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Friday, June 15, 2012

The Greek Vote, the Euro, and the Fall of Italy

I see a lot of doom and gloom stories coming from the European press over what would happen if Greece votes to reject the EU's conditions. There is, for example, this one today from the Daily Mail:
On Monday morning, this modern European nation could be waking up to a nightmare scenario, which runs as follows. The cash machines start drying up. Supermarket shelves are cleared by families fearful that food supplies will run out.


There are queues round the block for the last dribbles from the petrol pumps, and deliveries come to a halt. Within a day or two, protests have turned to looting and random acts of violence against strangers. Overwhelmed, the police retreat to their bases. The most vulnerable citizens lock the doors and pray.


And gradually, the country that gave the world ‘democracy’ descends into another word it also created — ‘anarchy’.
Is it really true that giving up its national sovereignty is the only solution for Greece, or is the media trying to scare the Greeks into voting in favor of turning control over to Brussels? Marc Faber has suggested that Greece should exit the Euro. Another economist, Martin Feldstein, suggests that it would also be better for Greece to leave the Euro and issue its own currency. (See also here).

This op-ed goes further, and actually suggest that it would be in the best interest of all if Germany were to withdraw from the Euro.
What, then, might a German exit do? With integration and multiple restructurings so unlikely and withdrawal of the weak members so fraught, it might actually be the best of all available options.


A single, powerful nation would have the best shot at executing a relatively swift exit that would be over before anyone could panic. No agonizing over who exits and who doesn’t. Stripped of its German export powerhouse, the euro would depreciate sharply, but would not become a virtually worthless currency, as, for example, any re-issued Greek drachma surely would. With the euro devalued, a Greek exit and devaluation would be relatively pointless. So, no contagion or bank runs. With new exchange rates making all the non-euro financial havens prohibitively expensive, and with the threat of forced conversion into devalued national currencies removed, depositors in southern Europe would lose their impetus to run.


Germany’s exit would provide immediate benefits to all the remaining euro-area nations. The currency depreciation would radically improve their trade competitiveness -- exactly what many observers have said the weaker nations in the south need most. The euro area’s balance of payments would improve, providing sorely needed funds to service its external debt. The benefits would accrue to the euro area as a whole, as opposed to serial exits at the weak end of the spectrum, which would crush one weak nation after another, with each exit increasing pressure on the next candidate.


Other relatively strong euro-area nations, such as the Netherlands, would probably pause before following Germany’s lead. If they left, they would lose the trade advantages offered by the newly depreciated currency, and would have to bear all the costs and complications of reintroducing their own money.


The cheaper euro, of course, would be bad for foreign investors holding euro-denominated assets. On the bright side, the losses would be simultaneous in timing, spread evenly across creditors, and more moderate in the southern European countries than they would be in a euro-exit scenario.
Meanwhile, Greeks have engaged in a silent bank run, as described in this story from CNBC from a couple days ago:
Greeks pulled their cash out of the banks and stocked up with food ahead of a cliffhanger election on Sunday that many fear will result in the country being forced out of the euro. Bankers said up to 800 million euros ($1 billion) were leaving major banks daily and retailers said some of the money was being used to buy pasta and canned goods, as fears of returning to the drachma were fanned by rumors that a radical leftist leader may win the election.


The last published opinion polls showed the conservative New Democracy party, which backs the 130 billion euro ($160 billion) bailout that is keeping Greece afloat, running neck and neck with the leftist Syriza party, which wants to cancel the rescue deal.


* * *


Fears that Greece will collapse financially and leave the euro have slowly drained Greek banks over the last two years. Central bank figures show that deposits shrank by about 17 percent, or 35.4 billion euros ($44.4 billion) in 2011 and stood 165.9 billion euros ($208.1 billion) at end-April.


Bankers said the pace was picking up ahead of the vote, with combined daily deposit outflows from the major banks at 500-800 million euros ($625 million to $1 billion) over the past few days, and 10-30 million euros ($12-36 million) at smaller banks.


"This includes cash withdrawals, wire transfers and investments into money market funds, German Bonds, U.S. Treasuries and EIB bonds," said one banker, who spoke on condition of anonymity.


Retailers said consumers were stocking up on non-perishable food while almost all other goods were seeing a huge drop in sales as cash-strapped Greeks have no money to spare in the country's fifth year of recession.


"People are terrified by the prospect of returning to the drachma and some believe it's good to fill their cupboard with food products," said Vassilis Korkidis, head of the ESEE retail federation.


"It's over the top, we must not panic. Filling the cupboard with food doesn't mean we will escape the crisis," he said.
At the Wall Street Journal, Gerald O'Driscoll explains some of the underlying issues with the Euro and why it is ultimately doomed to failure:
The euro is the world's first currency invented out of whole cloth. It is a currency without a country. The European Union is not a federal state, like the United States, but an agglomeration of sovereign states. European countries are plagued by rigidities, including those in labor markets—where language differences and the protection of trades and professions in many countries impede labor mobility. That makes it difficult for their economies to adjust to cyclical and structural economic shifts.

For such reasons, when the euro was created in 1999, Milton Friedman famously predicted its demise within a decade. He was wrong about the timing, but he may yet be proven right about the fact.

Greece is the epicenter of a currency and fiscal crisis in the euro zone. Markets fear a "Grexit," or Greek exit from the euro. That exit is almost a foregone conclusion. The endgame for the euro will be played out in Spain.

But first to Greece, which is devolving from a money-using economy. Firms, households and even the government are short on cash. The government isn't paying its suppliers and workers in a timely fashion, so households cannot pay their bills to businesses with whom they transact. Businesses, in turn, cannot pay their suppliers. There is a cascade of cash constraints.

Normally, credit supplements cash in economic transactions. But there is scant credit in Greece. Anyone who can is moving their money out of the country, either to banks in other euro-zone countries, such as Germany, or out of the euro to banks in Switzerland, the United Kingdom and U.S. (the franc, pound and dollar, respectively).

Absent a truly dramatic event, Greece will exit the euro not by choice but by necessity. It will do so not because the drachma (its old currency) is superior to the euro, but because the drachma is superior to barter. Greek standards of living, which have already fallen substantially, will fall further in the short- to medium-term. It will then be up to the Greek people to forge a new future.

While a Greek exit from the euro zone will have substantial repercussions, it won't unleash the doomsday scenario painted by some. A Spanish exit would be an entirely different matter. Unlike Greece, Spain is a major economy. According to the International Monetary Fund, at official exchange rates in 2011 the Spanish economy was more than five times the size of Greece's. And unlike Greece, Spain has numerous banks, some large and global.

The Greek tragedy began with a fiscal crisis—brought on by the government spending more money than it took in—that became a banking crisis. In Spain, there is a fiscal crisis that exacerbates a banking crisis.

Fiscal and banking crises are often linked because in modern economics the state and banking are joined together. Banks purchase government debt, supporting the state, and governments guarantee the liabilities of banks. When one party is weakened, so is the other.

Spanish banks are impaired not only because the Spanish government is running large fiscal deficits, but also because of bad loans to the private sector. Many Spanish banks lent heavily to property developers and to individuals who wanted to purchase homes built by the developers. Spain's construction sector is substantially larger relative to the rest of its economy than is the construction sector in other euro-zone countries or the U.S. And bank debt to finance that sector grew much faster than elsewhere.
Finally, at the Ulsterman Report, in a recent interview with the unnamed "Wall Street Insider," he warns:
Related to this situation is not the situation in Spain, but the dire condition of Italy. If Spain buckles, the European Union will survive. If Italy soon follows, that may prove the Euro’s death blow. The man calling himself Obama, when most recently told of this potential outcome, was entirely indifferent. This indifference is likely the direct result of his ignorance. So let me re-affirm again, it is the situation in Italy that you must watch. Not so much Spain but Italy. The Italians are in very serious trouble and the implications of that economy collapsing are immense and the shock waves will reach America soon after. Measures are being taken to avert this crisis, but it is a crisis that stems from decades of fiscal neglect, and the outcome is at this time, entirely unknown to me. If Lagarde pushes but a bit harder, Italy will collapse.

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