The sheer insanity of the economic policies being followed in Greece at the moment is painfully obvious. This story ends in one of three ways:
- fiscal union in the Eurozone. If the EU had a central budget and fiscal transfers between higher-income and lower-income states (like the US) for example, the Greek debt would be a relatively minor issue. The EU would be able to issue "Eurobonds" at relatively low rates of interest to fund the Greek deficit. This is unlikely to happen because Germany doesn't want Eurobonds. It wants a "fiscal compact" to bind member states into austerity but this is not at all the same thing as fiscal union; rather, it's a measure to outlaw "structural deficits" which, if anything, will exacerbate economic depressions by making Keynesian counter-cyclical spending harder.
- Greece as a technocratic colony. This is the option that Germany and the IMF want - bypassing the Greek electoral system and putting "yes men" in place who will enact austerity measures for "as long as it takes" - perhaps in perpetuity - in a (probably futile) attempt to meet fiscal targets through spending cuts and tax rises.
- Greece in default. I think this is the most likely option now. It's no longer a question of if Greece defaults, but rather, when it does.
I would be very surprised if plans were not afoot behind the scenes for a Greek default and the return of the drachma. (The return of the drachma is not inevitable - it is possible that Greece could default and stay in the Euro - although that raises a host of issues, for example regarding contagion, and how to stop the same thing happening again to Greece a few years down the line). But being kicked out of the Euro is more likely than defaulting in it.
It is important to make clear that although default is the best available option for Greece it is by no means an easy option. The drachma will collapse in value in the short run and Greece is likely to experience high inflation as the cost of imported goods rise. Much of the debt held by Greek consumers and businesses (as opposed to government debt) will be Euro-denominated and so its value relative to Greek GDP will increase greatly in the event of the drachma reappearing. This will most likely lead to a wave of secondary defaults in the business and household sectors.
However, readopting its own currency would give Greece the necessary flexibility to work its way back to economic health. Tourism would boom hugely as Greece would suddenly become a very attractive cheap holiday destination. The reduction in the wage and price level relative to the Euro would make Greece a much more attractive location for foreign direct investment by foreign-owned businesses. Greek exports would be much more competitive than before... and so on.
So, for me, given that a US-style European fiscal union is off the table, default followed by economic rebuilding from a vastly lower exchange rate looks like the best option for Greece.
But what does Loukanikos, the world-famous riot dog, say?