Two of the great risks facing the European Union (EU) economy are the exit of Greece from the euro area and the exit – or distancing – of the United Kingdom from the European Union. It is easy to think of these threats as similar, even if only because they have similarly catchy names to use in popular debate. But Kings College London Professor Anand Menon reminded me in a recent conference call that they are actually very different. His point was that any British exit from the European Union – or ‘Brexit’ – would be a long, difficult, and conflictive process. My argument here is that any Greek exit from the euro – or ‘Grexit’ – would centre on a short, punctuated event.
Author / Erik Jones
Now Is Not the Time
Today was another ‘crunch day’ in the negotiations between Greece and its creditors in the euro area. The Greeks have made their proposal. Now the Economics and Finance Ministers have to make a decision about whether to extend the Greek bailout That decision may require that the Greek government offer even more. The Greek government is reluctant because it fears betraying the electorate that just voted it into office. The German government is reluctant to concede more either because it has its own voters to worry about. It also has to worry about its allies – like Finland, Slovakia, Portugal, Ireland, and Spain – who have supported a hard line on Greece, also for domestic political reasons. Hence we are at a democratic impasse. The two sides are close to an agreement, but close is still ‘no cigar’.
Credibility as a Powerful Idea
As an academic, I am interested in the power of ideas. If ideas didn’t matter, I would probably look for another job. Fortunately, the power of ideas is all around us. This is not a reference to the terrible events in Copenhagen, although I suppose it could be. That was a conference about ideas attacked by people who have a deep fear of the power of ideas to threaten them. Slavoj Žižek made that argument about the Charlie Hebdo attacks earlier this year; his reasoning applies equally well in this more recent tragedy.
The power of ideas I find most interesting at the moment centers on the notion of credibility. The reason this is interesting is credibility can seem so solid at one moment only to collapse in another. I worry this could happen to the euro as a single currency if some accident were to happen and Greece were to leave the euro. This essay is a long way of making a simple point. Anyone who thinks that Greece can leave the euro without having dramatic consequences is underestimating the power of ideas.
Central Banking as Politics
Central bank independence used to mean that central bankers would take economic decisions without regard to the political consequences; now it appears to mean that central bankers take political decisions without regards to the economic consequences. This is a very bad development for macroeconomic policymaking because it is likely to give political momentum to those who oppose the prevailing policy framework. The result will be a crisis of legitimacy for the central banking community and an increase in volatility and uncertainty in the world economy writ large.
Hard Bargaining
Italian Prime Minister Matteo Renzi won a big victory this weekend. He threw support behind Sergio Mattarella as candidate to replace Giorgio Napolitano as President of the Italian Republic and Mattarella managed to win almost two-thirds of the votes of the Italian electoral college in the fourth round of balloting. This means that Renzi was able not only to hold together his fractious Democratic Party but also to split Silvio Berlusconi’s Forza Italia on the Center Right and to show the growing irrelevance of Beppe Grillo’s Five Star Movement in national politics. Mattarella becomes President and Renzi is much strengthened as a consequence.
This result was not a foregone conclusion. Things could have ended differently. The Democratic Party could have split, Renzi’s center-right coalition partners could have refused to support Mattarella for President, Berlusconi’s Forza Italia could have held together in the electoral college and then turned on Renzi’s institutional reform agenda, or Grillo’s Five Star Movement could have tried to create chaos in the whole proceedings by introducing a Democratic Party grandee like Romano Prodi or Pier Luigi Bersani. Renzi had to negotiate skillfully to avoid most of these obstacles; he had to be lucky to avoid the rest. Hence the take-away for most Italians is that Renzi has a good mix of cunning and bravery — the Italian word is ‘furbizia’ — to carry the day.
Quantitative Easing: Toward a New Liquidity Glut?
The European Central Bank’s new quantitative easing program may end up pushing liquidity into the wrong economy: the United States. This may be beneficial for the euro area in the short run as the money that flows out of Europe pushes down the value of the euro relative to the dollar and as the capital inflows into the United States fuel U.S. demand for European exports. To give you a sense of how strong this effect is likely to be, I am pasting a recent history of the euro-dollar exchange rate that dates back to the start of the Greek sovereign debt crisis in January 2010. This data is provided by the Dutch national bank.
Greek Elections and Moral Hazard
Viewed from the United States – or, maybe better, from an American perspective – the Greek elections highlight the problem of moral hazard in Europe. This is not a normal problem you would expect to arise from a democratic contest. ‘Moral hazard’ describes a condition where one party takes on excessive risks because they believe, whether rightly or wrongly, that any negative consequences can be shrugged off onto someone else. The classic example is a borrower (or a banker) who takes on too much debt and then walks away when it proves unsustainable. When we talk about elections, it is hard to see how this situation might arise. Voters can vote irresponsibly, but they are likely to bear the consequences of their own foolishness.
The State of the Union and the Atlantic Alliance
Republicans will remember President Barack Obama’s 2015 State of the Union address for the many veto threats it contained against legislation to reverse the affordable care act, to restart the deportation of illegal immigrants, to weaken banking regulation, or to impose new sanctions on Iran while negotiations are still ongoing. Democrats will remember those commitments as well, but they will also focus on the President’s promise to promote more equitable growth, to create new jobs, to provide greater access to childcare, to reduce the cost of higher education, and to protect the environment.
The Threat of Financial Disintegration
A number stories in European financial markets last week are connected by increasing concerns within the investment community about what Europe’s future has in store. Swiss central bankers abandoned their currency peg, Greek commercial bankers asked for emergency liquidity assistance, and German economists raised questions about the deterioration of Italy’s position within the Target2 system.
Worse, each of these developments feeds into new uncertainties — about whether other countries will follow Switzerland’s example or take preventative measures to lower the market pressure on their national currencies, about whether Greek banks will experience an accelerating run on their deposits now that their liquidity has been questioned, about whether the German government and the Bundesbank will increase the pressure for restraints on any ECB program for quantitative easing, and about whether the Italian presidential elections will further undermine international confidence in the Italy’s banks.
The Euro Area is Already in Crisis
The euro area is already in crisis; European policymakers are just reluctant to admit that fact or to act accordingly. That is the punchline I want to deliver. It is a hard line to sell. We tend to think of moments of ‘crisis’ as moments when the signs of distress are all around us. It is a towering inferno, a crashing airliner, a listing ferry, or a hostage situation. It is hard to see evidence of any such disaster scenario unfolding in Europe at the moment. Neither the Greek parliamentary elections nor the Italian presidential elections would qualify; we are not in 2012 anymore, or even 2013 for that matter. This time is different.
