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Grexodus: The Death Spiral


Greece seems to have finally entered the death spiral. After a final session on Saturday – they cannot be called negotiations – Alexis Tsipras’ government refused to accept the Trouka’s diktat.


With that, Mr. Tsipras has done two things:

1. Declared a plebiscite to have the Greek people decide whether they will accept the terms of unconditional surrender demanded by their creditors. The referendum will be on the 5th of July, which is after the VLP (Very Large Payment) due the IMF at the end of the month;

2. Declared a bank holiday for Monday. This was necessary to stop the already ongoing hemorrhage from getting any worse.

Greece is going to miss that VLP, though they may have enough money to pay the ECB and EIB the much smaller amount due to them as well. Or they might not; it is hard to see how that will make much difference, so they might as well keep the cash. Once the IMF payment is missed, Greece will be in default and a credit event will be declared. At this point, there no longer seem to be any tricks or technical loopholes to save the Hellenes from default. Whether or not that triggers the acceleration of other outstanding debts is a political decision and appears unlikely; more likely is that the ECB cancel the ELA lifeline to the Greek banks: hence the bank holiday.

A week is not much time to organize a national referendum. Just getting the ballots made and distributed might take that long. It leads one to think that the Hellenic government has been planning this for at least a few days.

The Greek “corralito” is going to have to last until after July 5th. The last chance of a positive outcome is for the Greek people to vote “Yes” to capitulation and for the creditors to make some extraordinarily fast disbursements (to themselves). The fact of the default on the IMF is somewhat irrelevant at this point; no one is paying attention to things like lending rules anymore. The debt is all in institutional hands anyway, so there is no market to scare away. It will be interesting to see how bond markets react to Spanish, Italian and Portuguese bonds on the 1st of July.

It is hard to see Greece getting out of the death spiral. The bank holiday is the first step; it will be very easy to slip into capital controls; then issuing tax-backed IOUs, which they might as well call patacones. And that will be that. Grexodus, new Drachma and the end of the “irreversibility” of the Euro. So much for ever closer union.

It is ironic that Europe finds itself in so similar a position to the original Greek crisis. On that occasion, George Papandreou sacrificed himself when he playing with a flush hand: throwing Greece under the bus would have meant triggering a German banking crisis. He was replaced by the nonentity Lucas Papademus, a former ECB technocrat, who was supposed to implement the reform program and set Greece on the right track to growth. Of course he failed since that was never the purpose of the reforms or the bailout. Now Mr. Tsipras is going down the same route with a pair of fours and the Greeks are finally going to be given the choice of slow death by arsenic poisoning or quick death by cutting their own throats.

If those are indeed the only two choices open to the Greeks, the the single currency is a vastly bigger failure than the Hellenic Republic. And what is true of Greece is true of others. Italy may return to its pre-crisis GDP by 2023; Spain may return to its pre-crisis level of employment by 2025; Portugal may recover its emigrated youths, but probably won’t. Or none of these things might happen. That is not a vote winning proposition in these countries.

It is a terrible shame: Mr. Papandreou behaved like a European statesman and his reward was exile and misery for his people. He should have acted like a Greek patriot and things might have turned out differently. Mr. Tsipras has understood this lesson and it is probable that other leaders will too. It will undermine European solidarity – what’s left of it – and strengthen the disturbing increase in nationalism. Marine Le Pen will only be strengthened by the treatment being dealt out to tiny Greece.


It is also clear that Christine Lagarde was the wrong person for the top job at the IMF; in fact, she might have been the worst possible choice. Not because of her personal qualifications, which are exemplary. But it is impossible to imagine a Mexican or Indian Director allowing the Fund to violate its lending rules to the extent they have with Greece or to issue such ridiculous growth forecasts or to so unwaveringly back the official EU position for so long and with such disastrous consequences. What Europe needed was an outside objective voice at the table, and that is precisely what they did NOT get with Mrs. Lagarde. It is to be hoped that the next Director will not be burdened with so obvious a conflict of interests.

29 June Update:

The Greek government has formally introduced capital controls on financial transfers. According to reports, domestic account holders will be limited to 60 euros per withdrawal at ATM’s, but no limitation will be placed on foreigners visiting Greece. The exception is pension payments, with banks expected to open to allow pensioners to withdraw their monthly allowance. Electronic transactions are also not affected at this time, though it may become increasingly difficult to find anyone willing to accept a credit, much less a debit, card at this time.

This is pretty much it for Greece, unless the people are scared witless enough to vote “Yes” next Sunday. At some point soon, the Greek government is almost certainly going to have to start printing IOU’s to cover even their pensions and salaries costs: that is a patacón no matter what the government calls it and the following step is the official recognition of a parallel currency internally. That will lead inevitably to the long anticipated and so often denied Grexodus from the Euro.

As a bonus to readers, I thought it worthwhile to reproduce here my article from 2011 on “Lessons from the Argentine Default of 2002”. I’ve updated it slightly to reflect the current situation in Greece:

A brief history of the Argentine crisis

  • Following a second bout of hyperinflation in late 1990, the government of Carlos Menem took executive measures that fixed the value of Argentine currency at ₳ 10,000 per USD. To secure this “convertibility” the Central Bank of Argentina had to keep its U.S. dollar foreign exchange reserves at the same level as the cash in circulation. This eventually became the Currency Board;
  • As a result of the convertibility law inflation dropped sharply, price stability was assured and the value of the currency was preserved. This raised the quality of life for many citizens who could now afford to travel abroad, buy imported goods or ask for credit in dollars at very low interest rates;
  • Argentina still had external debts to pay and it needed to keep borrowing money. The fixed exchange rate made imports cheap, producing a constant flight of dollars away from the country and a progressive loss of Argentina’s industrial infrastructure which led to an increase in unemployment;
  • Government spending continued to be high and corruption was rampant. Argentina’s public debt grew enormously during the 1990s. The International Monetary Fund, however, kept lending money to Argentina and postponing its payment schedules;
  • A series of external macroeconomic shocks buffeted the vulnerable Argentine economy – Mexico (1994), Asia (1997), Russia (1998), Brazil (1999). These financial crises raised the cost of debt to all Latin American countries and depressed the overall economy of the region. After the Brazilian devaluation of 1999, Argentine exports were seriously harmed and Argentine trade within Mercosur declined even more;
  • By 1999, newly elected President Fernando de la Rúa faced a country where unemployment had risen to a critical point and the undesirable effects of the fixed exchange rate were showing forcefully. Argentina’s gross domestic product dropped 4% and the country entered a recession.

The pace of events accelerated very rapidly in 2001 leading to a November default:

Argentina timeline

Two things are evident from this timeline:

  1. The economic and financial crisis in Argentina had become “the new norm” which led investors and citizens to discount the possibility of a default and a removal of the dollar peg, even though all the fundamental macroeconomic indicators pointed towards the unsustainability of the Argentine debt;
  2. When the break came, events unfolded with shocking rapidity. Three weeks passed from the default on 06 Nov to the “corralito” imposed by the Argentine government; the government collapsed three weeks after that; and only two months passed from the default to the collapse of the dollar peg.

In the event of a major European default, we could expect an even more rapid transition, especially if it is a planned default in concert with the rest of Europe (i.e. with German agreement). If Germany decides that the situation becomes untenable, I would expect a “corralito” and exit from the euro to precede a default on the debt. It would be messier the other way around, but also very rapid. This is how events have proceeded with regards to Greece.

This is because a default will cause a run on the banks as citizens desperately try to withdraw their euro deposits on the (largely correct) assumption that a defaulting nation will not be able to stay in the euro. To avoid this, the government would anticipate the reaction by declaring a bank holiday or other severe limitations on withdrawals until it were able to convert the monetary base to the new currency. In this case, Greece has declared capital controls and a bank holiday with the excuse of the referendum, but it would be shocking if contingency planning was not now being undertaken at a furious pace in the Greek Finance Ministry. If the referendum delivers a “No” vote, the government is going to have to be ready to start issuing “temporary” currency the following Monday to allow people to survive and the economy to function on some basic level: but that will be the end of Greece’s participation in the Euro.

The consequences of the uncontrolled default and conversion were devastating to Argentina. GDP collapsed in 2002, inflation exploded, and the mass of Argentines living in poverty soared.

Argentina impacts

 The Mediterranean contains much richer countries than Argentina, so it is unlikely that the deep poverty experienced in the South American country would be so widespread. Greece is not, however, one of the richer Mediterranean countries and my report was written in 2011, before 4 more years of austerity had set back the economy by 30% of GDP. Given that a quarter of the Greek population already lives below the poverty line and another 30% are in the “danger zone”, I would expect poverty rates to increase to similar levels as those seen in Argentina (though the absolute income level will still be higher than in the South American country).

However, I would expect the following impacts:

  • Access to credit will dry up completely as the defaulter was locked out of international capital markets for a number of years, deepening the recession and worsening unemployment; This is not entirely the case. Greece has signed a preliminary agreement with Russia to extend the proposed Turkish Stream gas pipeline from the Black Sea to Anatolia and then to Greece. The construction could begin as soon as 2016 and the Russian development bank VEB would fully finance the 2 billion euro project. If this project were to go through, it would create lots of jobs and a nice source of guaranteed, hard-currency revenue for the Greek government.
  • Inflation would increase substantially as the government would most likely expand the money supply very quickly to first create sufficient new specie for business and then in an attempt to stimulate the economy through liquidity injections; The Greek government is in a better position than the Argentine government from a fiscal point of view, as the Hellenic Republic had been running a primary fiscal surplus until December of last year. Also, with the economy so moribund and such high levels of unemployment, it is hard to see non-energy inflation going up substantially in the short-term. I believe the Greeks will be able to print away like mad for quite some time before experiencing substantial rates of inflation. They will need to do so if they wish to jump start the growth motor.
  • The new currency would rapidly depreciate, destroying the purchasing power, overall wealth and patrimony of citizens, as well as driving inflation. The Argentine peso depreciated 50% in the first couple of months after the default and stabilized after a 70% depreciation; The Greeks are in a better position than the Argentines, for while the latter also sent their savings abroad to dollar deposits in Uruguay and the US, the “corralito” still caught most Argentines by surprise. The Hellenic “corralito” has not caught anyone by surprise: any Greek with substantial savings has already sent them abroad to a Euro account in SEPA country. This money will trickle back into the country after the initial depreciation of the new drachma and could help reactivate the economy to a certain degree. Additionally, Greece has a much larger potential as a tourist destination than Argentina: unless Grexodus is followed by political and civil strife, we can expect Greece to win back many tourists in summer 2016, with the tourism services and infrastructure sectors becoming key growth engines.
  • The government would impose temporary withdrawal restrictions to prevent bank runs, limiting the availability of cash to consumers. A temporary withdrawal from Schengen might also be necessary in order to impose border controls to prevent large-scale smuggling of cash and other assets out of the country.

On the bright side, any European nation exiting the euro would not have to depend exclusively on its own resources, as Argentina did. It would still be a member of the European Union, with all the advantages that entails. It would be in the EU’s interest to ensure a quick recovery of any defaulting member; so while a return to membership in the EMU might be a very long way off, a rapid economic recovery could be expected. Germany, after all, still wants to sell Volkswagens in the Mediterranean, whether they’re paying in Euros or drachmas. This was written before the issue became so acrimonious. In fact, I’m no longer sure that the European Union would want a quick and complete Greek recovery. It would only prove what many economists have been saying since the crisis (or even earlier): that there is life outside the Euro and for the Mediterranean nations, life might actually be better outside the Euro. I don’t know whether or to what extent the EU might try to sabotage a post-Grexodus recovery, but I doubt they would welcome it.

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