THE BLOG
06/10/2016 03:38 pm ET | Updated Jun 13, 2016

If Grexit Meets Brexit

My mother is of both Greek and German heritage, which could mean that my prejudices regarding the Greek debt imbroglio should be perfectly balanced. However, as I delved into economist James Galbraith's new book, Welcome to the Poisoned Chalice I became convinced of the impossibility and injustice of the situation in which Greece now finds itself, as the country negotiates its financial fate with the German government, the EU and the IMF. And as we draw nearer to Britain's vote to leave or stay in the European Union on June 23rd, what could go wrong in Europe this summer that could impact the global economy? We are very close to finding out.

Unless it is a work of fiction, I begin by reading the end of a book, and in this case I was particularly well rewarded. If absolutely everything does goes wrong, we all want to know, what is Plan B for Greece? Last summer, at the Ministry of Finance in Athens, Galbraith and his small team thought through the ramifications of Greece exiting the European Union, which they called Plan X. "The Plan X Memorandum" is an inside peek into what if? and the legal basis for a "Grexit". It contains details of necessary actions such as notifying telecommunications companies so that services would be maintained throughout the transition, and the challenges of printing of new paper money.

If Grexit is how things might end for the European Union, how did they evolve to this point? Galbraith explains how Greeks are being dispossessed of assets in order to pay debts that never benefited them in the first place. As he told the Institute for New Economic Thinking:

The Greek people are being maneuvered into a position where they cannot pay their mortgages and are being dispossessed from their homes. For what? For debts that were incurred under previous governments for completely useless things where the benefits went to German construction companies and French arms firms. The notion that this debt should be paid is absurd.

The IMF believes that debt reduction or forgiveness is critical, but the European Central Bank and the Eurogroup do not. Negotiations are continuing on a framework for debt relief that would prevent Athens from defaulting on a major loan repayment in July. Before that deadline, Greece must also pass an additional tax amounting to 1% of GDP which then must be collected, another difficulty. Protests are likely; the Greek police say that there have been more than 27,000 demonstrations in the past five years.

So Galbraith's book, a series of essays, letters, and memos written during the heart of the Greek crisis in 2015, appears at a crossroads in modern Greek history. While our attention has been diverted by Brexit coming up on June 23rd, the clear and present danger to the Europe Union remains the failure of Greek debt restructuring. The European Stability Mechanism should give its approval on June 16th of next week, kicking the can down the road for now.

Galbraith explains how and why Greece's problems did not get resolved last summer.
'The situation in Greece, coupled with the pending vote by the UK this summer about whether or not to remain a member of the EU represent twin crises from which there might be no recovery.'

The book has two main protagonists, the author himself, an eminent economist at the University of Texas at Austin, and his friend and colleague Yanis Varoufakis. Varoufakis is also an economist and the former finance minister of Greece, and is currently touring the US with a book of his own, "And the Weak Suffer What They Must?". When Varoufakis became a member of the Greek government, he called upon Galbraith to help him understand the consequences of a possible default. Galbraith had a fascinating vantage point from inside the makeshift offices of a revolutionary Greek government.

Galbraith's role in the unfolding drama of last summer brings to mind a long tradition of Yale-trained economists who have consulted and influenced foreign governments. Many do not realize that Yale economist Ma Yinchu for example, crafted China's one-child policy, and it is hard to be more influential than that. But Galbraith also reminds me of a Princeton economist, Arthur Nichols Young, who advised several governments in crisis in the mid-twentieth century.

Galbraith avoids the term "Grexit" throughout, calling it "an odious Goldman-Sachs coinage for Greek exit from the euro". His focus is on the human costs of payment terms that are unsustainable, based upon an imperfect and unsustainable union, which is effect a confederacy. In a lecture about his book, Galbraith summarizes his conclusion:

Since there is in Greece no longer a political outlet it will be that much more unpleasant as the fires burn. That's the price that both Greeks and Europe will bear from accepting a set of policy recommendations dictated by economists, driven by ideology and utterly disconnected from the reality of what it might take to restore a viable social and economic entity on that particular outskirt of Europe.

Galbraith has an interesting take on why this was allowed to happen. He claims banks, not the real economy, were the major target of the Greek rescue. Former IMF head Dominique Strauss-Kahn, with the French presidency then firmly in his sites, used the rescue to curry favor among his supporters, who also happened to be Greece's creditors.

The situation has similarities with the Asian Financial Crisis in 1998, and the IMF's stance toward Korea which required major austerity measures. The difference was that South Korea had the ability to increase exchange rate flexibility, and Greece as a member of the European monetary union does not. As has been debated by economists but ignored by some policymakers, austerity can lead to desperate measures to raise short term liquidity, but in the long term this inflicts fatal blows on the economy. According to the Economist, sharp increases in business taxes (now 29%) have caused 200,000 businesses to close or leave the country, in a country of only ten million people. This would be the equivalent of six million businesses closing in the US. (Ironically, the Athens Stock Exchange has risen 42% in the last three months.)

Another issue is although Greek banks have done what has been asked of them, the current government has delayed a progress review of the third international bailout. Michalis Sallas, the chairman of Piraeus, Greece's biggest bank and three other banks met a November deadline to bring in an additional 14B euros of new capital, but infighting in the Tsipras government has resulted in a failure to complete negotiations with the EU and the IMF. Sallas sees this as threatening revitalization of Greece's private sector and international investment.

The situation in Greece, coupled with the pending vote by the UK this summer about whether or not to remain a member of the EU represent twin crises from which there might be no recovery. Galbraith is unsure if Greece will be the first to exit, citing battle fatigue, and thinks that perhaps another player such as Finland could be the first to leave. That would be a surprise. Greece is a small country, but the reason for concern is that the crisis symbolizes all that has gone wrong with the European experiment. Wolfgang Munchau writes in the Financial Times:

The cardinal mistake of our time was the decision to muddle through the Eurozone crisis. Europe's political leadership failed to generate the public support for what was needed: creating a political and economic union...

Economic history has shown time and again that efforts to muddle through financial crises never work-think of the Great Depression or Japan's lost decade. For the EU it was a catastrophic policy error. It has not only given us an economic depression from which many countries have not yet recovered. It has also destroyed public confidence in the EU and in the very idea of European integration.

Galbraith frames the issue of institutional failure differently. He describes the current structure as inherently flawed and is not sanguine about the future of the European experiment:

Europe was a bright political project at the formation of the European Community and again when it expanded at the end of the Cold War. Its purpose was not so much power as peace: truly a noble vision. But that noble project was built on an end-of-history economics, on frozen-in-time free-market notions and on dogmatic monetarism linked to arbitrary criteria for deficits and public debt. In the wake of a global financial meltdown, these no longer serve. Unless they are abandoned soon, they will doom Europe as sure as communism doomed the empire of the East.

Was the entire Greek debacle the result of greedy French and German bankers who made risky loans, who were then rescued by politicians? When in 2010 it became clear that Greece was insolvent, did the IMF (France) and the EU (Germany) conspire to offload those loans to the entire European Union through a restructuring of that debt? It is almost more hopeful to believe that than the probable reality, that in more prosperous times things were not thought through, including an exit for any member who might not want to remain part of the EU. Getting to this point was a concatenation of the best of human aspirations for peace and prosperity, and the worst of human inclinations of greed and fear, now played out on a tragic stage in Athens.

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