Thursday, 24 May 2012

The Inevitable Option

With the people of Greece going to the polls for a second time, after pro-austerity parties were not supported as much as needed (Funny that!), the possibility of a Greek exit from the Eurozone has become increasingly real. The The fall out this could have for the rest of the zone and the world would be massive. However a state in which Greece would keep the single currency could potentially do even more damage in the longer term. Let’s have a look at what could happen next if Greece decided to leave the zone and return to the Drachma.

First off the Drachma would plummet in value against all other currencies, and fast. This would then make imports, which include a lot of food and medicine for Greece, much more expensive and exports extremely cheap. There would almost certainly be a run on Greek Banks which would leave them on the brink of collapse. Greeks would not be able to easily access their own savings, many businesses would go bust due to lack of funds. This would also impact on other European Banks, particularly French ones, which have lent heavily to southern Europe. These banks would become nervous and slash their lending. Thus forcing many firms and consumers to cut back on their own spending. Events that all strongly point to a potential Eurozone recession. Furthermore all this would increase investor’s nervousness across the world, thus leading to the value of stocks falling and the selling off of many risk assets while the fight over safe assets would begin. Moreover let us not forget the immediate impact this would have on other zone states such as Spain especially and Italy. Access to market funds will become even harder as bond yields rise, leaving bailouts as the most viable option. In all, the worst case scenario is that the global economy falls to its knees once more.

However if Greece decided to keep the euro, which basically depends on the results of the second election in June, what would happen then? Well first off it would have to devalue to become more competitive in order to reduce its debt in the long term. The only way it could do this is through internal devaluation, reducing the unit costs of the goods and services it produces to increase its total exports. However with the unions in uproar already due to the savage public sector reductions already in force, anymore action towards reducing the public sector and its costs in further will face increased opposition. Secondly it is likely that the Greek Government would have receive further funds into to keep up with its debt repayments, something that seems increasingly unlikely due to both increased resistance by the German taxpayers and the lack of belief from other zone countries that Greece can actually pay back its debts. The pressure by investors on other southern states such as Spain and Italy would also mean that more bailout funds could be needed. In all it would be a costly and painful process for not only the Greek people but the majority of Europe.

Regarding the longer term existence of the euro, two main ideas have been put forward by both politicians and commentators. The first, which is being advocated by the new French government and is supported by Greece, is the creation of Eurobonds. These are bonds, probably 10 year bonds, which would be released by the zone states together which would allow them all to borrow money from the markets, in all it would be collective debt for the Eurozone. With Greece, Spain, Italy and Portugal facing increasing difficulties and costs from borrow money by releasing separate bonds; Eurobonds would allow these countries to borrow at a cheaper rate thus increasing the possibility of these countries repaying their debts. The main opposition to this is from Germany, who argues that it goes against the EU treaty and could lead to a large increase in costs for their country who can currently borrow around zero, or even negative, rates.

The other suggestion is increased integration of the Eurozone countries, both politically and economically. Some analysts have stated, rightly in my opinion, that creation of the euro was flawed from the beginning due to its failure to have both fiscal and monetary integration of member states. A need for a ‘United States of Europe’ or something to that effect would be needed for the zone such that if problems, like that in Greece, arose again then a transfer union and central fiscal authority would greatly help troubled zone states. This is similar to the way some poorer states, such as New Mexico and Mississippi, in the US are compensated by richer states, such as New Jersey and New York. While the future of the Eurozone and its type of existence still has some time to be decided, the current existence of Greece in the zone has not got time and even multiple options. The inevitable has finally come. The Greek exit will, for the sake of its people and the future of the euro project, and needs to happen.

Author: Thomas Viegas

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