“Our economy is bleeding,” says Greek Prime Minister Antonis Samaras of the New Democracy party in an interview with German daily Süddeutschen Zeitung Thursday. It is for this reason that he suggested at a meeting the day before with Eurogroup Chairman Jean-Claude Juncker that Greece be granted more time to implement budget cuts and find new ways to raise revenue. Eurogroup is the association of European Union finance ministers, who together exercise political control over the shared euro currency.
Samaras is in no way exaggerating the situation. Greek paper Thema reports that since the beginning of the year, 1,250 businesses in Thessaloniki, the country’s second largest city, have shut down.
It was only in March that the country defaulted on 75 percent of its debt outstanding to the private sector—banks and insurance companies as well as individual investors. Whereas official holdings of Greek debt—mostly at the European Central Bank, the International Monetary Fund, as well as the European Financial Stability Mechanism—retained their full value. During the course of the debt restructuring, the above-named government institutions agreed on a timeline for Greece to return to financial stability and solvency, which mandates implementing budget cuts.
Most of these cuts must be delivered by 2014, but evidently Greece is not on track, as Juncker used strong language to claim that Greece is suffering a “credibility crisis.” In addition, despite Samaras’s promise, in his interview with the Süddeutschen Zeitung, that Germans will get back the $125 billion in loans they have already extended to Greece, German leaders are less sanguine about giving Greece more time—delaying cuts until 2016—a move that could cost creditors $24.8 billion according to the Wall Street Journal.
German Finance Minister Wolfgang Schäuble said in a radio interview with SWR2 Wednesday that allowing Greece more time would cost the creditors more money and that “more time would not constitute a solution to the problem.” He believes that renegotiating the contract after only six months would jeopardize the confidence of financial markets, something that the German leader thinks is very important. The next assessment by the creditor institutions will be undertaken in September.
German Chancellor Angela Merkel and French President François Hollande are meeting Thursday to hash out a common stance on Greece, as France seems to be more willing to be lenient in the matter. Then Samaras will meet Merkel Friday and Hollande Saturday to pitch his ideas, which according to an interview with France’s LeMonde, also includes selling some of Greece’s uninhabited islands: “As long as it doesn’t pose problems for national security, some of these isles could have commercial use,” and they could be sold as part of a larger privatization program.
Citigroup Sees Greek Exit as Early as September
Despite the fact that European leaders are still paying lip service to Greece remaining in the eurozone, chances of an exit are increasing according to a report by investment bank Citigroup: “While the ECB’s decisions may help limit the economic and financial market spillovers of Grexit (Greek exit), the likelihood of Grexit itself is coming into even sharper focus, in our view. There appears to be a sizeable—and probably unbridgeable gap between the Greek government’s ability to quickly cut the fiscal deficit and implement major supply-side reforms and privatizations, and the measures that creditor nations would require to extend further funding.”
Citi sees the likelihood of a Grexit in the next 12–18 months as high as 90 percent, but the analysts think that the timing will be crucial. Citi analysts do foresee a possibility that Greece could exit as early as September, if the report on Greece’s progress is very negative and creditors lose patience to extend further help. Nonetheless, creditor nations also have to make necessary preparations, which could delay the process: “However, creditor nations may provide enough funding to delay Grexit to after the December review, for example to allow plans for common bank supervision to be finalized.”
Result of Greek Exit Could Lead to Dissolution of Currency Union
If Greece were to exit, however, it could be the start of the complete dissolution of the eurozone. According to Peterson Institute economist Anders Aslund in his Aug. 21 column on the European policy website, Vox, the consequences would be disastrous: “If one country (Greece) departs from the eurozone … the current slow bank run from the south will accelerate quickly and become a massive bank run from most banks in southern Europe, and the banking system would stop working…If the drachma were reintroduced in the midst of a severe financial crisis, its exchange rate would plummet like a stone by probably 75%-80%. High inflation would result and mass bankruptcies ensue because of currency mismatches. Output would plunge and unemployment soar. Greece would experience a new default and other countries would follow.”
Examples from recent history include as many as three failed currency unions in Europe that all ended in hyperinflation as the participant countries sought to competitively devalue their currencies to escape an economic depression: The Habsburg Empire, the Soviet Union, and Yugoslavia.
In the three historical examples, however, it was a small wealthy country, rather than a small weak country, that exited and devalued first. Says Aslund, “In the three hyperinflationary currency union collapses, it was small, wealthy countries that left first: Czechoslovakia from the Habsburg Empire, Slovenia and Croatia from Yugoslavia, and the three Baltic states from the former Soviet Union. The countries that departed early and resolutely were most successful. Hence, the main concern should be whether small, wealthy northern countries want to abandon the eurozone.”
Given the severe reduction in economic output that followed the hyperinflations in the three prior distinct European monetary blocs—many of the member countries did not recover their GDP per capita in purchasing power parities until decades later—Aslund believes, “that the eurozone should be maintained at almost any cost.” If the currency bloc were to break up, however, “it would be better to agree on a complete and speedy dissolution into the old national currencies.”
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