June 20, 2012

We're Doomed! No, We're Saved! Euro Scenarios

Patrick Marren
Partner

Scenario consulting has rarely had a better promotional material than Europe has been pumping out the past year or so. Uncertainty abounds.

Sunday's election in Greece has once again caused the Very Serious People in Europe to breathe a sigh of relief. "New Democracy, the mainline conservative party that wants to stay in the euro, won the election and can form a government! We're saved!" 

But Sunday's result guarantees nothing. The ultimate fate of Greece's membership in the Euro Zone rests not on which party is in power – the Coalition of the Radical Left, Syriza, had also promised to stay in the euro – but rather on macroeconomic realities. And those realities tell me that Greece probably cannot stay.

Austerity has taken a terrible toll on the Greek people. Sure, they over-borrowed and didn't know when to say when. That's what happens when a people that used to face 32% mortgage rates suddenly has German and French bankers pushing loans onto them and telling them that, sure, they can afford to take on more debt. How would they know? No one had ever lent Greeks a dime before. "Ta faghame ta ola," as a Greek friend told me last year – "We ate it all." 

But now, Greek unemployment matches the absolute worst ever experienced in America during the Great Depression – without anything like the tremendous natural resources and market size America still possessed in the early 1930s. And Greece, unlike America in the 1930s, does not control its own currency, and cannot therefore cut down its debt burden through devaluation. 

Not that I blame German taxpayers for being angry about being asked to foot the bill for Greek politicians' extravagance and dishonesty. Greece is the one country in the euro zone that actually was as improvident and unreliable as some northern Europeans like to pretend all the "PIIGS" (Portugal, Ireland, Italy, Greece, Spain) were. And they seem not to be trusted to stick to agreements made on austerity packages.

But there is a fundamental disparity between the annoyance suffered by the Germans on the one hand, and the profoundly destabilizing suffering of the Greeks; and there is a similar disparity between that Greek suffering and the culpability of the average Greek for his or her own situation (usually slight).  Greeks on average work more hours than Germans, and the percentage of their GDP spent on social welfare is less than that spent by Germany. 

More telling, the victory of New Democracy doesn't mean that austerity will be lessened. On the contrary: ND's victory means that it will be maintained, at the least, and perhaps tightened a bit more. To date, austerity has meant a continuing round of declining GDP, hence declining tax receipts, hence a lessened ability to pay off debt, hence a larger debt burden compared to GDP...and hence another round of aid from the northern Europeans, tied to another round of harmful austerity measures. And so the whole cycle begins anew. An economy that is completely stalled cannot pay down ANY level of debt, no matter how small. The debt can only grow.

The lack of a central political-economic authority has meant that EU policy responses have been too late, due to the necessity of inter-country negotiation, and too small, and too often accompanied by contractionary conditions that exacerbate the suffering and guarantee continuation of the crisis. There is no particular reason to believe that the current slight tilt toward stimulus away from austerity, resulting from electoral defeats for every austerity-supporting government that has faced an election the past year, will be large enough or swift enough to end the Greek tragedy. 

Add to all this the fact that the effects of economic policies tend to lag their implementation, and it's highly likely that Greece has not even hit bottom yet. So good luck to Mr. Samaras, the new prime minister. He will need it. Because he is very likely to preside over the exit of Greece from the euro. The one potential upside? Frank default and leaving the euro may, after the initial hit, be the best course of action for the country. It could finally mean an end to the entire brunt of the economic burden being borne by the average Greek worker. Which might be the best political outcome for ND and Mr. Samaras.

And any further streaming toward the euro exits by Spain, Italy or others? Or the knock-on effects of a Euro Zone mess on the U.S.? Not the Greeks' problem anymore. 

A Syriza victory would probably have meant a swift exit from the euro. But a ND victory may only delay that exit slightly.

Comments  | 

Lance Benton
The most concise and easily understood analysis that I have read so far. Well done. r/LOB
Mark Safford
The Euro crisis in Greece and other nations may also reveal the impossibility of trying to establish a common currency across several nations without also assuring a common monetary and fiscal authority that can make uniform decisions for all of those same nations. Without the equivalent of a U.S. Treasury and Federal Reserve System that can make the same decisions for all nations using the Euro, there is no way to assure that these sorts of localized crises will not continue to occur. It may be better to declare the Euro an interesting but premature exercise in greater European cooperation until all member nations agree to submit to a single economic authority.

Thoughts?