Is Greenspan right about Grexit inevitability

Alan Greenspan, former governor of the Federal Reserve, believes that a eurozone without Greece is an inevitability. But, he does not believe the departure will be as much of a catastrophe as it looked like being in 2012.

Is Greenspan right about Grexit inevitability


Speaking to the BBC on Sunday, the former head of the Federal Reserve told Mark Mardell that he does not think that it helps anyone for Greece to remain within the currency bloc.

“It would not be a catastrophe for the markets. Holding the system together is putting a strain on everybody. And, those strains are occurring because of the fact that, prior to the onset of the euro, most of the southern members devalued periodically against the Deutschmark. They are locked in at this stage and they have all of the characteristics of countries that wish to devalue but cannot.”

Prior to the elections in Greece on 25 January, many were of the view that Greece would continue on its debt repayment path and a slow, muddle-through scenario might well play-out. However, the increasingly hard line on debt repayments taken by the incoming Syriza government has seen a belief that Greece might actually leave grow in prominence. So much so that, according to reports, UK Prime Minister, David Cameron, called together senior officials on Monday to prepare UK contingency plans for such a departure.

But, where in 2012 such a possibility had markets roiling, this time around, the view seems a lot more sanguine.

Increasingly, the debate seems to be shifting from if Greece should leave to when. This is, in part, linked to the rise to power of Syriza and the party’s stance on debt forgiveness.

As fixed income investment leader at Newton Investment Management, Paul Brain said in a note out last week: “Firstly we have to think what signal would giving into the Greeks send to other new parties across Europe. The accepted view is that it is the Northern Europeans who want to play hard-ball with the Greek government. Recently, however, comments from Madrid suggest it may be the governments that have put their citizens through the hardships of past austerity programs that have the most to lose.  A recent rally in support of the Spanish anti-austerity leftist party Podemos shows the growing desire for change in these countries that have faced high unemployment for many years.”

Investec Asset Management investment strategist, Max King agrees. Speaking to Portfolio Adviser on Monday he said that there is an overwhelming political reason to see Greece leave the euro. “One thing you don’t want to do is to give encouragement to the extremist political parties that they can remain in the euro and, at the same time, write off their debts.

King is also agrees with Greenspan that it is impossible to rescue the Greek economy and have it remain within the eurozone.

“The current situation in Greece is similar to the one faced by Argentina in the early 2000s,” he said.
Adding: “We are looking at a Greek crunch, but what it means for markets is not a lot. The markets will be able to take this in their stride.”

A second view

How a Greek departure from the eurozone will affect markets is likely to be predicated on exactly how that departure is orchestrated, how sudden it is and how surprised markets are when it happens. And, the fallout for the rest of Europe will, in part, be measured by what sort of example Greece sets, should it leave.

But, what is perhaps more important is how the build-up and ultimate resolution to this crisis is viewed. And, to this point it is worth considering another view of the situation, one put forward persuasively by economist Michael Pettis.

In a lengthy note out last week, Pettis points out that the European crisis should not be viewed as a conflict among nations, the as it has been constructed above – and especially not as a battle between prudence and irresponsibility – but rather as a conflict among economic sectors.

As he explains: “Because the cost of saving Europe is debt forgiveness, and Europe must decide if this is a cost worth paying (I think it is), to the extent that the European crisis is seen as a struggle between the prudent countries and the irresponsible countries, it is extremely unlikely that Europeans will be willing to pay the cost.”

Pettis argues that the creation of the euro as a common currency led to an inability on the part of national currency and monetary policy regimes to absorb economic volatility. which created a series of deep imbalances among various sectors of the European economy.

“Because Europe’s existing economic and political institutions had largely evolved around the national sovereignty of individual countries, and also because the inflation and monetary histories of individual countries varied tremendously before the creation of the euro, it was probably almost inevitable that these imbalances would manifest themselves in the form of trade and capital flow imbalances between countries.”

These imbalances led eventually to the crisis within which the bloc now finds itself. Indeed, he added:“the current European crisis is boringly similar to nearly every currency and sovereign debt crisis in modern history, in that it pits the interests of workers and small producers against the interests of bankers. The former want higher wages and rapid economic growth. The latter want to protect the value of the currency and the sanctity of debt.

For Pettis, there are two paths from here. Should counties like Greece and Spain be forced to repay their debts, it will result in many more years of “economic hell” or the debt could be restructured and partially forgiven in a “disruptive but short process, after which growth will return and almost certainly with vigour”.

Should the various political parties fail to do this, he warns: “extremist parties either of the right or the left will take control of the debate, and convert what is a conflict between different economic sectors into a nationalist conflict or a class conflict. If the former win, it will spell the end of the grand European experiment.”

Increasingly, if the comments from Greenspan that started this piece are any indication of how markets are thinking, from this admittedly removed vantage point, it looks as though this has already begun.