Category: EMU

I wrote the following background piece in response to a request last week.  It’s similar to John’s Compact Logic.  My respondent wrote back:  “So a Yes will facilitate EU growth policies, the exact opposite of the No position?”. I was also asked about the consequences of a Greek exit:

Adopting the euro as our currency was supposed to give us much greater stability than the fixed exchange rate regimes that preceded it.  But if Greece leaves the euro, financial markets will no longer accept at face value a statement by a struggling country such as Ireland that it intends to remain within the single currency.  We are likely to see a repeat of the Irish currency crisis of the early 1990s when markets lost their faith in the fixed exchange rate arrangement of the time and Irish short-term interest rates quadrupled over the space of a few months.

Ironically, the currency turmoil of that time was triggered by the outcome of a European treaty referendum but, for once, not one of ours.  Everything had been proceeding smoothly towards the eventual introduction of the euro.  Financial markets believed that Central Banks would intervene to any extent necessary to defend existing exchange rates and a speculative attack on a currency could not possibly be successful.  All changed when Denmark voted no to the euro in June 1992.  It was possible that France would do likewise in September. Suddenly the single currency was no longer inevitable.  Sterling succumbed to  speculative attack and devalued, and attention shifted to Ireland.  Over a billion pounds flowed out of Irish financial markets over the course of a few days and short term interest rates soared to almost 60 percent.

The Irish government tried to hold off the speculators.  Currency control were reintroduced.  The Central Bank raised its lending to the money markets more than twenty-fold to prevent mortgage and commercial interest rates rising by more than 4 to 5 percent.  But this could not be sustained over the longer term as all the country’s foreign exchange reserves would be lost.  Ireland succumbed to devaluation in January 1993.

The same turmoil, with a run on the banks and a massive risk premium on foreign lending to Ireland, would undoubtedly follow a Greek departure from the euro.  The difference in the present case is that where then we had only our own Central Bank, we now have the European Central Bank with its vastly greater firepower.

The fact that numerous other countries would be calling on the firepower of the ECB at the same time, and possibly indefinitely into the future, is why the eurozone powers seem lately to have drawn back from the precipice of countenancing a Greek exit.

The ECB has recently shown itself ready to provide enough liquidity to stave off catastrophe.   At the behest of the Americans, the IMF and now the French, the German government now seems to agree that austerity alone on the fiscal side will fail, just as it did in the Great Depression of the 1930s. But can the Germans be expected to run deficits to stimulate the European economy, or countenance eurobonds – which would put their own credit rating at risk –  before the rest of the eurozone has promised to limit its borrowing?  As a German politician said this week, “you don’t lend your credit card to someone who doesn’t know how to control their spending”.

Lorenzo Bini Smaghi is fond of the word “irrational”. It appears several times in the article that Philip linked to yesterday. In particular, it seems that LBS thinks that Greek voters are irrational. Given that Greece is the birthplace not only of democracy, but of Euclid and the rest of them, it seems worthwhile querying the notion that Greek voters are irrational.

One evidence of their irrationality that is sometimes advanced is that while they have overwhelmingly rejected the current austerity measures in a democratic election, polls also show that they would like to remain in the euro.

What is irrational about this?

I guess the first best solution for Greeks is for Greece to stay in the euro, but for the current programme, based on multilateral austerity and internal devaluation, which has failed and indeed has no chance of succeeding, to be replaced with a programme which involves more debt forgiveness and more fiscal transfers from the centre. What is irrational from a Greek perspective about wanting this? That it probably isn’t going to happen is of course an important fact, but there is nothing irrational about wanting what is best for you.

Then there is the question of whether it is irrational to vote for Syriza. Let us assume that if Syriza forms a government with like-minded parties, and refuses to implement the current austerity programme, Greece is somehow ejected from the Eurozone. Knowing that this is a likely outcome, is it irrational for Greeks to vote for Syriza?

I’m not so sure.

If they vote for the two parties that have brought Greece to this sorry state of affairs — and why on earth would they? — then what is the likely outcome? The programme continues, and what Greece has lived through for the past few years continues for the next few years. This would offer zero hope for ordinary Greeks; no prospect of anything changing in the foreseeable future which might improve their lives. And in the end the strategy will probably fail, anyway.

If they vote for Syriza, perhaps Greece will leave the Eurozone. In that case, what happens? There is the certainty of a major economic crisis in the short run, but then what? Some commentators argue that the result will be hyperinflation. Given that the Greek primary deficit is very small, I am puzzled by the certainty with which this prediction is sometimes made. I suppose there is a certain probability of a very bad outcome like this occurring, but the probability is surely much less than one. On the other hand, there is also the possibility of default and devaluation leading to a recovery in two or three years. Again, the probability of this scenario occurring is less than one, but it is surely rather greater than zero.

And then there is the possibility that the Europeans will blink, and that the Greeks will get something like their preferred solution. I think this probability is vanishingly small myself, but perhaps I am wrong.

So, Greek voters can do what Europe’s elites are now urging them to do, and vote for the two establishment parties. In this case, they know with certainty that nothing will get better, and indeed that things will continue to get worse. Or, they can roll the dice. I don’t think it’s irrational for them to roll the dice. And thankfully, they seem to be gambling on Syriza, not Golden Dawn.

Of course, with a certain probability, which may be less than one, but is certainly much bigger than zero, a Greek Eurozone exit will lead to financial chaos elsewhere, and possibly even the collapse of the single currency. But that will primarily be our problem, not a problem for Greek voters.

So I am unconvinced by the argument that Greek voters are irrational, even if one only considers the economics of the situation they find themselves in. And this argument is strengthened when you consider non-economic factors. Everywhere in Europe you hear ordinary people saying that they feel powerless, that voting changes nothing, that they feel disenfranchised. In Greece, voters may be about to really change things, regaining some control over an agenda which has up till now been dictated by people like Lorenzo Bini Smaghi. I guess that many voters will derive utility from this.

Knowing all of this, leaders in other European countries should surely be trying to offer Greek voters something that the status quo excludes: hope. Instead, they are offering warnings about dire consequences, and statements to the effect that the rest of us can handle a Greek exit. You do have to ask: who is it that is being irrational here?

Charles Goodhart and Sony Kapoor have a really good article here.

If true this is madness. It can’t be true, surely: can it?

Dublin is lobbying Paris against pushing for changes to the core treaty text or anything that could be considered “constitutional” in character and require a second Irish referendum for ratification.

Source: here.