...and Germany shot itself in the foot. A futuristic fable with a moral for those who want Athens out of the euro.

04 Apr 2012
Stephen King, Group Chief Economist

At the end of 2015 the Greek Government could look back with some satisfaction at its recent achievements. The outside world, once so despairing of Athens, now regarded Greece as the "Hellenic tiger". Its stock market, which had fallen by 90 per cent from its 2007 peak through to the early months of 2013, was roaring back. Interest rates, once in the financial stratosphere, were now much lower than in Italy or Spain. And while growth wasn't quite in the double-digit range, Greece was giving China and India a run for their money.
Having severed its links with Europe in response to what had become known as "the calamity," Greece's future now seemed assured, reflecting its growing connections with the world's more dynamic economies. Even as its former European partners walked away, Greece had found new sources of financial support, thanks to the deep pockets of the Russians – who were planning to build a giant gas terminal in Thessalonika at the end of a new pipeline – and the Chinese.
Even during the calamity, China had shown its enthusiasm for all things Greek: the operation of Piraeus's container terminals had been transferred to China's COSCO Pacific Ltd and the port had established itself as the hub for Chinese goods going to southeast Europe, the Levant and North Africa (much to Turkey's irritation). Meanwhile, Greece had cornered the rapidly growing Chinese market for olive oil, undercutting its southern European rivals thanks to a much more competitive exchange rate.
Athens' decision to leave the eurozone – and the EU – had been made with a heavy heart. The Greek people wanted to be part of Europe but had increasingly felt abandoned in an economic wilderness. Admittedly, some of their politicians had been economical with the truth and their wealthiest citizens had found ways of escaping the taxman's clutches but, after three years of devastation, with income down 25 per cent from the peak, it was time to move on.
At first the introduction of the "new drachma" looked like a disaster: those Greeks sufficiently fleet of financial foot removed all their money from the Greek banking system in an attempt to prevent their euros being swapped into devalued drachmas. In response, the new currency halved in value against the euro. The Greek economy shrank by a further 8 per cent as the banking crisis went from bad to worse. Yet with the introduction of capital and exchange controls – mimicking an approach seen in the fast-growing emerging world – Greece could soon insulate itself from the ups and downs of international capital markets. Within a handful of months, domestic economic collapse had been halted.
Inflation threatened, rapidly rising import prices brought big domestic wage demands, but in the absence of support from its former European partners the Greek Government persuaded its people that austerity and wage restraint were necessary for a vital one-off improvement in competitiveness. Within months there were signs of an export recovery. The economy was slowly being rebalanced.
Politicians had repeatedly warned Greece about the costs of leaving the eurozone and the EU, yet it seemed as if it had emerged smelling of roses.
But that was only the beginning. After the exchange rate collapse, and the final debt swap, Greece had rapidly established itself as an extraordinarily attractive destination for foreign investors looking to get a foothold in a dynamic part of the world, particularly after reforms stemming from the Arab Spring. As the investment came in, opposition from domestic Greek unions collapsed: admittedly, workplace practices had to adjust but no one could afford to ignore the sudden and welcome reduction in unemployment thanks to an influx of foreign money.
Europe looked upon this rebirth with a mixture of envy and alarm – politicians had repeatedly warned Greece about the costs of leaving the eurozone and the EU, yet it seemed as if it had emerged smelling of roses.
After Greece's success, all hell had broken loose in the eurozone's financial markets. Germany was still demanding austerity from the likes of Spain and Italy, even as their economies faced a fourth year of contraction. As investors priced in the possibility of a Spanish or Italian departure from the euro, borrowing costs for the southern European nations rose dramatically. The contrast between Greek success and Spanish and Italian failure was obvious, so much so that the Spanish and Italians began to demand their own version of the Greek escape.
The Germans, meanwhile, began to wonder what had gone so badly wrong. They thought that austerity would fix all ills. They believed the fiscally recalcitrant could be brought to heel. The Bundesbank had vehemently opposed any programmes offering support to the weaker members of the euro, fearing fiscal backsliding. Yet, with the prospect of the euro disintegrating, the risk for Germany was obvious – a huge increase in the value of its currency on the foreign exchanges sufficient to wipe out vast swathes of German industry.
Angela Merkel, now the grande dame of European politics, recognised the danger. Forcing Greece out of the euro had, it turned out, been a mistake. The costs to Greece had been outweighed by the benefits. Parts of the eurozone, however, were still mired in recession. Ms Merkel faced a choice: push for a fiscal union that would lock in for ever the transfer payments that, in Greece's case, she had so strenuously opposed; or head for a euro exit, with all that entailed for German industry.
Germany's gamble had failed. In the attempt to punish Greece, it had ended up with an impossible choice: creating a fiscal union or huge currency upheaval. Berlin had taken aim at Greece but shot itself in the foot.
This fantasy is hardly an orthodox view. There is no particular reason why the events described will happen (although the bit about COSCO taking control of container ports in Piraeus is true). But the idea that Greece can leave and that the rest of the eurozone will then live happily ever after – a view that is quickly becoming the conventional wisdom – is surely wrong. Departure might eventually be an answer to Greece's difficulties but it only asks questions of everybody else.
Stephen King originally wrote this article for The Times newspaper, published on 4 April 2012.


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