Greek Crisis To Interfere With Eurocrats' Vacations?

The Greek crisis is heating up again, with the Bank of Greece releasing a hysterical monetary policy report. Apparently all the problems were caused by elected politicians, and rampant mismanagement by the eurosystem had nothing to do with it. According to orchestrated leaks (which are designed to maximise the run on Greek banks), this weekend is allegedly a "drop dead" date, whereupon capital controls will have to be imposed if Syriza does not capitulate to the diktats of the institutions. The timing is somewhat plausible, as the eurocrats possibly believe that the fallout will be contained, and they will be able to take their vacations in August without interruptions.

UPDATE (2015-06-18):  The EU finance minister talks collapsed in acrimony. Apparently there will be a meeting Monday to discuss the situation. However, this weekend would be a convenient time to impose capital controls. Have a nice day. 

Two Plausible Endings

There are two ways in which the "Greek Situation" will likely be resolved, as I discuss below. However, there is a third short-term outcome: the status quo continues. Liquidity could be magically found to allow Greece to keep going again for a few months - until the next "drop dead" date. Alternatively, the Greek government could cave in to Europe's demands, and buy a liquidity reprieve. However, since the underlying economic problems would be made worse, not better, this will essentially just kick the can down the road until the crisis erupts again. Since either case is just a continuation of present trends, I will not discuss it. That said, such an outcome has a reasonable probability of occurring.

The reason why the can be kicked down the road is that the euro is still a fiat currency. Unlike the Gold Standard, there are no gold reserves to run out of, creating a tangible limit to policies. The constraints facing governments are almost entirely determined by politics, with a nod towards the governing treaties.

The first and most likely resolution is that Greece will once again have its own currency. The most likely way this will happen is that capital controls will be imposed. Capital controls will create a "Greek euro", and it will trade at a discount to "rest-of-Europe" euros. The beauty of this is that there is no re-denomination of contracts, and the new Greek currency has a nominal anchor - the old 1:1 parity with rest-of-Europe euros. There is the problem of notes and coins, but it's fair to say that will be easily dealt with. Greek-supplied notes will be treated separately, in some devious fashion to get around the treaty rules regarding legal tender laws.

The second resolution is that European policymakers get hit by an attack of common sense, and drop their more idiotic demands. In any other region, I would normally view this as the highest odds outcome. Unfortunately, European policymaking has a pretty dubious track record going back to at least 1914, and there are no signs of improvement on the horizon.

It is entirely possible that the can will be kicked a bit further down the road, but the euro experiment will end up in the ditch eventually.

Excluded Scenarios

The following scenarios are possible, but I do not see them as being plausible.

• Greek default, but no exit. The Greeks can announce that they are not paying whenever they want, but the rest of the euro area can refuse to listen. The only way to make the default stick is to close the Greek capital account.
• Greek reforms magically work, problem goes away. The existing reforms are fighting against accounting identities, so I see no chance of success.
• Deus ex machina. The rest of the world (or the euro area) could enter a self-reinforcing private sector investment boom. A rising tide would lift all boats, even Greek ones. This starry-eyed optimism was still plausible in 2010, but there is no reason to believe in it now. The global private sector already has excess capacity in practically everything, and governments are tightening the screws on fiscal policy. And in case a bright light does appear at the end of the tunnel, Fed rate hikes would probably squash the over-extended animal spirits in the financial markets.

The Beauty Of Capital Controls

The advantage of imposing capital controls is that people are so focussed on form, they do not notice function. Imposing capital controls allows Greece to create its own currency, and largely without running afoul of EU laws. They are not imposing a re-denomination upon citizens, it is just that their euros are suddenly worth less than other euros. The fiction could be entertained that the Greek euro would re-enter at a 1:1 parity, creating a nominal anchor for the new "currency". It will also let the rest of the euro nations pretend that the Greek TARGET2 balances are still money-good.

Additionally, it would allow the government to clamp down on capital flight. Some sense of normality has to return to the Greek private sector, in order to allow it to actually have a chance to grow again.

Once the realisation that Greece has a new currency has sunk in, the markets will start sniffing around for the next countries in line. Given the haplessness of euro area policymakers, that is a long list. Meanwhile, enterprising Greeks will be able to set up consulting firms that could export their capital control expertise to those other peripheral countries.

Will Damage Be Contained?

European policymakers are acting in a fashion which indicates that they believe that a Greek "exit" can be contained. This is probably correct from an economic standpoint (but hyperactive equity markets might jump around). The only immediate risk is that some of Europe's dodgier banks still have some exposure that blows up on them. 

In the longer term, the reality that the euro is not irrevocable will have sunk in. The Greek experience will repeat elsewhere, probably when the global economy next falls into recession.

Geo-Politics

Historians will be able to take the map of 2015 and mark it as the high water mark of European industrial civilisation. The loss of peripheral Greece, in the Balkan "powder keg of Europe" is somewhat ominous, particularly when developments to the east and across the Mediterranean are not confidence inspiring. Greece is a member of NATO, and there is no reason to expect dramatic developments in the near run. Political strains will make it much harder for Europe to manage the waves of refugees that are inbound. Relative to the size of continental Europe, the amount of refugees entering are small. However, they are concentrated in the poorer southern countries (the point of first entry), which are less able to absorb them.

(c) Brian Romanchuk 2015