Economic News & Analysis—May 9, 2012
Greece: Trying to have its cake and eat it too?
By Brian Jacobsen, Ph.D., CFA, CFP®, Chief Portfolio Strategist, and John Manley, CFA, Chief Equity Strategist

Brian Jacobsen photo

Summary:

  • The shift in leadership in France and Greece has increased the strains in the countries’ already stressed economies.
  • The three main parties in Greece all agree that they want Greece to use the euro. They differ in whether they want to renegotiate the terms on which Greece stays in the eurozone.
  • While it is probably true that Greece would be better off if it had its own currency, the country is probably stuck with the euro.
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In the wake of the elections on Sunday, the eurozone crisis seems to be getting more chaotic. The shift in leadership in France and Greece has increased the strains in the countries’ already stressed economies. The movement isn’t “anti-euro” but rather “anti-incumbent” and “anti-austerity.” For France, the effects will likely be felt as the new government, in trying to balance its budget, determines which group bears the brunt of the pain. For Greece, the effects are likely a bit more complicated.

There is no single party in Greece with a majority. In fact, the previously dominant parties, Pasok and New Democracy, are two seats short of a majority (with 149 out of 300 seats) and so won’t be able to cobble together enough support to pick a prime minister. The party that garnered the second-most votes in the elections—Syriza, which is in itself a coalition of communist and left-leaning groups—has categorically refused to work with New Democracy and Pasok. New Democracy or Pasok would need to reach out and compromise with one of the other four remaining parties to put together a large enough base to form a new government, which seems unlikely. The result may be another set of parliamentary elections in the middle of June.

In the interim, Greece’s government is effectively shut down: The measures that must be passed for the country to qualify for the next round of payments from the European Union (E.U.), the European Central Bank (ECB), and the International Monetary Fund (IMF) cannot happen until a prime minister and parliament are in place. Greece has fallen into a financial limbo, hence the chaos in the markets.

Should Greece leave the eurozone?

The three main parties—New Democracy, Syriza, and Pasok—all agree that they want Greece to use the euro. They differ in whether they want to renegotiate the terms on which Greece stays in the eurozone.

This may seem like splitting hairs, but I think it is important to recognize that Greece could leave the eurozone but still use the euro as its currency. Andorra, Monaco, and Montenegro all officially use the euro as their currencies, but they are not members of the eurozone. Similarly, certain countries use the dollar but are not part of the “dollar zone” (for example, Ecuador, El Salvador, and Panama).

The eurozone is the political arrangement by which the member countries have recourse to the various institutions that make up the eurozone—namely, access to the ECB as the central bank for the member countries. The big benefit of being a member of the eurozone is—ostensibly—that Greece’s concerns are considered when monetary policy is set by the ECB. Greek banks can look to the Greek central bank as a lender of last resort, but the Greek central bank is backed by the ECB only if the country is part of the eurozone. This is important because the ECB could, if necessary, provide unlimited support to its member banks. If Greece kept the euro but left the eurozone, then the Greek banks would be left on their own. At the earliest whiff of the prospect of Greece leaving the eurozone but retaining the euro, you’d probably see a lot of deposits leaving Greek banks and going into German banks. That could be devastating for Greek banks. Because of this unpleasantness, I think that, when push comes to shove, Greece will stay in the eurozone.

Greece is probably stuck with the euro

While it is probably true that Greece would be better off if it had its own currency—the drachma— the fact is, the country is probably stuck with the euro. To introduce its own currency could be a painful and bloody proposition: The borders would have to be closed to the free movement of people as well as capital. Basically, it would take martial law to get rid of the euro and get people to use the drachma. Other countries have gone through the process of currency reform, and it’s never been a pleasant or pretty sight: Bolivia and Mexico in 1982, Peru in 1985, Pakistan in 1998, and so on. It’s not exactly a list a country aspires to be on!

At the moment, it looks like dissident parties are expressing their disgust with the current path Greece is on in trying to keep the eurozone together. Their tune may change when they they’re forced to come up with an alternative. It could mean the government defaults on its loans to the E.U., the ECB, and the IMF, but this could be a temporary default until a new coalition government is elected. Then Greece might be able to start real reforms to write down its debts and work toward getting an economy that is actually competitive instead of one that’s been trying to have its cake and eat it too.

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