Let Greece Stumble Out of the Euro

34 APR 20, 2015 11:19 AM EDT

By Mark Gilbert

Bloomberg 

As the weeks since the Greek election have rolled into months, the government elected in January seems no closer to resolving the dichotomy between its anti-austerity inclinations and the reforms its creditors demand as the cost of handing over more money. Today's news that the government has seized the cash of the nation's local governments, citing "extremely urgent and unforeseen needs," suggests the money really is running out. And none of the likely scenarios for what happens next seems compatible with Greece staying in the euro.

The hard-to-admit truth is that Greece seems both unwilling and unable to pay the dues that accompany euro membership. By ceding control of its currency, the country has ruled out devaluation as an option to pull its economy out of its tailspin; some clever people are starting to say Greece might be better off on its own.

It's worth recalling how Greece got behind the velvet rope of the euro club in the first place -- by cheating. The country couldn't clear the 3 percent deficit-to-gross-domestic-product ratio to qualify for membership; so it hired Goldman Sachs to do some fancy financial engineering in the derivatives market to manufacture the right number by 1999.

And when the deficit stubbornly refused to decline to the required level in subsequent years, Greece came up with an easier way of fudging the data: It lied, and lied, and lied again, finally coming clean in 2004 by revising up its deficits for the previous three years. So there's a strong argument to be made that Greece should never have been allowed in to the euro in the first place, and should probably have been ejected as soon as its malfeasance was revealed.

A decade later, it's still not clear when the day of reckoning might finally arrive. David Powell at Bloomberg Intelligence reckons Greece can just about get away with not making a May 12 payment of about 774 million euros ($828 million) owed to the International Monetary Fund. On July 20, however, it has to pay 3.5 billion euros to the European Central Bank, whose largesse via Emergency Liquidity Assistance is currently the only thing standing between Greek banks and bankruptcy. If Greece defaults, though, its banks will go bust as the value of the government debt they own plummets, and the ECB rules forbidding it from propping up insolvent institutions will halt the flow of funds to the financial sector.

The list of what-might-happen-next to Greece includes: Capital controls to staunch the outflows that have seen Greek banking deposits shrink by as much as 15 percent this year; the nation falling into arrears with the IMF; paying public sector workers with IOUs; and flat out defaulting on all payments because there really is no money left.

Even though Cyprus hung onto its seat at the euro table when it needed capital controls, Germany may take a tougher line on Greece, especially since the risk of contagion does seem to have diminished. The yields of Greek three-year bonds surged past 28 percent today, but that has produced barely a ripple in the borrowing costs for other euro countries including Portugal, Spain and Italy. Meantime, the idea that a nation could be in default and still be treated as an equal by its euro peers stretches credulity. And according to prices quoted in the derivatives market, default is seen as an ever-more likely outcome:

Richard Woolnough, a bond manager who oversees Prudential Plc's 24.5 billion-pound M&G Optimal Income fund in the U.K., wrote today that a return to the drachma might be the solution to Greece's economic woes:

"The ability of Greece to provide for its citizens is damaged like the famous Venus de Milo statue. It could well be that politicians recognize the invisible hand of the exchange rate is still an important tool, and a free-floating drachma, though painful, might be the best shot at providing an economic solution given the extent of Greece’s problems."

Roger Bootle, the managing director of London-based Capital Economics, wrote in the Telegraph newspaper today that the only way out of a "prolonged near-death experience" is for Greece to have its own, cheaper currency:

"Currency devaluation has always played a central role in the IMF’s classic treatment for countries in difficulties. And, let’s face it, for Greece there isn’t much alternative."

While polls consistently show a large majority of Greeks wanting to stay in the euro, it's far from clear they'd vote in either a referendum or a snap election to accept the economic strictures -- selling assets, liberalizing labor-market rules, and cutting back on perks for government workers -- that continued membership demands.

A smart reveller knows when it's time to exit the party; a smart barman knows when it's time to stop serving the drunk in the corner and summon the bouncer. For Greece, the euro party might be over, whether it stumbles out of its own accord or gets tossed out for misbehavior.

To contact the author on this story:

Mark Gilbert at magilbert@bloomberg.net

To contact the editor on this story:

Cameron Abadi at cabadi2@bloomberg.net

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