Jun 29th 2015

Path to Grexit tragedy paved by political incompetence

by Barry Eichengreen

Barry Eichengreen is Professor of Economics at the University of California, Berkeley.


Since our last episode, the crisis in Greece has escalated further. Negotiations between the government and its creditors collapsed over the weekend, and restrictions on bank withdrawals will now follow.

The next step is for the government to issue the equivalent of IOUs to pay salaries and pensions. The country is seemingly on the slippery slope to exiting the euro.

Many of us doubted that it would come to this. In particular, I doubted that it would come to this.

Nearly a decade ago, I analyzed scenarios for a country leaving the eurozone. I concluded that this was exceedingly unlikely to happen. The probability of a Grexit, or any Otherexit, I confidently asserted, was vanishingly small.

My friend and UC Berkeley colleague Brad DeLong regularly reminds us of the need to “mark our views to market.” So where did this prediction go wrong?

Why a euro exit didn’t make sense

My analysis was based on a comparison of economic costs and benefits of a country exiting the euro. The costs, I concluded, would be severe and heavily front-loaded.

Raising the possibility, however remote, of exit from the euro would ignite a bank run in said country. The authorities would be forced to shutter the financial system. Economic activity would grind to a halt. Losing access to not just their savings but also imported petrol, medicines and foodstuffs, angry citizens would take to the streets.

Not only would any subsequent benefits, by comparison, be delayed, but they would be disappointingly small.

With the government printing money to finance its spending, inflation would accelerate, and any improvement in export competitiveness due to depreciation of the newly reintroduced national currency would prove ephemeral.

In Greece’s case, moreover, there is the problem that the country’s leading export, refined petroleum, is priced in dollars and relies on imported oil, which is also priced in dollars. So much for the advantages of a depreciated currency.

Agricultural exports for their part will take several harvests to ramp up. And attracting more tourists won’t be easy against a drumbeat of political unrest.

What went wrong?

How did Greece end up in this pickle? Some say that the specter of a bank run was no longer a deterrent to exit once that bank run started anyway due to the deep depression into which the Greek economy had sunk.

But what is remarkable is how the so-called bank run remained a jog – it was still perfectly manageable until the Greek government called its referendum on the terms of the bail out deal offered by international creditors, negotiations broke down and exit became a real possibility.

Nonperforming loans — ones that are in default or close to it — were already rising, to be sure, but the banks still had all the liquidity they needed. The European Central Bank supported the Greek banking system with emergency liquidity assistance (ELA) right up to the very end of June. Only when Greece stopped negotiating did the Central Bank stop increasing ELA. And only then did a full-fledged bank run break out.

So I stand by the economic argument. Where I need to mark my views to market, however, is for underestimating the role of politics. In particular, I underestimated the extent of political incompetence – not just of the Greek government but even more so of its creditors.

In January Syriza had run on a platform of no more spending cuts or tax increases but also of keeping the euro. It should have anticipated that some compromise would be needed to square this circle. In the event, that realization was strangely late in coming.

And Prime Minister Alexis Tsipras and his government should have had the courage of its convictions. If it was unwilling to accept the creditors’ final offer, then it should have stated its refusal, pure and simple. If it preferred to continue negotiating, then it should have continued negotiating. The decision to call a referendum in midstream only heightened uncertainty. It was a transparent effort to evade responsibility. It was the action of leaders more interested in retaining office than in minimizing the cost to the country of the crisis.

A hard lesson learned

Still, this incompetence pales in comparison with that of the European Commission, the ECB and the IMF.

The three institutions opposed debt restructuring in 2010 when the crisis still could have been resolved at low cost. They continued to resist it in 2015, when a debt write-down was the obvious concession to Mr Tsipras & Company. The cost would have been small. Pretending instead that Greece’s debts could be repaid hardly enhanced their credibility.

Instead, the creditors first calculated the size of the primary budget surpluses that Greece would have to run in order to hypothetically repay its debt. They then required the government to raise taxes and cut spending sufficiently to produce those surpluses.

They ignored the fact that, in so doing, they consigned the country to an even deeper depression. By privileging their own balance sheets, they got the Greek government and the outcome they deserved.

The implication is clear. Never underestimate the ability of politicians to do the wrong thing. I will try to remember next time.

The Conversation

Barry Eichengreen is Professor of Economics and Political Science at University of California, Berkeley.

This article was originally published on The Conversation. Read the original article.

Browse articles by author

More Current Affairs

Jan 24th 2020
EXTRACT: "........while over 80% of the ECB scheme buys government and other public sector bonds, a huge chunk still goes into corporate bonds and other assets. At the time of writing, the ECB holds €263 billion worth of corporate bonds – a very significant amount in relation to individual firms and the sectors in question. According to the ECB, 29% of these bonds were issued by French firms, 25% by German firms and 11% each by Spanish and Italian firms. As at September 2017, the sectors they came from included utilities (16%), infrastructure (12%), automotive (10%) and energy (7%)."
Jan 17th 2020
EXTRACT: "Thanks to cutting-edge digital technology, cars are increasingly like “smartphones on wheels”, so manufacturers need to have access to the latest patented 4G and 5G technologies essential to navigation and communications. But often the companies that hold the patents are reluctant to license them because manufacturers will not accept the high fees involved, which leads to patent disputes and licensing rows."
Jan 13th 2020
EXTRACT: "Recent polling from Pew Research demonstrates how the public’s attitudes toward the US and President Trump have witnessed sharp declines in many nations across the world. In Europe, the Americas, and the Middle East favorable attitudes toward the US went from lows during the years of George W. Bush’s presidency to highs in the early Obama years to lows, once again, in the Trump era. And in our Zogby Research Services (ZRS) polling we found, with a few exceptions, much the same trajectory across the Middle East."
Jan 13th 2020
EXTRACT: "In the absence of a declaration of war against Iran, the killing of a foreign official – by a drone strike on Iraqi territory – was possibly illegal. But such niceties do not perturb Trump. The evidence is that Trump’s decision was taken without consideration of the possible consequences. The national security system established under Dwight D. Eisenhower, designed to prevent such reckless measures, is broken to non-existent, with ever-greater power placed in the hands of the president. If that president is unstable, the entire world has a very serious problem."
Jan 9th 2020
EXTRACT: "It is possible that Trump’s reverential base won’t be sufficient to keep him in the White House past 2020. But such ardent faith is hard to oppose with rational plans to fix this or that problem. That is why it is so unsettling to hear people at the top of the US government speak about politics in terms that rightly belong in church. They are challenging the founding principles of the American Republic, and they might actually win as a result."
Jan 7th 2020
EXTRACT: "If anything has become clear in our recent Zogby Research Services (ZRS) polling in Iraq, is that most Iraqis are tired of their country being used as a playground for regional conflict, especially the conflict between the US and Iran. In fact, our polling has shown Iraqis increasingly upset with the role played by both the US and Iran in their country. Majorities see both of these countries as having been the major beneficiaries of the wars that have ravaged their nation since the US invaded in 2003. "
Jan 5th 2020
EXTRACT: "Under his [Suleimani's] leadership, Iran helped Hezbollah beef up its missile capabilities, led a decisive intervention to prop up Syrian President Bashar al-Assad, supported the Houthi rebels who have been waging a war against Saudi-led forces in Yemen, and backed a wave of resurgent Shia militias in Iraq. According to Gadi Eizenkot, who completed his term as the Israel Defense Forces’ chief of general staff last year, Suleimani had plans to amass a proxy force of 100,000 fighters along Syria’s border with Israel."
Dec 31st 2019
EXTRACT: ".....stunning technological progress during the 2010s makes it possible to cut GHG emissions at a cost far lower than we dared hope a decade ago. The costs of solar and wind power have fallen more than 80% and 70%, respectively, while lithium-ion battery costs are down from $1,000 per kilowatt-hour in 2010 to $160 per kWh today. These and other breakthroughs guarantee that energy systems which are as much as 85% dependent on variable renewables could produce zero-carbon electricity at costs that are fully competitive with those of fossil-fuel-based systems."
Dec 31st 2019
EXTRACT: "Predicting the next crisis – financial or economic – is a fool’s game. Yes, every crisis has its hero who correctly warned of what was about to come. And, by definition, the hero was ignored (hence the crisis). But the record of modern forecasting contains a note of caution: those who correctly predict a crisis rarely get it right again. The best that economists can do is to assess vulnerability. Looking at imbalances in the real economy or financial markets gives a sense of the potential consequences of a major shock. It doesn't take much to spark corrections in vulnerable economies and markets. But a garden-variety correction is far different from a crisis. The severity of the shock and the degree of vulnerability matter: big shocks to highly vulnerable systems are a recipe for crisis. In this vein, the source of vulnerability that I worry about the most is the overextended state of central-bank balance sheets. My concern stems from three reasons."
Dec 14th 2019
EXTRACT: "Conspiracy theories about sinister Jewish power have a long history. The Protocols of the Elders of Zion, a Russian forgery published in 1903, popularized the notion that Jewish bankers and financiers were secretly pulling the strings to dominate the world. Henry Ford was one of the more prominent people who believed this nonsense."
Dec 13th 2019
EXTRACT: "In previous British elections, to say that trust was the main issue would have meant simply that trust is the trump card – whichever leader or party could secure most trust would win. Now, the emerging question about trust is whether it even matters anymore."
Dec 5th 2019
EXTRACT: "Europe must fend for itself for the first time since the end of World War II. Yet after so many years of strategic dependence the US, Europe is unprepared – not just materially but psychologically – for today’s harsh geopolitical realities. Nowhere is this truer than in Germany."
Nov 23rd 2019
Extdact: "The kind of gratitude expressed by Vindman and my grandfather is not something that would naturally occur to a person who can take his or her nationality for granted, or whose nationality is beyond questioning by others. Some who have never felt the sharp end of discrimination might even find it mildly offensive. Why should anyone be grateful for belonging to a particular nation? Pride, perhaps, but gratitude? In fact, patriotism based on gratitude might be the strongest form there is."
Nov 20th 2019
Extract: "Moody’s, one of the big three credit rating agencies, is not upbeat about the prospects for the world’s debt in 2020 – to put it mildly. If we were to try to capture the agency’s view of where we are heading on a palette of colours, we would be pointing at black – pitch black."
Nov 17th 2019
Extract: "Digital money is already a key battleground in finance, with technology firms, payment processing companies, and banks all vying to become the gateway into the burgeoning platform-based economy. The prizes that await the winners could be huge. In China, Alipay and WeChat Pay already control more than 90% of all mobile payments. And in the last three years, the four largest listed payment firms – Visa, Mastercard, Amex, and PayPal – have increased in value by more than the FAANGs (Facebook, Apple, Amazon, Netflix, and Google)."
Nov 14th 2019
Extract: "Trump, who understands almost nothing about governing, made a major mistake in attacking career public officials from the outset of his presidency. He underestimated – or just couldn’t fathom – the honor of people who could earn more in the private sector but believe in public service. And he made matters worse for himself as well as for the government by creating a shadow group – headed by the strangely out-of-control Rudy Giuliani, once a much-admired mayor of New York City, and now a freelance troublemaker serving as Trump’s personal attorney – to impose the president’s Ukraine policy over that of “the bureaucrats.” "
Nov 4th 2019
Extract: "Trump displays repeated and persistent behaviours consistent with narcissistic personality disorder and antisocial personality disorder. These behaviours include craving for adulation, lack of empathy, aggression and vindictiveness towards opponents, addiction to lying, and blatant disregard for rules and conventions, among others." The concern is that leaders with these two disorders may be incapable of putting the interests of the country ahead of their own personal interests. Their compulsive lying may make rational action impossible and their impulsiveness may make them incapable of the forethought and planning necessary to lead the country. They lack empathy and are often motivated by rage and revenge, and could make quick decisions that could have profoundly dangerous consequences for democracy.
Oct 31st 2019
EXTRACT: "......let’s see what happens when we have less money for all the things we want to do as a country and as individuals. Promises and predictions regarding Brexit will soon be tested against reality. When they are, I wouldn’t want to be one of Johnson’s Brexiteers."
Oct 21st 2019
EXTRACT: "Were Israel to be attacked with the same precision and sophistication as the strike on Saudi Arabia, the Middle East would be plunged into war on a scale beyond anything it has experienced so far. Sadly (but happily for Russian President Vladimir Putin), that is the reality of a world in which the US has abandoned any pretense of global leadership."
Oct 20th 2019
EXTRACT: "Europe also stands to lose from Trump’s abandonment of the Kurds. If, in the ongoing chaos, the thousands of ISIS prisoners held by the Kurdish-led Syrian Democratic Forces escape – as some already have – America’s estranged European allies will suffer. Yet Trump is unconcerned. “Well, they are going to be escaping to Europe, that’s where they want to go,” he remarked casually at a press conference. “They want to go back to their homes." "