In memory of Dr. Andreas Höfert

Grexit is easier done than managed

| Tags: Andreas Höfert

Neologisms can spread like bushfires. Just days ago, no one would have understood, what “Grexit” means. Now, it is a buzzword used by all sorts of pundits and financial TV talking heads. Grexit, the exit of Greece from the Eurozone, is not science fiction anymore.

A Grexit could occur in two ways. One: ongoing bank runs. Two: the European Monetary Union and the International Monetary Fund stop funding Greece.

Since the failed parliamentary election on 6 May, the run on banks in Greece, i.e. the withdrawal of bank deposits, already present before, has sped up dramatically. Several news agencies reported that last week, over 700 million euros were taken out by the Greek population in one day alone. So far the European Central Bank, and in some cases the Bank of Greece through the European Liquidity Assistance mechanism, have been able to compensate for this liquidity outflow. However, the Bank of Greece’s liabilities to other Eurozone central banks now stand at around 100 billion euros. If the ECB stopped the Bank of Greece from lending to other banks in Greece, Greece will have to exit the euro and print its own money.

A new parliamentary election will take place on 17 June. If this second election fails again to deliver a stable majority or a majority compliant with the austerity measures agreed upon in the last rescue package, then the country might also be forced to leave the euro, because without the external help the Greek government cannot finance its outlays anymore.

A Grexit is definitely not something European politicians officially want. Eurogroup President Jean-Claude Juncker commented forcefully last week, “It is our unshakeable desire to keep Greece in the eurozone. We will do everything possible to this effect.” This is, however, the same Jean-Claude Juncker, who said just a year ago, “When it becomes serious, you have to lie.”

Mendacity aside, the truth is a Grexit can happen, and it would have dismal and dangerous consequences both for Greece and for the Eurozone.

Many economists still explain that a Grexit would be the best solution for Greece. The new drachma would depreciate heavily against the euro, allowing Greek exporters to be competitive again, the Greek economy to grow and everyone to live happily ever after. This might be true in the long run, but remember John Maynard Keynes, “In the long run we are all dead.”

Even if Greece defaulted on all its remaining debt, once it left the euro it would still have a primary government deficit, so that even without paying interest on outstanding debt, the Greek public budget is not balanced. There are only two ways to tackle this: with more austerity or by financing the deficit through the printing press. With the Greek economy currently depressed, we assume that using the printing press would irremediably lead to hyperinflation there.

Europe would bear severe consequences from a Grexit. Here again, some economists take a rosy view that without Greece, the Eurozone will solve its crisis more easily, even that a Grexit could boost the euro because it is one weak country less. The long run may tell, but short-term, a Grexit creates a precedent in Europe.

Portuguese, Irish, Spanish, even Italian savers will grasp that their bank deposits now risk being converted; runs on the banks in those countries might result. Such runs could only be stopped by creating a Europe-wide bank deposit guarantee: This must happen quickly. Given the track record of European politicians in this crisis, I doubt that this would happen in time. However, if the run on the banks in the European periphery is not stopped, then in a self-fulfilling prophecy, those countries will also be forced to leave the euro. The question then is, where does it stop?

The fact that the management of the crisis after a Grexit is far more difficult than the Grexit itself leads us to estimate a scenario probability which is lower than 50%. Still, the probability is higher than zero.