As the impasse between Greece and its creditors is approaching an inevitable
train wreck resolution, commentators who should know better have depicted the possible outcomes as Grexit or a deal. As we have said from the outset, the best of Greece’s bad options is a default while staying within the Eurozone. And given that a Grexit would be messy, would result in losses on the ELA and potentially Target2 balances being allocated to member states (a political nightmare) and could lead to eventual political contagion (as in paving the way for future departures) the least risky path for the EU and Eurozone is also to keep Greece in the fold.
As Ed Harrison discusses in a Boom/Bust segment, a default in place is the most likely outcome of negotiations that have degenerated into Greece and the Troika talking past each other. The news wrap starts with an update on Greece and moves straight into the interview with Ed.
Keep in mind that Schauble saying that Greece must stay in the Eurozone is a big shift in his position; he has repeatedly said in the past that if they can’t adhere to the rules, they should leave. However, even though Varoufakis and Schauble now agree that there should be no Grexit, that decision does not lie in their hands. The key party whose forbearance is necessary is the ECB. Now it might seem obvious that the ECB has plenty of reason to accommodate what Germany apparently wants. However, the Bundesbank’s Jens Weidemann has yet to weigh in on this issue, and it is possible that he is more bloody-minded than Schauble. Moreover, the ECB has long been uncomfortable about the use of the ELA, which is meant to be used only with solvent banks that are having temporary liquidity problems, to prop up insolvent institutions.
However, the ECB has plenty of latitude to do as it pleases, and Draghi’s official policy is to do whatever it takes to keep the Eurozone intact. As Paul Murphy at FT Alphaville points out:
Received wisdom has it that the ECB will withdraw the ELA — emergency liquidity assistance — currently propping up the Greek banking system, which will promptly collapse; Tsipras and Co would then be forced to bring back the Drachma (or similar) and Greece would exit the eurozone.
But what do the “rules” here say? In the case of the ELA they run to all of two pages…..Now, Malcolm Barr and the economics team at JP Morgan remind us that when we are talking about Mario Draghi and the ECB, it helps to think of “rules” in the sense of…
vaguely specified guidelines with scope for multiple interpretations at differing points in time
With that in mind — and having studied that ECB ELA two-pager in full — Barr reckons the ECB governing council can pretty much do what it likes in the event of a Greek default, since the rules as they stand are self-imposed and self-policed…
The JPM line here is that sure, Greek default will bring on capital controls, but it is a mistake to assume that it will lead straight to euro exit. There’ll be lots more to play out first, such as a break up of Syriza, maybe a Greek referendum on euro membership, or even the introduction of a quasi parallel currency in the country, such as government IOUs or tax credit notes.
A critical issue to keep in mind is that a default does not bring Greece relief. The prospect of a Grexit (remember, it’s rational for Greek depositors to prepare for the worst) means an acceleration of the ongoing bank run. The imposition of capital controls would further fray nerves domestically, given that polls show majority opposition to leaving the Eurozone. Ongoing cash hoarding plus uncertainty will further weaken the already very sick Greek economy. That will hit tax receipts. If Greece has to resort to issuing TANs or other government scrip to pay workers and pensioners, that will likely further damage confidence. Thus Greece will remain in the Troika’s sweatbox.
Thus even with its intention of remaining in the Eurozone, Syriza may be forced to contemplated a Grexit as it struggles to finance its budget after its primary surplus has vanished. Of course, that assumes that the government remains popular after it imposes capital controls and starts issuing funny money. But if it does, a Grexit is not impossible, since the creditors’ continued unwillingness to fund a defiant Greece will make it harder and harder for the government to meet commitments that it has defined as red lines, such as paying pensions and spending on humanitarian relief.
Thus even if a Grexit is probably not an immediate result of a Greek default, that does not necessarily mean that Greece remains in the Eurozone. Even though the costs of an exit are extremely high, the costs of staying in are set to increase.