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Grexcessive concern

15 June 2012 By Edward Hadas

The tension over Sunday’s Greek election is almost palpable. The financial world is watching Athens as if this vote, the second in two months, will change history dramatically for the worse. It just might, but probably won’t. But either way, the world economy will remain troubled for years.

The bad news story goes like this. The Greeks elect a government which acts so badly that the other euro zone members force it out of the single currency. The candidate whose victory is widely seen as increasing that risk is leftist Alexis Tsipras, although he says he wants to keep the single currency. But conservative rival Antonis Samaras, or a coalition, would not have an easy time working with the EU either.

In the doomsday narrative, the shock of Greek departure leads to financial panic in other weak members of the euro zone. Discord replaces precarious political harmony, and the European Central Bank goes into lockdown. The single currency breaks up, bringing a global financial panic, a mega-recession and, for serious pessimists, military conflict. The mere possibility is enough to frighten many investors. Their flight to safety has increased the risks. For example, the reluctance to hold Spanish government debt has made it harder for Spain to borrow.

Still, a less flamboyant outcome is far more likely. Greece has no good place to go and the other euro zone members don’t really want to let it out. The current painful austerity, slow reform and inadequate progress on meeting unrealistic targets is undesirable. But the alternative is worse. In Greece, exit would be followed by inflation, bitter political recriminations and quite likely a huge drop in GDP. It would rock the rest of the world.

But suppose Greece does abandon the euro. After two years of rolling crisis and at least six months seriously considering the possibility, political and monetary players should be well prepared. The visible fallout is likely to strengthen the remainder of the EU, leading weak members to redouble their reform efforts, the ECB to provide more help, and the politicians to stop bickering for a while. Germany could perhaps tolerate a Greek exit, but might then be willing to open its coffers much wider to help Spain avoid the same fate.

The legalities and processes are complex. But the only thing that really matters for the whole EU project of “ever closer union” is whether politicians accept sharing the pain of troubled members. Up to now, they have. The EU doesn’t inspire much idealistic fervour, but for ruling parties and leading opposition groups across the region, it still beats the alternatives. As long as that remains true, the single currency will probably survive.

The last part of the worst-case story is further financial contagion. When Lehman Brothers failed in 2008, no one was prepared for the aftermath. That shouldn’t be the case even if the euro zone loses members, one reason the analogy fits so badly. Central bankers have discovered they can ease financial crises by printing money, without – so far – inflaming inflation. Since the post-Lehman low, no other big banks have failed. With enough new money – even including new Deutschmarks, francs and liras – the economic disruption could be minimised.

In any event, the Greek election is more likely to lead to breakthrough than breakdown. Suppose the Greeks elect a reasonably functional government that is willing to cooperate with the EU. That could calm investors down and bring them back to euro zone government bond markets. With reduced uncertainty, the euro zone – which has lower fiscal debt and deficits than the United States and Japan, and more balanced trade – could even start to look relatively healthy.

Yet that would only be relative to an unsettled world. The financial stresses which brought the 2008 crisis have not disappeared, while new ones have been added. Even in China, which was spared the pain of the last recession, the economics look more fragile than they did. Whatever happens in Greece on Sunday and in the almost inevitable negotiations that will follow the vote, it will be hard to avoid several more years of global economic discontent.


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