I last blogged (Greek Drama Unfolds) on the Greek drama in June 2011. I suggested that Greece had to leave the Euro. Reading the press in the last couple of days I am convinced more than ever that they will. Worse, the hardship one reads, and hears about, for the “average man in the street” sounds terrible. Only a little of the bail out money that has gone to Greece has actually gone to help them it seems. Most has gone to try to keep the banks afloat. But the economic climate seems to worsen every day and the chance that Greece can pay anything back continues to diminish. It seems very unlikely.
And there is no backstop. Germany does not want to “reward profligacy” and so the German government won’t put in place what is needed to save Greece. The bad news is, as with the Fed and Lehman Brothers, someone has to fall and in this case it will be Greece. My rough estimate of a timeline is:
- Before end of 2012, Greece is kicked out of the Euro. A new currency is launched immediately. Massive devaluation, short uptick in inflation, massive loss of savings. In the run up to this point, bank withdrawals will be seen to increase, thus threatening a bank run. ECB won’t support Greece central bank. Greek government orders new currency. Exchange rate controls forced into place. 5 months later some stability as Greek assets are agreed (in terms of value) against the new Euro (see below). This helps stop inflation running away, and 6 months later helps stabilize exports, and so controls will then later be relaxed. 1 year on, Greece will feel economically like it did 3 years ago, though its GDP will be notably lower than today, but stable. I give this a 0.8 probability.
- Within 3 months of Greece’s expulsion, Germany agrees to the ECB to create a Euro bond to indemnify Euro debt. This will lead to higher interest rates in Germany but they had no choice. With Greece gone, the market shifted focus to Portugal, Ireland, and also Spain and Italy. The back drop is no longer an option. Greece was the example (think Lehman) so now the response can kick in. With the “team” united, the market efforts to exploit a peripheral weakness will be undermined. Germany won’t like it, neither did the Fed. The risks are too great but with Greece gone, Germany ends up doing the right thing. I give this a 0.7 probability.
- Germany interest rates increase slightly, inflation too. Consumer spending will still need to increase in Germany, though this will remain an ongoing imbalance. Greece will, in time (once stable) be able to use its currency to manage that imbalance. Much of the rest of the Euro area will not. So the ongoing dialog about greater fiscal and political union will continue, resulting in a new Euro within 2 years of the Greek exit. This new Euro will be issued to replace the shared/common debt structure, not the ECB-to-local Sovereign support in place today. This new Euro will have initially a fixed exchange rate to the current Euro, and not be a commercial currency. Trade will start to be denominated in the Euro II and increasingly so. Finally a date to transition the public Euro for the Euro II will be set. The exchange rate will fluctuate slightly, but allow for a “drift’ between interest rates between borrowing and saving, this temporarily alleviating the imbalances across the Euro zone. The ECB will want to perpetuate the mixed model for as long as possible as it releases the pressure (much like pressure cooker) but it cannot last for too long. Finally the Euro I is killed off and Euro II becomes the only currency. New imbalances will now exist, between savings mountains and export gaps. We will be back to where we started (before 2009) though with another runway ahead before the cracks will show. I give this a 0.4 probability.
The timeline might not be perfect, and there are numerous other variations being touted in the press. The real people in this mess that are being hurt most are normal Greeks. If only the politics could get out of the way they could be helped sooner rather than later.