Monday, 18 June 2012

Greece today - Greece tomorrow?

Now when New Democrazy (sic!?) has won the Greek elections, everybody's eyes are on the Mediterranean. But after a super short bull run this morning everybody seems to be back into the "OK, so what now?" gear. Understandably, since it seems like it is just a question of time now when and how Greece defaults on the current "stabilisation" program. But will it go back, hat in hand, to Troika and ask for readjustments on the bailout or will it just outright default and exit the euro.

Who knows?! But for those of you who might want some clarifications of what the brush strokes of possibilities are, the classic "impossible trinity" might help.

Greece is as it is on the south side of the triangle, in the euro and with free flow of capital (as can be seen on the capital flight from Greece). If you're in a euro zone economy, you're perhaps more likely than not to think that Greece will stay on the south side (I can't find the link now, but the majority of economists from the euro zone countries don't think it will collapse while the opposite applies to economists from non-eurozone countries). But if they do not stay in the eurozone, how will the get out?

The impossible trinity and Greece. Greece is currently placed on the south side with fixed exchange rates (the euro) and free flow of capital. Doing so, they sacrifice independent monetary policy. But they could go for either the north-east or north-west sides as well. If they choose to adopt the drachma (independent monetary policy) they have to decide whether they will allow the capital to flee (north-east side) or lock it in and then devalue (north-west). If they choose the north-west side, they effectively "go Argentinian" on the bond owners by unilaterally change euro-denominated bonds with drachma-denominated ones. Then, they allow the drachma to fall by 40-60%.

Now, regarding where Greece will be "tomorrow": it's not entirely impossible that Greece will lock down the economy with capital controls. The purpose would be to get out of the euro in a "tranquil" way, not with massive unrest and collapsing internet banks. Yes, it's not permitted to apply capital controls in the EU according to the Four Freedoms but Iceland did it and is still at it. And we're a member of the Four Freedoms contract as well through the European Economic Area. The ESA has said it is OK for us to lock the capital in, at least for the time being because of the systemic collapse, but they did as well state that they effectively could come knocking and tell us to open up any time.

I think most people who think Greece will exit kind of assume that one day the drachma will be recreated, free flow of capital still applied and the new currency allowed to plummet immediately. But why not lock the money in, recreate the drachma and then devalue the currency through the central bank? Is it impossible they will do that in the end?

Anyway, whatever happens the choices the Greeks have are pretty limited. They can either stay in the euro and have a slowly decaying economy or they can rip the plaster off, experience the massive default-pain and then hopefully get back up again later. Judging from the results of the elections, they are still up for the euro deal. Still. But maybe not tomorrow.

The two real choices Greeks have. They can either have the euro and a disastrous economy or adopt a new drachma and have a disastrous economy.

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