the plan relied on unrealistic growth projections, and predicting myself that the Greek electorate would in any case vote against the plan.

Three months later, things have moved on.  The "Sustainability Report" behind the plan projected that the Greek economy would shrink by 4.3% in 2012, or by 4.8% in a downside scenario.  Now Official estimates published this month say there was a contraction of 6.2% in the first quarter alone.  There is nothing at all to make one think that's going to turn around: rather the uncertainty, and in particular the possibility of an exit from the Euro, is making things worse (why invest Euros when you may get back Drachma, or pay bills in Euros when you may be able to pay them in Drachma).  The plan is already hopelessly off course.

Also this month, the Greeks held a general election (a little later than previously promised).  The result was that PASOK and New Democracy, the two parties which had backed the austerity deal - previously the two dominant parties - lost a lot of support, PASOK especially.  (Because of the collapse of the PASOK vote ND emerged as the largest single party, which earns a 50-seat bonus, so it actually increased its number of seats.)  It proved impossible to form a government, so the electorate will vote again on 17th June.

So the bailout plan is failing, and the Greeks can't abide it anyway.  What next?  Greece seems to have been a vote against austerity, but not against the Euro.  However, there are limits to what can be decided democratically.  Absent armed intervention, a country's government can make all sorts of decisions about how to run the economy, including choosing not to pay its debts.  But it cannot decide that other countries should give or lend it money.  So if the bailout money stops flowing, Greece will run out of Euros.

Suppose that the June election results in SYRIZA being able to form a coalition government.  The likely policy of such a government would be to attempt to renegotiate the austerity plan.  The new French government might be sympathetic, but it's Merkel that decides.  Merkel would have to address the fear that if Greek banks are allowed to fail that will increase the perceived risk of failure of banks in Spain and the other PIGS, and if Greece leaves the Euro that will increase the perceived redenomination risk (i.e. the risk of having one's money in the bank converted to a new, rapidly depreciating currency).  Either way, there would be a run on the banks, in Spain especially.  This would be so bad for Germany that the Greeks might hope that Merkel is just bluffing when she insists they have to stick to the austerity plan.  However, Germany is a democracy too, and its electorate seems unsympathetic to Greece.  I expect Merkel to offer some modest measures to promote growth, but no more.

If the EU and Greece can't agree a bailout plan, can they agree a plan for Greece to leave the Euro?  I can't see them suddenly becoming decisive.  My guess (but my crystal ball is rather murky) is that there will be no formal divorce.  Instead, the Greek government will introduce a New Drachma in parallel with the Euro, with whatever legislation is needed to allow it to meet its domestic obligations in the new currency, and to make it possible for the recipients to buy stuff and pay mortgages with it - there would be an official conversion rate for these purposes, but no right to exchange Drachmae for Euros.  Legislation would follow piecemeal to address the resulting difficulties by extending its use.  And Gresham's law would operate.

Meanwhile, I have one helpful suggestion.  Greece should cut its arms imports to zero.  That's a big cut, Greece is Europe's largest arms importer, and the tenth largest globally.  Its debt would be manageable now if it hadn't spend so much on arms over the last twenty years.  And cutting arms imports would do no damage to the economy - there's no multiplier effect on such spending.  It would need to cancel existing contracts, but since the largest contracts are with Germany and France, which are anxious to see Greece balance its budget, that should present no problem.  And if Greece perceives a military threat from Turkey, the European powers can meaningfully guarantee to protect it - a free promise, since Turkey is not in fact going to start anything.

Yes, you're right, that's a hopelessly impractical suggestion.  Germany and France are strongly in favour of Greek budgetary responsibility, but not so strongly as they're in favour of their own exports.


  1. Nice try, Paul. But as you say, hopeless. Last October, just before the bailout agreement, France sold Greece frigates on a DFS-style "buy now, pay later" deal. Germany objected of course - but not because of the complete irresponsibility of selling arms to a country on the point of default. No, they objected because their arms manufacturers wanted the deal and they thought the French had stitched them up. Charming.

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