Thursday, May 17, 2012

What If Greece Thrives Outside the Euro Zone?

At virtually every analyst meeting I have attended recently - including the one I just left - it is assumed that Greece will be forced to leave the euro block.

The consensus thinking is that Greece's profligate spending habits, and its reluctance to adopt the austerity measures that the rest of euro countries have tried to force on its citizens, have made it inevitable that Greece will be forced to exit.

But what if Greece actually does better outside the euro?

Tuesday's Financial Times carried an editorial authored by Arvind Subramanian titled "Why Greece's exit could be the eurozone's envy".  Here's an excerpt:

There is an overlooked scenario in which default is not a disaster for Greece.  If this is the case, the real, more existential threat to the eurozone might be a very different one, in which the Greeks have the last laugh. Consider that scenario.

The immediate consequences of Greece leaving or being forced out of the eurozone would certainly be devastating.  Capital flight would intensify, fueling depreciation and inflation.  All existing contracts would need to be redenominated and renegotiated, creating financial chaos....

But this process would also produce a substantially depreciated exchange rate...And that would sent in motion a process of adjustment that would soon reorientate the economy and put it on a path of sustainable growth.  In fact, Greek growth would probably surge, possibly for a prolonged period, if it adopted sensible policies to restore rapidly and sustain macroeconomic stability.

Mr. Subramanian notes that other countries have gone through similar wrenching economic events, and have come out stronger than before:  South Korea; Russia; and Argentina all were forced by external events to change their economic ways, and their economies recovered nicely..

And this is Germany's problem.

Germany has been a huge beneficiary of the euro idea.  Unemployment is at lows not seen for at least two decades, and corporate profits have soared. 

While the consensus thinks that Germany has the strongest negotiating hand, it could in fact be one of the weaker players, since it needs the euro to survive in order to continue to enjoy strong economic growth.

Think of it this way:  if Greece does better outside the euro block than it had as part of the euro, why would other countries not wish to follow its lead, and leave the euro.

Mr. Subramanian continues:

Suppose that by mid-2013 Greece's economy is recovering, while the rest of the eurozone remains in recession.  The effect on austerity-addled Spain, Portugal and even Italy would be powerful.  Voters there would not fail to notice the improving condition of their hitherto scorned Greek neighbor.  They would start to ask why their own governments should not follow the Greek path and voice a preference for leaving the eurozone.  In other words, the Greek experience could fundamentally alter the incentives for these countries to remain in the eurozone, especially if economic conditions remained grim.

In other words, could a Greek exit from the euro be Germany's nightmare?