INTERNATIONAL AFFAIRS by Peter WestmoreNews Weekly
Eurozone shaken as Greece goes into default
, July 18, 2015
The default by Greece’s Syriza Government on a €1.5 billion ($2.2 billion) repayment due to the International Monetary Fund by July 1, followed by the referendum which voted overwhelmingly to back the government’s refusal to accept the continuation of the European Union’s austerity program, have triggered Greece’s expected exit from the Eurozone.
Alexis Tsipras, left, with Yanis Varoufakis,
who resigned as finance minister after
the “No” vote in the referendum.
Greek Prime Minister Alexis Tsipras tried to manoeuvre events to make it look as if Greece’s main lenders – the European Union, the European Central Bank and the International Monetary Fund – had forced Greece into default, but it is clear that they have been keeping Greece solvent for months but could not reach agreement.
The immediate question is whether the European Central Bank will continue to extend emergency funding to Greek banks, staving off their immediate insolvency.
Living beyond its means
The basic problem is that the Greek Government has for many years been living beyond its means, borrowing from EU countries to make up its chronic and rising deficits.
The lenders continued to bankroll Greece on the understanding that Greece would restructure its debts to ensure repayment over the long term. But the pain of restructuring was enormous: unemployment over 20 per cent (and at 50 per cent for young people), as well as a 25 per cent decline in Greece’s GDP since the beginning of the global financial crisis in 2007-08.
The problem with the EU-imposed program was that it did nothing to rebuild Greek industries or make its economy, which is highly dependent on tourism, stronger in the long term.
This is the fundamental weakness of the EU debt program: it was designed to ensure that debts were not written off – in other words, to protect the banks – rather than rebuild a viable Greek economy.
Clearly this could not go on forever.
The so-called “rescue plan” was largely restricted to cutting government expenditures – including extravagantly generous pensions and welfare payments, as well as government employment, and increasing taxes, particularly the unpopular value-added tax, Europe’s equivalent to the GST.
Last January, following a parliamentary deadlock, the Greek people voted for an end to the pain by ousting the former centrist government and electing the radical-left Syriza party, on a promise to end austerity.
The past five months have seen protracted and often heated negotiations between Greece and its lenders, but without either side fundamentally changing its position.
For Greece, default on its debt means that the flow of money from the EU will dry up – sooner or later.
Even before the deadline, the Greek Government had declared a “bank holiday”, closing the banks, to put a halt to a run on deposits. Billions of euros had already been drained from bank accounts in anticipation of default.
Without the inflow of euros, the Greek Government will not be able to meet its wage and social security obligations, nor service its foreign debts.
Many poor people who depend on pensions will run out of money, and industry and commerce will grind to a halt as confidence in the banking system collapses and banks impose onerous new conditions on lenders.
The most sensible thing for the Greek Government to do would be to reintroduce its own currency, the drachma, and meet its domestic obligations in its own currency.
However, international transactions will not use the drachma, so there needs to be a mechanism for the exchange of drachmas into euros and vice-versa. Unless the exchange rate is set at a level acceptable to both Greece and its lenders, lenders will simply refuse to exchange euros for drachmas, regarding it as toy money.
The outcome of the Greek referendum will certainly strengthen anti-austerity and anti-EU sentiment elsewhere in Europe.
One consequence of default is that the lenders will lose most if not all the money they have lent to Greece over the years. This will threaten the bottom line of many of the largest European banks, possibly for years to come.
A Greek default could damage the liquidity of some of Europe’s major banks, as their capacity to lend depends on the banks’ balance sheets. This is the risk of “contagion”, the spread of the Greek crisis to other countries in the Eurozone.
However, with Greece teetering on the brink of default for years, the banks have had a long time to prepare for this eventuality. And in recent months, the European Central Bank has embarked on “quantitative easing”, a polite phrase for flooding the European economies with euros, in anticipation of a Greek default.
What is not clear is how the countries that have extended most of the money to Greece over the years – including Germany, France, Spain and Italy – will deal with the huge losses arising from the Greek default.
Sovereign debt defaults are more common that you would think. Countries such as Russia, Argentina and Cyprus have emerged from defaults in recent decades and, after a period of painful adjustment, rebuilt their economies.