Will Greece leave the euro?

Chris in Paris has been doing a great job covering the Greek financial crisis, by far the worst in Europe. His latest pieces are here, here, and here.

Now we are starting to find speculation that the Greece may be forced by circumstances to abandon the euro, and the euro has responded with a sharp drop, from a high-flying $1.48 and change (fueled by talk of higher interest rates) to a chastened $1.43, thanks to speculation about Greece. That five-cent drop took just two days. (Oops, now $1.42 as we speak.)

One of the voices recommending a euro exit is Mark Weisbrot (h/t Paul Krugman), who writes in the New York Times:

Sometimes there is turmoil in the markets because a government threatens to do what is best for its citizens. This seemed to be the case in Europe last week, when the German magazine Der Spiegel reported that the Greek government was threatening to stop using the euro. The euro suffered its worst two-day plunge since December 2008.

Greek and European Union officials denied the report, but a threat by Greece to jettison the euro is long overdue, and it should be prepared to carry it out. As much as the move might cost Greece in the short term, it is very unlikely that such costs would be greater than the many years of recession, stagnation and high unemployment that the European authorities are offering.

Weisbrot then talks about Argentina, which was in a similar situation — a long and deep recession with very high international debt. Yes, they had their own currency, but the peso was hard-pegged to the dollar. With that peg in place, Argentina had as little control of its currency as Greece does today. Weisbrot notes that:

Argentina defaulted on its foreign debt and cut loose from the dollar. Most economists and the business press predicted that years of disaster would ensue. But the economy shrank for just one more quarter after the devaluation and default; it then grew 63 percent over the next six years. More than 11 million people, in a nation of 39 million, were pulled out of poverty.

So the first piece of information I want to point you to is this — it's likely in Greece's interest to cut loose from the euro; even the credible threat to do so would get Greece a better deal from the austerity-loving Germans and others like them in the core eurozone.

The second piece is this: Argentina indeed defaulted on its debt. That's the national equivalent of declaring bankruptcy, and sometimes, that's what you have to do. (As my amoral business friends like to say, "It's not immoral, it's business. It's only immoral when humans do it.") The same with Greece. As Weisbrot states, "Greece would not pay this debt," so even the inevitable devaluation (and attendant increase in the debt burden) would not matter to them. Your debt can be anything if you're not going to pay it.

Weisbrot recommends that Greece leave the euro, or at least make a credible threat to do so. Krugman goes less far:

I agree with a lot of what he says, but am still not ready to counsel that step, for a couple of reasons. First, while I agree that Argentina is the right parallel, it’s an imperfect parallel: although Argentina had a supposedly irreversible peg, it still had peso notes in circulation, so the mechanics of exit from the peg were much easier than exiting the euro would be. ... Second, Greece, as a relatively poor country with a history of shaky governance, has a lot to gain from being a citizen in good standing of the European project[.]

The mechanics of a euro-exit matter a lot. (By the way, that link on the phrase "Argentina is the right parallel" is a very good read.)

My third piece of info is about those mechanics — they may be self-triggering. Krugman agrees that Greece will inevitably default, in any scenario. But, he writes in a separate article:

the main argument against the possibility of a euro breakup has been precisely that any hint of exit would unleash the mother of all bank runs.

He adds that while no one would deliberately want to trigger that, if a banking crisis were to occur anyway:

I can easily see how events could lead to a situation in which euro exit becomes the least bad option.

So if you're watching the euro, for whatever reason, watch the banks in Greece. While no one may want the crisis that a euro-exit would cause, that crisis may show up first, making the exit eminently thinkable.

GP