Greece “Very Likely” to Leave Euro

Ever since the euro was created more than a decade ago, it has been viewed as an unshakeable competitor to the U.S. dollar. For most of its life the euro has actually been stronger then the dollar, and it has even made inroads as a denomination currency for international trade.

Only a couple of years ago, it was unthinkable that the euro zone would start to fall apart. It was as absurd that any euro zone country would leave the common currency as it would be for, say, Louisiana to replace the U.S. dollar with its own currency. But the crisis in Greece is putting the euro zone to its biggest stress test thus far, and according to at least one credible source, the outcome could very well be that the euro zone loses a member for the first time. Here is what the EU Observer has to say about today’s Greek election:

Greece’s two main parties are set for heavy losses in Sunday’s (6 May) elections, with anti-bail-out groups on the extreme left and right to enter parliament for the first time, raising again the prospect of an exit from the eurozone. Public anger at the austerity measures linked to the second, €130 billion strong bail-out package could translate into a new Parliament unable to form a ruling coalition and a new round of elections being called in the next months.

And just as an emphasis on the enormous risks that come with this type of situation, I pointed yesterday to the scary parallels between today’s Greece and Weimar Germany. The prospect of a new election in Greece in just a few months only adds to the delicacy of the situation.

The EU Observer again:

Some eight smaller, anti-bail-out parties including neo-Nazi Golden Dawn and nationalist Laos, are to make it into the Parliament. It will be the first time so many parties will form the legislature since democracy was restored in the 1970s. No new surveys have been allowed to be published for two weeks ahead of the elections, with pollsters warning that the result may be unexpected. The last surveys put [conservative] New Democracy at 22 percent and [social democrat] Pasok at 18 percent.

These two leading parties, which have been used to splitting 80 percent of the votes between them, are closely tied to the Greek EU membership, its joining the euro zone and the austerity packages that in recent years have wreaked havoc on the country’s economy. There is widespread resentment toward these parties, which explains why their total share of the votes appears to be cut in half in this election.

In fact, the resentment toward New Democracy and Pasok is so strong that many Greeks call this a “slit wrist election”: they will rather slit their wrists than vote for one of the two major parties. Instead, they want to punish the big parties by voting for a “micro party”. This is interesting for two reasons:

1. Greek voters deliberately want to fragment parliament. They see no merit in a stable political majority – after all, the reasoning goes, the two “stable” parties brought about the current crisis. Therefore they turn their backs on the notion that the country needs a business-as-usual majority in its legislature. While this is refreshing from one viewpoint – it brings new ideas in to the inner hallways of political power – it is a matter of concern in another. It means that a growing number of Greek voters are willing to turn their backs on parliamentary democracy itself. The support for authoritarian parties like the Nazis and the Soviet communists is a clear indicator of this.

2. The anti-EU sentiment that has risen in the wake of the EU-imposed austerity policies will be reflected in today’s election results. As a direct consequence, there will be changes in Greece’s relations both to the EU and the euro zone. The “micro parties” could very well rally around the idea of Greece leaving the euro and propose a currency secession. New Democracy and Pasok may be forced to agree in order to avoid a further downward spiral of political chaos.

This second aspect on the deeply felt hostility toward the political establishment can have widespread consequences.

[Frequent] strikes, violent protests and a shocking suicide in front of the parliament earlier this year have all signalled how little support the pro-bail-out camp has among voters, even though any deviation from the prescribed austerity may lead to a Greek exit from the eurozone. … But with unemployment at almost 22 percent, four years of continuous recession and no positive outlook for the next few years, nerves are wearing thin on accepting further lay-offs, lower wages and higher taxes. Meanwhile, warnings of a Greek euro-exit have multiplied. Central bank governor George Provopoulos last week said that as “painstaking” as the bail-out requirements may be, not following them would “take the country several decades back and eventually drive it out of the euro area and the European Union.” And Fitch ratings agency on Thursday (3 May) said it was a very likely scenario that Greece will quit the euro. “Greece would very likely have to re-denominate its debt and default again,” it said in a press release, describing the consequences of the event.

A switch back to the drachma, the national Greek currency, would be treated as a debt default by international ratings agencies. It is unlikely that this would actually be the case, but the risk of default rises significantly.

Another risk is hyper inflation. If Greece ends up with its own currency again, there is always the temptation to use the monetary printing presses to get rid of the foreign debt. This would, again, be another disturbing parallel to pre-Hitler Germany. Such a massive expansion of the money supply would only be the consequence of a radical shift in political leadership in Greece, which is unlikely in the immediate future. However, it could very well happen within a year or two; let’s remember that today’s political situation in Greece and the country’s potential secession from the euro were unthinkable two years, or even one year ago.

To summarize, two things are at stake today: the Greek democracy and the European common currency. Neither will fall immediately but both will start to wither away if the outcome of the election is an unstable, uncertain parliamentary situation. As for the euro, the immediate reaction among European political leaders will be to prop up the euro and keep it looking as strong as possible. This will have a short term depreciation effect on the U.S. dollar. Long term, though, the euro will grow weaker if Greece leaves – after all, Spanish, Portuguese and Italian debt is all denominated in the same currency – and that will strengthen the dollar.

Europe is in deep trouble. I have serious doubts that its political leadership is capable of straightening things out. So far they have done the exactly wrong thing at every turn. That does not mean they will make the wrong decision again at the next turn, but as of today the short-term outlook for Europe is overwhelmingly negative.