Greece and the rest of Europe are at a nasty impasse. Europe wants to curb its financing of ‘reforms’ that didn’t produce results, while Greece no longer wants to submit to ‘policies’ that didn’t produce results. Each side blames the other. Reciprocal animosity has intensified with each
Today the odds of a deal failure are extremely high. Gone are the claims of “they would never let it happen” and “there are no legal provisions for it”. In short, Grexit has become the central case.
How bad would Grexit be?
There’s a lot we can’t know. But there’s also a lot we do know, and pretty much all of it has changed for the better. Here’s my take:
- We’re more psychologically prepared than we were in 2010. Like with the Greek default, after talking about the prospect of Grexit for a long time, we become somewhat desensitized to the event. In markets, expectations at t-zero are hugely important;
- We’re more financially prepared. There were no firewalls in place three years ago. Moreover, every monetary innovation was met with a German ECB resignation. Today, LTRO, ESM, QE, “Whatever it takes”, etc. are part of the landscape. And we know they worked. Draghi won. Germanic phobias lost. Not likely to be much principled pushback if Draghi needs to get aggressive with runway foam;
- We’re more economically prepared. Growth is still the Achilles heel of the EZ, but Ireland and Portugal have made decent progress under programs, and even Spain has started to bob back to the surface. It’s not great, but it is better. Globally, the US and Japan are in a much better place, and China has repeatedly confounded the doomsayers with its own brand of muddling through;
- Sword of Damocles has been hanging over the global economy–not just over Greece and the EZ. Removing this would be good for animal spirits globally—even though in and of itself it wouldn’t resolve Europe’s growth problems;
- Greece, with its own currency, would finally get a path to growth. The confidence that things will get better makes even great sacrifice manageable—and IMO the much of the adjustment has already occurred. Yes, sadly, Greece would get one final gut check, but history suggests it would soon be followed by rapid growth. The alternative—financing future rounds of internal devaluation/further economic contraction—seems at best, more temporizing. Greece would also emerge with (1) its labor force competitively priced and (2) greater degrees of fiscal freedom to cushion the pain of transition;
- EZ would emerge stronger. The heartless truth is Greece adds very little to the EZ and has subtracted a lot. It was a noble experiment, but it failed. Now we can and should own up to that.
- Having a template for leaving the euro is a good thing, not a bad one. ‘Learning by doing’ would prove a huge help should another country decide/need to leave in the future. Of course, long-term risk premia would likely rise for certain borrowers. But is that really a bad thing as long as the ECB ensures it’s orderly? Rates are low in absolute terms, and the real constraint to lending has had more to do with balance sheets and growth prospects than the price of money.
I know it seems less than serious if we don’t furrow our brows and darkly recite things like “this has never happened before”. And sure, in the short term markets have been leaning toward a last-second deal and would be wrong footed. Some markets have been looking tired, so it could even get rough. But when I look at Grexit I see a world in much better fundamental position to avoid the cascading systemic contagion we (rightly) feared as recently as a year ago. Now is the time to do what the system could not handle in 2010: get Greece off the toxic medication and onto a path of growth and dignity.