Greece Is The Word…Again

To paraphrase Mark Twain, history may not be repeating itself but it has some familiar rhymes

Reviewed by: Peter Westaway
Edited by: Peter Westaway

In Greece, history hasn't repeated itself but, to paraphrase Mark Twain, there are still some familiar rhymes.

In 2012 financial markets were convulsing in response to the possibility that Syriza, the Greek radical party, could be elected to government, forcing its own country out of the euro area. At the time, Greek sovereign bond yields and in other peripheral countries of the euro area were at sky-high levels, pricing in the possibility that the whole eurozone could unravel.

In the event, the Greeks elected a government that was prepared to commit to a punishing programme of fiscal austerity and structural reform, a programme that satisfied the terms of the financial bail-out required by its creditors. But despite the partial debt write-off and rescheduling that took place at that time, many commentators were still sure that “Grexit” was inevitable.

Backlash against austerity

With another election in 2015, Syriza was elected to power, and although it is committed to keeping Greece in the euro area, it has set out to defy the terms of the financing that the so-called Troika (the IMF, euro group and European Commission) had imposed on it. The chances of Greece leaving the euro were heightened again.

Whether or not this happens is of critical importance to Greece’s future prosperity, and in my view the benefits of staying in the euro area far outweigh the negatives. But the reason this question really matters is because of the risk of contagion. If Greece were to be granted easier financing terms, why should other peripheral countries work hard to improve the competitiveness of their economies? If Greece were to leave the euro area, what price would investors need to compensate them for the risk that other countries might follow suit?

Markets remain sanguine

Given that contagion risk, some commentators have been surprised at the nonchalance with which market participants have reacted to this recent stand-off between Greece and European authorities.

Yet it is possible to see why they would be nonchalant. Financial conditions in Europe are very different now to what they were in 2012. European Central Bank (ECB) president Mario Draghi gave his "whatever it takes" [to save the euro] speech in the summer of that year, demonstrating a commitment to use the ECB's balance sheet to protect the currency against speculation of a euro area break-up.

And more recently, the ECB has embarked on a programme of quantitative easing (QE) which has pumped liquidity into sovereign bond markets, driving yields to levels that are now looking unsustainable because they are too low – not because they are too high as we had seen in the recent past.

Creditors take control

Perhaps the most compelling reason why markets were more relaxed about this latest version of the Greek crisis is that it was always clear that all the power during the negotiations lay with the German-led creditors. It is one thing for the Greek electorate to try to reject the terms of their bailout loans. But with the Greek economy so dependent on the financial lifeline provided by the ECB, their capacity to force a compromise was weak.

Indeed, the taxpayers and governments of the creditor nations would not have had it any other way.

A long and painful journey

Of course, the new deal could yet unravel and Europe could yet find itself with a euro area shrinking in membership. But, most likely, Greece will continue on the same long and painful journey of adjustment that other peripheral countries, such as Ireland, Spain and Portugal have endured. In the long run, this can only be good for Greece and all those economies that wasted the first decade of the monetary union by indulging in unsustainable growth brought about by over-loose fiscal policy and lax credit conditions.

Investors looking at Europe are still divided. Some think that its lagging stock markets offer outsized returns in the years ahead; others say that the unresolved issues in Europe around fiscal consolidation, structural reform and political governance mean that investors should steer well clear until the uncertainty has been resolved. For the immediate future, it is at least sure that ECB monetary policy will be extremely accommodative as policymakers look to coax this huge economic area into something resembling a sustained recovery.

Peter Westaway is chief economist at Vanguard UK

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