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lundi 14 mai 2012

OUR GREEK BROTHERS: The Prodigal Greek The Greek crisis through a different prism: Ground zero

Courtesy of Yannis Mouzaky

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The Prodigal Greek
The Greek crisis through a different prism

Ground zero

The result of May 6 elections in Greece led to a complete reshuffling of the local political dynamics, shook the relative calmness post the completion of the PSI and brought back with intensity on the agenda the country’s exit from the euro zone.
The undisputed momentum of the radical left party of SYRIZA, combined with the inability of the local political establishment to handle the outcome of the elections in a nationally united manner, will most likely lead to a repeat election mid June and potentially in a prolonged period of political instability and governance void.
SYRIZA’s leader Alexis Tsipras, whom polls last week saw in the first place in the event of an elections re-run, has a revolutionary view of Greece’s relationship with the troika, combined with some radical proposals in terms of the country’s fiscal response to the crisis. This has brought back the stand-off between European officials, in particular Germany, and parts of Greece’s political establishment.
Cornerstone to SYRIZA’s ideological platform is the belief that Greece has a strong negotiating position on the basis that it will never be left or pushed to abandon the euro because such a development would have severe implications for the entire eurozone, already in fragile condition after Spain’s troubles have been added to the mix.
On the other side of the argument, there are those who believe that the euro now has now built strong defences to withstand such a shock with the ability to contain the impact.
The impact on euro zone of a potential Greek exit, Spiegel magazine estimated today the damage for Germany to be me the region of €77bln, will depend on the response from the ECB, which recently through LTRO showed that is willing to intervene in unconventional ways to support the single currency.
On the other hand, it is possible to map how a potential exit will impact the Greek economy and based on past crisis episodes estimate how the developments will unfold.
Thus far, the Greek political establishment and mainstream media have approached the topic of euro exit in a rather superficial manner, always under the pressure of the receipt of a tranche or the vote of an austerity package, attempting to shock the public with references of empty super market shelves, shopping tokens, closed schools and under-performing hospitals.
Considering the new dynamics in the Greek political arena, it is essential the Greek people are sufficiently and intelligently informed on the impact of a euro exit, provided the country’s strategy and negotiation with the troika could incorporate a change from the approach to date and attempt to apply pressure with a potential euro exit episode.
The post does not attempt to take a political stance in the debate.  The sole intention is to highlight a probable sequence of events from a Greek euro departure.  There is a body of respected economists that since the beginning of the crisis support the view that an exit from the single currency is the best solution to the country’s troubles.  However, even the euro exit supporters agree that the impact of such a move in the short-term will be painful.
The crisis and solutions implemented over the last two years have developed in such a way that euro membership or exit are a choice for Greece since by treaty a country can only voluntarily exit the union and subsequently the euro.
Currently, Greece’s access to euros comes from two sources, troika loans and the ECB through the euro-system. Should Greece decide a stand-off with the troika that will lead to the withholding of the program’s next tranche, the country will find itself with no funds to re-capitalise its cash strapped banks and no money in the escrow account to meet debt obligations, something that will lead to default.  Greek banks’ only source of funds at the moment is the ELA through Bank of Greece, something that in the event of default is highly unlikely that the ECB will allow to continue.  Without the recapitalization from the EFSF and with no access to the euro-system, the country will effectively find itself without a banking system, and without a banking system economic activity will come to a halt.
It will not be a diplomatic gang up of eurozone partners attempting to oust Greece from the euro.  It is Greece itself, dry from cash, that will make the forced decision to leave the euro and return to a currency that its central bank will control.
Upon introduction the new currency is expected to devalue between 30-40% relative to other major currencies, automatically wiping out the equivalent of the purchasing power of the country for all transactions outside Greece.
As much as this loss of value for the newly introduced currency will favour the trade balance, since imports of final goods will most probably collapse, Greece remains dependent for large parts of its raw materials and energy on imports.  This increase in costs will eventually get cascaded to the final products and services leading to significantly higher prices and inflation levels.
Provided that the government will remain outside the markets, it will need to monetarise the running deficit of 2012 and print additional money to recapitalize the failing banking system, it will significantly increase the money supply further putting upward pressure on prices.
In the first weeks after the exit announcement, they usually come in the weekend, the government will need to impose capital controls in an attempt to avoid capital flight and control the hard currency reserves of the central bank.
The Greek central bank in an attempt to avoid a run on the currency, exit from greek currency denominated assets and control its hard currency reserves, will probably raise interest rates to levels high enough to entice Greek currency holders to hold on to it.  The effort to maintain some level of stability in the banking system, almost with certainty will bring a deposits freeze and controls on the amounts of withdrawals.
There is nothing to guarantee that those measures will suffice to keep the situation under control.  Combining with the need of businesses for cash since no partner outside Greece will be trading with them on credit, the central bank will need to print additional money that through the banking system will flow in the market intensifying the inflationary pressures.
The Greek economy will experience in the short-term a collapse in domestic demand that will not be able to substitute with foreign demand, unlike other crisis hit nations that managed to export their way out of their crises in much more favourable global economic prospects.  Some economists estimate that euro exit could cost Greece as much as half of the GDP on grounds of collapsing consumption and investment.
The abrupt stop of economic activity will have severe impact on the budget revenues and the government will need to cover this shortfall with additional money printing, further eroding the value of the new currency.
This collapse in domestic demand, combined with an only modest increase in exports, will eventually lead to unemployment levels significantly higher than the current 21.7% feeding the vicious cycle of lower tax and social insurance revenues, higher transfer payments and increasing budget deficit.
After two years of severe recession, loss of disposable income, disappointment to the point of desperation and growing anger, there is very little to suggest that the social fabric is strong enough to withstand this severe shock in a composed manner.  Social cohesion and democratic institutions will be tested.
Tourism, along with shipping the only substantial sources of hard currency in the country, is expected to take a further hit from the one already experienced this year with arrivals and revenues significantly lower as a result of the uncertainty around the country’s place in the euro zone.  The rebound of the Greek economy from tourism that many expect after the euro exit and new currency devaluation is overestimated.  There is higher probability that Greece for a period will be avoided as a destination in light of the uncertainty and the perceived hostile sentiment against certain European nations rather than take advantage of the cheaper touristic product that the country will have to offer.
From a macroeconomic perspective, should Greece decide to follow a euro exit path, could find itself within a matter of months having lost a substantial portion of its GDP, inflation in the region of 30%, unemployment much higher than the current devastating levels, a complete halt to investments further impacting the country’s competitiveness and large parts of the society, primarily the weakest, paying the high price with incomes and savings wiped out by an eroding from inflation new currency.
The entire spectrum of Greece’s political establishment agree on their intention to change  the course that the country has taken as a result of the EU/IMF austerity programs.  However, a potential euro exit will not necessarily have the desired result and it is highly likely that it will force the country even deeper into the recessionary spiral.
The dynamics in Europe are gradually changing after the election of a socialist president in France, the collapse of the Dutch government over new austerity measures to comply with targets, voices even within the European Commission speak of addition of growth inducing measures to compliment the fiscal pact.
Now is the time for Greece to ensure that it stays in the game, see how things will play out and putting political differences aside, form a unity government that will present a comprehensive national plan with the aspects of the program that require amendments and will give the country more room to breathe while it puts its house in order.
 Food for thought…

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