While much of the world’s attention was concentrated on France’s
presidential election last Sunday, the real action was in Greece.
French President-elect François Hollande may be promising 75
percent income tax rates and a renegotiation of the European
Union’s fiscal treaty, but it was the result of the Greek elections
that will determine the future of Europe.
The irony is that Greece should never have been allowed into the
euro in the first place. It did not meet the entrance criteria, but
Eurocrats in Brussels turned a blind eye because they viewed the
creation of a European identity as more important than financial
stability. When the process began to unravel, a panicked EU, along
with the International Monetary Fund, responded by throwing money
at the problem, in exchange for a promise of austerity.
The result of the Greek elections was a resounding rejection of
the coalition government — comprised of mainstream socialists and
conservatives — that engineered an EU/IMF bailout. The
Conservative New Democracy (ND) party, the junior party in the
coalition, received the most support of any party, but only 20
percent of the total votes cast. The coalition socialist party,
PASOK, placed third, behind a coalition of other leftist parties
calling itself Syriza. The Independent Greeks, a pro-Russian,
anti-Turk conservative group led by a former ND legislator placed
fourth, with the Communist KKE in fifth, the neo-fascist Golden
Dawn sixth, and yet another leftist block seventh. No other parties
achieved enough support to gain representation in parliament. Fully
66 percent of votes cast were for anti-bailout, anti-austerity
parties.
Thanks to a bizarre quirk in the electoral system, ND gained 50
extra seats in parliament for coming in first. This measure,
designed to aid the creation of coalition governments, could
plausibly have resulted in a pro-bailout government forming despite
the overwhelming rejection of the bailout parties. By Monday
afternoon, however, ND leader Antonis Samaras had conceded defeat
in his efforts to find a majority, which will allow the Syriza
faction to attempt to form a coalition of the anti-bailout
groups.
The upshot? Greeks have exchanged a democratic crisis for a
financial crisis with far-reaching implications. If an anti-bailout
government is formed — a big if, as that would require the various
anti-bailout groups to overcome their considerable ideological
differences — the subsequent rejection of the austerity policies
demanded by the EU and IMF would almost certainly lead to a Greek
sovereign default, Greece leaving the Eurozone, and the return of
the Drachma.
If this happens, Greece will experience severe short- and
medium-term financial pain, likely exacerbated by confiscatory
leftist or autarkic policies — or some combination thereof.
However, there is some good news. By leaving the euro, Greek
living standards will eventually reach a market-clearing level,
and, assuming that the Greeks have fully appreciated the problems
caused by statist policies during this process, they may be well
placed to welcome industry back to their country with low costs and
barriers to entry. How urgent is market liberalization? A recent
Financial Times column tells of one entrepreneur who was
asked to provide a stool sample to the government before he was
allowed to start an online business.
Add to reform Greece’s unique national assets — an amazing
history and climate — and tourism should also boom, raising Greek
living standards once more.
Yet if the future for Greece in this scenario looks potentially
fine in the long-term, the same cannot be said for the euro. It
recently become obvious to everyone that the Eurozone’s Target-2
system of payments between central banks
tuned out market signals that otherwise would have warned that
a crisis was coming. This system places the euro in very grave risk
if a country were to default.
Financial journalist Martin Hutchinson
described the system very well:
When a Greek makes a large euro payment to a German, his Greek
bank makes a payment to the Greek central bank, which makes a
payment to the Bundesbank, which pays the German bank, which pays
the German. This is quite different to the U.S. system. There is no
central bank of Alabama intermediating dollar payments between
Alabama and New York, and there was equally no need for such
intermediation in the [E]urozone — it just gave the otherwise
redundant national central banks something apparently useful to
do.
This means that the effects of capital flight are doubled. Not
only does the central bank of Greece have an existing imbalance
with the Bundesbank, the German central bank, but when a Greek
moves his money from Greece to Germany, the imbalance grows
larger.
Now consider what would happen if Greece were on the verge of
default. The fear of successive default by the other shaky
economies — Spain, Portugal, and Italy — would lead to rapid
capital flight from those countries to Germany. The Bundesbank is
probably able to absorb the effects of Greek default and capital
flight, but it simply could not absorb the capital flight from
other countries. Germany may well be forced to leave the euro
rather than subject itself to this risk. This could all happen
extremely quickly.
Should Americans be worried? Yes, because the United States will
be caught up in a crisis it could have helped prevent. The European
Project that now stands on the precipice of self-inflicted
destruction was enthusiastically supported by successive U.S.
presidents, who all urged Europe down the path to union for the
simple reason of diplomatic convenience. If the scenario I have
outlined above comes to pass, we may see a banking crisis that
could make 2008 look like a walk in the park.
