On Monday the banks will open again in Greece. By the end of the week we could see the end of the experiment in European unity called the Euro, the common currency.
In recent elections, Greek voters repudiated the conservative political parties that had agreed to cut government spending in exchange for continued loans from the European Central Bank. By European Central Bank, we really mean the Germans, since they are putting up most of the funding.
The ECB agreed to a complex deal that included holders of Greek government debt taking a fifty percent reduction in the face value of Greek bonds, and the Greek government agreeing to cuts that would reduce their deficit to around 3% of government spending. In exchange, the ECB would loan Greece more money so that Greece could continue making interest payments on bond they had already issued.
The political parties that gained the most in the election have declared their intention to renegotiate the deal. Their position is that pushing Greece into a depression so that German bondholders can continue to get interest payments is not a good deal for Greece. The new guys position is essentially this: “If you don’t continue to loan us money, we’ll default, and then your banks will get 0% of their money instead of 50% of their money. And your interest payments? You won’t get any of that either.”
The German position is pretty simple: “If we don’t loan you more money, your government defaults, you won’t be able to pay salaries or pensions, and you’ll have to pull out of the Euro zone and issue your own currency. Who wants drachmas? Nobody wants drachmas. And even with your worthless currency, you still haven’t solved the problem that your government spends more than it takes in.”
The problem with what is essentially a high stakes game of chicken between the left wing Greek political parties and the ECB is that they are out of time. The Greeks could not agree to form a ruling party after the elections, so now they are going to have another election on June 17. After that election a clear winner may emerge, which can then form a government. But the Greek government will require more bailout funds before then.
Meanwhile, Greek citizens are pulling their Euros out of banks, and either stuffing their mattresses or putting the money into non-Greek banks to hold. This is a process that has been ongoing. Last month Greeks pulled about 5 billion Euros out of Greek banks. Last week they took 750 million Euros out of their banks on Monday alone. If the pace of withdrawals accelerates, by the end of next week the Greek banking system could collapse, requiring a messy, unplanned exit of Greece from the Euro zone.
If the problems were limited to Greece, it probably wouldn’t be so bad over on this side of the Atlantic. Our banks don’t hold a lot of Greek government debt, and we don’t do a ton of trade with Greece either. What is keeping policy makers up at night is that nobody thinks the problem can be restricted to just Greece. Portugal, Spain, and Italy are the next potential dominos to fall. Italy alone is the eighth largest economy in the world. If the southern periphery of the Eurozone falls apart, it will have major implications for the world economy as a whole.
That’s the problem with playing chicken. Sometimes neither guy swerves out of the way in time.