Paul Krugman thinks that Greece will probably leave the Eurozone. It is generally foolish to disagree with PK, and what follows is a huge hostage to fortune, but here goes. It is clear that Greece wants to stay in the Euro. Their people do and so do most political parties, including Syriza. Their banks are losing money fast, but the Greek central bank will fill that gap, as long as the ECB allows them to. So a Greek exit will only occur if the Eurozone in some shape or form decides that Greece must go. (See John Quiggin here, for example.) This is the first reason why I think the Euro may survive. If the Greek people were less committed to the Euro, then in macroeconomic terms the option of Greece themselves deciding to leave would look quite attractive in all but the short term, so they might well take that option. (For a different view, see Jacob Kirkegaard here.)
The spin being encouraged in Europe at the moment (and I broaden the scope here deliberately, because it includes the UK government) is that the next Greek election is in effect a referendum on Greek membership. The implication, given the previous paragraph, is that if Greece tries to renegotiate the terms of its existing loans, the Eurozone will force Greek exit. The key question is whether this is a credible threat.
The question is not whether Greece has some moral duty to honour its debts. Creditors will always use this type of language, because they want as much of their money back as possible. There will also be plenty of talk of moral hazard: if Greece is able to renegotiate terms on this occasion etc etc. But all this is just rhetoric. Greece has already partially defaulted. There seems to be no obvious moral reason why private creditors should lose some of their money, but governments who lent to Greece should not, particularly when the terms of the loans were largely decided by the creditors under duress.
So is it a credible threat? The main plank of my flimsy optimism about the Euro is that the decision to abandon Greece is a Eurozone decision, rather than the decision of sections of German public opinion or particular European officials. The Eurozone remains a collection of national governments, acting mainly in their own national interests. Suppose Greece does attempt, after its elections, to renegotiate its loans. The Troika will have to decide how to respond. Let’s look at the costs and benefits of this choice.
If it refuses to move from current agreements, and offers little or nothing in return, Greece will suspend some or all of its interest payments, and the ECB would be instructed to withdraw support to the Greek central bank. Crudely, it will stop giving Greece Euros. The outcome is forced Greek exit, which will almost surely mean that the Eurozone would lose everything it has lent to the Greek government, because Greece would default on these loans. So in these very specific financial terms, rather than restructuring existing loans to try and get something back, it would lose it all. So far, so bad.
But, you may think, at least the Eurozone will have drawn a line in the sand, to discourage other debtor member nations to think along Greek lines. Exactly, which is why those debtor nations will not want to see Greece exit. If they have any sense, those governments will know that they too might find themselves in Greece’s current situation, and so they will not want to be treated in the same way. What about countries like France and Italy? The election of Hollande is clearly important in this respect: see Paul Mason here or Linda Barry here for example. In addition, I think both countries will fear the dangers of the contagion that Greek exit might bring much more than the benefits of discouraging future renegotiation of periphery country loans. See R.A. on this here.
We should also not forget that the IMF is part of the Troika. The IMF knows that in every case where a borrower nation gets into severe difficulties, some flexibility has to be shown by creditors. This is usually difficult in practice because the creditors are many, with each hoping that someone else will take the hit and lose their money. But not in this case. As we saw at the recent G8, the pressure on the Eurozone to be accommodating will be huge.
Now all this implicitly paints Germany as the odd one out. It is certainly possible, listening to some sections of German opinion, to believe that Germany will insist on taking a hard line. I suspect that in reality the German leadership is prepared to give ground to ensure the survival of the Euro in its present form, although electoral pressures may get in the way. However Germany is not in charge of the Eurozone or the ECB. Nor has it any obvious means of coercing the other Eurozone governments to take a hard line, even if it wanted to.
So the threat of pushing Greece out of the Eurozone is not credible, if the decision to do so is made by the Troika, or the Eurozone as a whole. This makes the important assumption that the ECB will be prepared to continue to provide Euro’s to Greece. As far as I can see, there is no technical reason why they cannot. (See Marshall Auerback on this.) I also strongly suspect that the last thing the ECB wants to do is to be seen to force Greek exit without clear political backing from the Eurozone as a whole. But the ECB is an independent body without any democratic control and little transparency, so we cannot be sure what it will do.
To get a different perspective on the same issue, consider what might happen if the centre ‘pro-agreement’ parties do much better in the next Greek election than they did in the past. Problem over? Hardly. It is much more likely that in the near future the Greek government would still have to ask for the loan terms to be renegotiated, because its fiscal position has got much worse as a result of austerity and the crisis. So renegotiation is likely anyway. Are Eurozone countries really willing to risk so much just to get slightly better terms on restructured loans?
If this analysis is right, it raises two questions. First, is it wise for the Eurozone to make threats which are not credible? Second (and this has some influence on the first), why does most of the media appear to act as if the threat is credible? (OK, I’m obviously talking about the media I see, and I’ve no idea how this is being discussed in Greece.) Is it lack of thought, or just because the more alarmist you sound the better the copy? I know it is a lost cause, but the media are an important part of this story. The Eurozone are hoping to influence public opinion in Greece by making these threats, and if the media called these threats as bluff, they would be ineffective and would stop being made. So they are complicit in this game of chicken. And the problem with games of chicken is that they can go horribly wrong, as the markets well know. In addition, politicians can get trapped by their own rhetoric. In which case my analysis above based on rational self interest may be worth very little at all.