Greece and the Future of the Euro: Whither Europe?

For now the Greek saga that was commanding front-page headlines has receded to judge by the news coverage. In its place have come more up-to-the-minute stories, such as the Iranian nuclear deal, the opening of embassies in Washington and Havana, and the latest outrageous statements of Donald Trump. The reduction in news prominence of Greece’s travails in the Eurozone is understandable. After all, the Eurozone countries and Greece have reached a tentative deal and an agreement to finalize that deal. (Of course, all this will be followed by more talks when current deals become clearly impossible for the Greeks to fulfill.) The banks have now reopened, albeit with strict limits on cash withdrawals and economy-crippling capital controls still in place. During this time as the new deal is finalized, the Europeans have extended a €7.16 billion bridge loan to the Greek government, which they have used to pay their creditors, including the IMF and the ECB.

Nevertheless, for those of us who have followed the progress the Europeans have made in forming “an ever closer union” over the decades, the recent Greek saga provides both fascination and horror. Fascination, because it is inherently interesting. The experiment of a monetary union of nineteen sovereign countries is unprecedented, and a crisis, however predictable, provides a storyline that proves irresistible for those of us interested in this sort of thing. The horror comes from the suffering of the Greeks, the seemingly mistaken negotiating tactics of the new Greek government, the stupidity of their European counterparties who fail to act in their own interests, as correctly understood (to borrow a Realpolitik concept), and the very real danger that the European project will shift into reverse. This all is consequential and the implications for Europe and the world are much greater than the fate of a small country (albeit beautiful and with charming and friendly inhabitants) in the European “periphery.”

I always thought that the adoption of the euro was premature. The countries involved were too different, and adopting a uniform monetary policy for countries with different economic and social policies and different cultures and languages seemed as asking for problems. Those spearheading the drive for greater European unification of course knew this; they hoped that problems as they arose with the euro would serve for greater harmonization of policies in other spheres.

What was surprising was that the euro did as well as it did for as long as it did. It was even conceivable that it could be a competitor to the U.S. dollar as the reserve currency of choice. The economic crisis beginning in 2008 changed all that, and the euro flaws became easy to see. While various countries in what is called the periphery had and have problems which have been made more difficult to manage because devaluation of one’s home currency is not an option, the Greek situation has become the most difficult for the Eurozone countries. It poses starkly the question of whether the strategy of achieving a closer union through engrenage is now failing and whether the movement toward an ever closer union will now shift into reverse.

The Greek crisis has not only put the conceptual problems with the euro in bold relief; it also has shown the inadequacy of the economic theories, such as they are, of the leadership of the dominant country in EU, Germany, and that of some of the other northern and former Soviet bloc countries following Germany’s lead. Clearly, the policy of using austerity to solve debt problems has not worked. In Greece’s case, it has made the debt problem worse. The denominator of the ratio everyone looks at, debt to GDP, has been falling, meaning that the ratio has been increasing. The austerity of the past five years has prolonged and worsened Greece’s recession, turning it into a depression. Greece also does not have the option of trying to offset the decreased demand from austerity with a looser monetary policy than its main trading partners, given the euro. Judging from a presentation German finance minister Wolfgang Schäuble made earlier this year at Brookings, he apparently believes that austerity will generate confidence that a country is getting its fiscal house in order. This confidence will lead to greater investment and hence growth. Neither conventional macro nor experience provides justification or evidence that in the face of double-digit unemployment that this is correct. Moreover, the worsening debts to GDP ratios due to slower economic growth most likely have the opposite effect on confidence.

But beliefs die hard. The Eurogroup insisted on continued austerity for Greece, along with reforms to certain laws which arguably will give Greece a more efficient and competitive economy. While these may help the Greek economy once the current depression is over, it is hard to see how reforms to certain uncompetitive laws will help Greece get out of its current slump.

Also, the Eurogroup played rough with Greece during the negotiations. For example, it has been reported that Dutch finance minister and Eurogroup president Jeroen Dijsselbloem told Greek finance minister Yanis Varoufakis that, if he did not agree to the Eurogroup demands, “your economy is going to collapse...We are going to collapse your banks.” 

As it turned out, this was no idle threat. On Sunday, June 28, the European Central Bank (“ECB”) announced that it would not raise the amount of Emergency Liquidity Assistance (“ELA”) that the Bank of Greece could extend as collateralized loans to Greek banks. This was the day after Prime Minister Tsipras announced that he would submit the terms of the latest offer from the Eurogroup in a referendum on July 5. The restriction on ELA loans led to the closure of Greek banks on the following Monday, withdrawal limits of €60 a day, and capital controls. After Greek voters overwhelmingly rejected the latest (and by then defunct) offer of the Eurogroup imposing austerity on the Greek economy in a much watched referendum vote on July 5, the ECB again said on the next day that it would not raise the ELA amount and would “adjust” (i.e., raise) the haircuts on Greek government debt serving as collateral. This essentially brought the Greek economy to its knees, and a probably panicked Alex Tsipras agreed to even harsher terms than the Greek voters had rejected on July 13.

While the Eurogroup led by Schäuble and Dijsselbloem played very rough with Greece, it is fair to criticize the Greek government for its negotiating tactics. The economic arguments that the Greek officials were making made more sense than that of their more strident interlocutors, but the abrasiveness with which they conducted themselves and the call for a referendum look in retrospect to have been mistakes. It did not get them anything, except perhaps a worse deal than was originally obtainable.

On this point, though, John Cassidy of The New Yorker argues that “Syriza’s surrender wasn’t necessarily an ignominious one.” The reason is that this episode points out the necessity for change in Europe, thus, perhaps, paving the way for that change:

In the Marxist intellectual tradition, from which many senior members of Syriza hail, progress comes about gradually. To overthrow the existing order, you have to first mobilize the masses by stripping back the democratic veil and showing the real workings of the system: only then will the “objective conditions” be ripe for revolutionary change. Tsipras and Syriza didn’t create the conditions for change. But in bringing Greece to the brink, and demonstrating that its creditors were willing to see it collapse if it didn’t buckle to their demands, they did, arguably, succeed in showing up the eurozone as a deflationary straightjacket dominated by creditors. And they did this with all of the world watching. “One must know who the enemy is, in order to fight the enemy,” Alex Andreou, a Greek blogger who is sympathetic to Tsipras, wrote last week. “Syriza has achieved that. Now, it is over to you, Spain. Take what we’ve learned and apply it wisely.”

Having followed the developments, I do not think that Tsipras had such a devious negotiating strategy in mind. Cassidy is correct, though, that the outcome of the negotiations, with more still to come, has highlighted problems with the euro and EU governance. This growing realization may bring change, but what kind of change is uncertain. Cassidy concludes his article by quoting Tsipras’s comment to the Greek parliament that “this fight will bear fruit,” but goes on to write: “Only time will tell if that was wishful thinking.”

Another interesting disagreement that the Greek crisis revealed is the irrevocability of a country’s decision to use the euro. Interestingly, Schäuble has made no secret of his desire for Greece to give up the euro, at least temporarily. For him, this is not an immediate cost issue, since he argues that Greece leaving the euro would make it possible to forgive some of Greece’s debt and he says that the EU would provide Greece humanitarian aid during the monetary transition.

Schäuble’s preference for Greece to leave the euro is not new. For example, Andrew Ross Sorkin of The New York Times wrote an article at the end of June discussing a conversation in July 2012 between Schäuble and then Secretary of the Treasury Tim Geithner on this subject. Geithner reported in this conversation in his book, Stress Tests: Reflections on Financial Crises. Geithner was visiting Schäuble at his vacation home on an island in the North Sea. They had been discussing how to keep Greece in the Eurozone, but then, according to the article:        

To Mr. Geithner’s dismay, however, Mr. Schäuble took the conversation in a different direction.

 

“He told me there were many in Europe who still thought kicking the Greeks out of the eurozone was a plausible — even desirable — strategy,” Mr. Geithner later recounted in his memoir, “Stress Test: Reflections on Financial Crises.” “The idea was that with Greece out, Germany would be more likely to provide the financial support the eurozone needed because the German people would no longer perceive aid to Europe as a bailout for the Greeks,” he says in the memoir.

“At the same time, a Grexit would be traumatic enough that it would help scare the rest of Europe into giving up more sovereignty to a stronger banking and fiscal union,” Mr. Geithner wrote. “The argument was that letting Greece burn would make it easier to build a stronger Europe with a more credible firewall.”

Fast-forward three years. What Mr. Schäuble articulated that summer afternoon to Mr. Geithner is finally taking shape.

 

This is interesting, since many economists, most prominently Paul Krugman, have argued that Greece would be better off leaving the euro. Krugman is no fan of the austerity Schäuble has prescribed for Greece and other countries with debt problems, but there seems to be some common ground between him and Schäuble on the question of Greece and the euro.

From an economic perspective, the argument that Greece should leave the euro is strong. That, though, has to be at least somewhat tempered by politics, because the motivation for creating the euro was politics, not economics. The determination of many leaders in Europe to keep the Eurozone intact should not be underestimated, though it will be severely tested in the coming months and years. German Chancellor Angela Merkel disagrees with her finance minister on the desirability of keeping Greece in the Eurozone. Also, disagreeing is ECB Mario Draghi (“whatever it takes”). At a press conference on July 16 (after the Greek parliament vote on the deal) in which Draghi announced that the ECB would increase the amount of ELA lending the Bank of Greece can make to Greek banks by €900 million, he said (according to Bloomberg): “We always acted on the assumption that Greece will remain a member of the euro area. There was never a question.”

The crisis also brought about a noticeable rift between the two key countries of the EU, France and Germany. France, along with Italy, is more sympathetic to the problems Greece faces and is more willing than Germany to offer concessions in order to preserve the Eurozone and not set the precedent of a country giving up the common currency.

The vision of an ever closer union seems more distant, and, as for Schäuble, it is not clear what his vision is. A Europe in which Germany is viewed as being able to dictate policy is not sustainable. There will be a reaction against that; in fact, there already is. The uncertainty of Britain’s continued membership in the EU is more open to question, with some leftist voices, seeing the Greek debacle, having doubts about the benefit of membership, along with politicians on the right who have long held that position.

Most observers believe that the targets for primary surpluses will be impossible for Greece to meet. A new Greek crisis is likely. Whether the EU will end up putting off difficult decisions (“kicking the can down the road”) when that crisis arrives is uncertain. What can be said, though, is that the intransigence of Germany and some other Eurozone countries has put the European project in doubt.