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FACTDROP: Greek default within the euro is the only real option
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11/07/2011

Greek default within the euro is the only real option


Πηγή: FT
By Robert Jenkins
Nov 7 2011

It was a possibility feared but unspoken – until last week. Suddenly a Greek exit from the euro was on the table. “Are you in or are you out?” Many Europeans no longer care. They should. Their leaders do. Here is why.

Greece will restructure. It can do so “within the euro” or it can do so “outside the euro”. The difference is crucial. If you already understand the distinction, stop reading here. If not, you may soon wish you had. For here is how an exit of Greece from the eurozone would play out:

1: The Greek cabinet decides an exit. Rumours begin to circulate. Greek citizens withdraw their euro deposits while they are still euros and not drachmas; supplies of banknotes run short; businesses shift their euro balances abroad. Foreign lenders to Greek businesses cancel credit lines. Banks close their doors.

2. Following an emergency cabinet meeting, the Greek government announces the new drachma. Capital controls are imposed and border patrols dispatched to enforce them. Public sector debt is redenominated in local currency. The value of the drachma plunges. Greek inflation soars.

3. Disputes erupt over private sector debt (for example a German bank’s loan to the Greek subsidiary of a multinational such as BMW). Is the obligation still a euro loan or is it now drachma-denominated? If it is a drachma loan then the German bank has a problem – a drachma asset worth a fraction of its euro book value. If, on the other hand, the obligation remains in euros then both bank and company have a problem as the Greek borrower now has a euro loan which it must service from depreciating drachma income.

4. Contagion commences. Portuguese citizens worry that it might happen there. Portuguese depositors begin to withdraw euros for fear they will soon be escudos. Companies in Portugal transfer funds abroad as a precaution. Banks close. Soon, similar scenes occur in Ireland with echoes elsewhere along the Mediterranean. Banks cease dealings with their “peripheral” counterparts.

5. Confusion mounts over the magnitude of European bank exposure to the private sector of the periphery. Trading with and between Europe’s banks stops. Bank stocks crater and haven assets rise. In response to an inward flood of capital Switzerland imposes punitive negative interest rates on non-resident deposits.

6. Bank lending across the EU ceases. Economic activity halts.

I could go on but you get the point. It is not a pretty picture. Let me just add the fact that European banking exposure to the private sector (corporations and households) of the “peripherals” is a multiple of that to the public sector (government debt) of the area. These numbers are not secret. They have appeared in the Financial Times.

The associated risks are what used to be called cross-border risks – a term well known to US bankers of a certain age who once recklessly lent dollars and pesos to the Mexican public and private sector – only to discover that sovereign risk involved not only the risk that the sovereign might not pay but also that the private sector might be prevented by law or currency changes from doing so.

Banks in Europe can be forgiven for making this mistake. The advent of the eurozone was to have abolished the notion of cross-border risk, n’est-ce pas? Was not a Munich bank lending to BMW Athens now akin to a New York bank lending to General Motors in San Francisco? That was the idea. Seemed sound, right? It is, if the eurozone hangs together.

A number of senior officials understood this early on. Others have taken time for the implications to sink in – so focused has been everyone’s attention on sovereign bond-related exposures. This explains the slow but predictable shift in rhetoric: from no default to “orderly default”, from default to “default within the euro” and more recently, “we will defend the euro at all costs”.

Yes, the European leadership has grasped the gory details. They must now share them with their constituents. The peoples of northern Europe need to understand that their interests lie not in hounding the Greeks out but in keeping them in.

And referendum or no, the Greek government must explain the consequences that a Greek exit from the euro would have for the Greek economy and its citizens. A Greek default within the euro is manageable and will be managed. Greek default outside the euro involves risks to a different order of magnitude.

This issue has been the elephant in the room – visible for all to see should anyone care to look. For a long time no one cared to. No one wanted to. Now they must.


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