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Greek Elections, Lessons From Argentina 2001-02 ...and a Call for Sanity

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Greece is on the verge of a national catastrophe. The local political leadership has made successive mistakes, only to be compounded by the recent vote, a vote that was more of a protest toward the morally bankrupt "pro-European" parties of the past (ND and PASOK), rather than a vote looking into the future. Once again, the Greek people were promised something unrealistic and, within their desperation, voted for it.

Mr. Tsipras and the other "anti-memorandum" parties promised the Greek people that Greece can stay in the EU and within the eurozone, yet renegotiate the terms of the so-called "Memorandum" to make the ongoing recession easier to cope with by extending the "adjustment period" for the Greek economy. He promised them that they can once again have the pie and eat it too. I am not sure if Mr. Tsipras (and others) are totally uneducated in history and economics or if they are just plain demagogues trying to win an election, following the footsteps of Andreas Papandreou. It saddens me to say but I hope it's the latter, for Greece's sake. I hope that just like Mr. Papandreou in the '80s and like Mr. Samaras a few months ago, Mr. Tsipras will sit at that Eurogroup meeting and after realizing that the "Memorandum" cannot be renegotiated, he will abide by the ongoing adjustment program. But what if he doesn't? What if he is serious about his beliefs that Greece can unshackle itself from foreign debt (aka its legal obligations toward its EU partners), yet stay within the eurozone?

Let's examine the scenarios...

The Fairytale Scenario:

Mr. Tsipras is correct about all of his predecessors being traitors or incompetent and Greece having unused leverage vis-à-vis the EU/ECB/IMF Troika. The EU is so afraid of setting a precedent of a country leaving the euro that it will write yet another blank check to Greece to keep it on life support. Mr. Tsipras becomes a national hero. He flies back to Athens a winner.

The Argentina Scenario:

Mr. Tsipras stays true to his pre-electoral promise. He tries to renegotiate the Memorandum with the Troika. The Troika rejects any renegotiation attempts (as it has stated it will) and asks him to proceed with the adjustment program. He refuses (or more likely) fails to do so. The Troika refuses to give the next loan installment. Greece is forced to exit the euro because it cannot find the hard currency but it has to print it and therefore it quickly issues laws to convert existing deposits to a new devalued currency.

There are several arguments "anti-memorandum" supporters make that scenario No. 2 cannot happen or even if it happens, it will not be that bad. I will try to debate and give an answer to all of them and prove that Mr. Tsipras (or whoever is arguing this) is engaging in a serious game of high-stakes poker with potential catastrophic consequences for Greece.**

Argument 1:

Europe will blink at the Greek threat of defaulting because a Greek exit from the euro would be catastrophic for Europe.

This argument carried some validity two, or even one, year ago, when the EU institutions were not prepared for a Greek default and exit. Since then, several things have happened.

a) Greek debt has already been restructured with a large part of it now in IMF/EU/ECB hands (as opposed to private hands). Those entities will suffer but can withstand a Greek default by getting recapitalized by governments (EU/IMF) or by printing money (ECB).

b) The ECB now has an implicit mandate to backstop eurozone banks by providing them endless liquidity (Fed-like) so even if there is a systemic shock for eurozone banks, which might put some of them in an insolvent position on a mark-to-market basis, they can still survive.

c) The rest of Europe has now been more or less "ringfenced" against a Greek default. Although Italy and Spain are still vulnerable, nobody is questioning their allegiance to the European experiment and they have shown good faith in implementing structural reforms. Similarly, although Belgium, France and the Netherlands are questioning the policy of pure austerity and would like to see a "growth component", they would not go as far as asking for Treaty renegotiation with Germany.

One can notice the change in rhetoric as well on behalf of Ms. Merkel, Mr. Schauble, Mr. Regling and Mr. Juncker. They once used to speak about a Greek exit as being "catastrophic for Europe." This past week, they spoke about it as being "catastrophic for Greece and its creditors" ... PIMCO co-CEO Mohammed El-Arian also talked about financial markets turmoil if Greece were to not honor its commitments.

So, both facts and independent analysis, as well as updated rhetoric point out to the fact that Europe will get mauled from a "Grexit" (Greek exit in financial lingo) but it will survive. While Europe will survive, the systemic shock for the Greek people will be so immense that will most likely lead to extensive social unrest and damage to the economy that will take years to repair. (See: Argentina). So here, I'll take it a step further. Maybe a "Grexit" will benefit the core eurozone in the long run. It will show the "survivors," the ones that stayed in the eurozone, the Irelands and the Portugals how much worse things can get if they don't get their house in order. It will make peoples and governments adhere to austerity rules by example. Greece will eventually be the example to avoid at all costs...

Argument 2:

Participation in the eurozone is "voluntary and irreversible." No country can be legally forced to exit the eurozone and the Treaty of Lisbon does not contain provisions for a country exiting.

Yes, no member state can be forced to exit the eurozone via a treaty but it can be forced de facto by deprivation of banking liquidity. In November 2001, Argentina failed to make reforms required by the IMF in order for the latter to disburse its next loan installment. The IMF refused to disburse the installment. Fearing a collapse of the banks that were technically on life support (similar to Greek banks now), a bank run started. To prevent the bank run, on Dec. 1, the government instituted withdrawal controls, the so-called "corralito," where nobody could withdraw more than 250 pesos (1P=1USD at the time) from their bank accounts. People sued the government, took to the streets, broke and torched banks. By January 2002, Argentina had ended convertibility of the peso to the dollar, had devalued the peso by 40 percent and finally allowed some people who had sued to withdraw their funds at the devalued exchange rate.

Greece would be in a similar situation. The Greek government eventually runs out of money and defaults on its debt. Greek people, fearing a collapse of the already insolvent banking system, initiate a bank run. Unable to print euros to provide liquidity to the banks (only the ECB can print euros), the Bank of Greece will have to impose similar controls on withdrawals to prevent a collapse of the banking system.

Starved with liquidity, eventually, Greece will be forced to either backtrack and implement the Troika-mandated measures or decide to convert to all deposits to its own currency and crank-up the printing presses. Banks will be required to convert withdrawals on the spot to the new devalued drachma. Therefore this will mean de facto devaluation and exit from the eurozone.

This whole process took less than two months to take place in Argentina, while the majority of the middle-class depositors saw their savings devalued by as little as 1.4-to-1 and much as 4-to-1 (the peso eventually regained some of its losses from the trough). Several Argentinians took the banks and the government to court but the wheels of the justice system were too slow when faced with the lightning speed of financial markets.

Therefore, technically, Greece will "voluntarily" exit the eurozone, forced by the conditions in its banking system. It's important to also note that Argentina did not bully the IMF at the time. It did not "refuse" to make the installment payment as Mr. Tsipras is threatening to do. It just failed to deliver on the cutbacks. That is all it takes when you play poker in the big boys' tables. You can bluff all you want but you also need to make sure you have good cards.

Bottom line: to all those lawyers (and wanna-be lawyers) who really believe that legal arguments can stand on the path of an avalanche of capital outflows and bank runs, please go ask someone in the Argentinean middle class how the legal framework protected them in December 2001.

Argument 3:

Even if Greece exits the euro, it will only be bad for a brief period of time and the Greek economy will eventually recover, just like Argentina did.

For those that are arguing this point, they are not familiar with either hyper-inflation or what happened to the middle class in Argentina immediately after the end of convertibility to the dollar. Hyper-inflation ensued. The devaluation of the peso took a huge bite out of the middle-class savings and earnings. Both poverty rates and Gini coefficient values kept rising until 2005, almost doubling from the 1998 levels.

Greece is running a huge current account deficit (exports are much less than imports). It relies on foreign-made goods for its well-being. A potential devaluation will make such imports (see: heating oil, gasoline, major industrial goods) much more expensive and will represent an automatic regressive tax to the middle class and the poor.

Yes, eventually, Argentina recovered. Yet, unlike Greece, a country dependent on tourism and a services economy, Argentina is a country sparsely populated, agrarian and with tremendous mineral wealth. Even if it recovered, its middle class and its poor paid a very high price.

Now, nobody would want that for Greece. Isn't that right, Mr. Tsipra?

*Here some people would argue that a bank run would not be necessary if the Greek people keep calm and don't panic. I am not sure what the readers think but I would take a bet that if Greece defaults and it's obvious that a) the government will soon be insolvent and b) the banks will not have the ECB liquidity lifeline, there will be a massive run for the exits. Another arguing point is that even though the Bank of Greece will not have a mandate to print euros, the National Mint that has euro-printing presses in its possession will act like a rogue employee and print euronotes without authorization by the ECB and enter them into circulation. I don't consider that an option as it would be a) "casus belli" on behalf of the rest of the EU and b) unrealistic to supply the banks with enough banknotes in due time to prevent a collapse of the banking system in case of a massive bank run due to the fractional banking system.

**To those who might rush to accuse me of parroting arguments of the international banking lobby or of IMF-driven neo-conservativism before finishing reading, I'd urge you to read the last few paragraphs of this article on who will suffer the most from a Greek default and exit.