Who Will Be the Winners and Losers in the Eurozone Stalemate?


Increasingly tense on-and-off talks between Greece and its creditors — represented by eurozone finance ministers — reached a new divide this week after Greece said it would turn aside an extension of its current bailout package. That set the stage for the expiration of the bailout package at the end of February.

Following that development, Greece has now asked for a new loan — rather than an extension on the bailout — that would run for four to six months. From Greece’s point of view, a new loan would allow some breathing room and also for some easing of the tough austerity measures that creditors want to continue. But so far, a number of eurozone member countries, led most strongly by Germany, are refusing to ease up on austerity measures or reduce the amount of debt owed.

So, what happens if there is no agreement this week, given that Greece and its banks reportedly would be close to being out of cash? In the immediate term, the European Central Bank may decide today or Thursday if it would support Greek banks with emergency funds.

To understand how the issues surrounding Greece’s finances may play out, Wharton Finance professor Franklin Allen looked ahead on the Knowledge@Wharton show on Wharton Business Radio on SiriusXM channel 111. (Listen to the podcast at the top of this page.)

It’s now down to politics more than economics and finance, and that is the problem Twitter ,” said Allen, who is also a professor at Imperial College in London and head of its Brevan Howard Centre. “It’s tough for both sides to walk away saying they are winners. If decisions were based only on the economics, they could probably find common ground.”

Allen also said that if Greece does leave the eurozone, it would be the eurozone that by far has the biggest problems. “Greece would probably come out of it in the medium term okay, although there would be a lot of uncertainty in the short term.” In the medium term Greece could “default on [much of its] debt. They’ve got a primary surplus and a lot of uncertainty would be gone.”

But the eurozone would have big problems of political contagion, “with politicians in other countries arguing they may also leave and negotiating harder [for better debt and austerity terms].” So, a Greek exit “may well cause enormous problems for the other countries.”

Thus, both sides have strong leverage, in Allen’s view. He notes that “they may well not reach an agreement, and we may see something we have not seen for a while … the parties … simply walk away and do a ‘Grexit.’ That is outside what is expected, but there is a good chance it could happen here”

While it is most likely that tough negotiations will go on for four to six months, it is also possible a Greek exit could happen within days if there is a run on Greek banks. “Greece would need its own monetary policy [and currency] and start being able to provide liquidity assistance themselves,” Allen says.

“It’s now down to politics more than economics and finance, and that is the problem.” –Franklin Allen

The underlying problem is that the eurozone “is simply not growing. And the problem is that they have been making policy decisions based on growth forecasts which are ludicrously optimistic and completely out of line with what has actually happened. And this is the sense in which the policies have failed, and this is why the Greeks have voted to change them in a dramatic way.”

Allen also pointed out that when Argentina exited a dollar peg in 2002 (with parallels to Greece’s situation today), “it started growing again within a few months. And in a few years it doubled GDP.” Greece’s GDP is now 25% below where it was before the crisis began, “so there is potential to grow, and they might [leave the eurozone].”

An edited transcript of the conversation follows:

Knowledge@Wharton: An article in The New York Times that says that we may be at a point of reckoning again with this situation between Greece and the Eurozone. Do you agree?

Franklin Allen: I think it’s going to take some time before we find that out. I think it’s a long, complicated process that they’re involved in. And neither side wants to back down, but nobody really wants to agree because it’s very difficult to come up with an agreement which politically is acceptable to both sides.

Knowledge@Wharton: And obviously that may be the biggest hurdle as you alluded to, is the fact that in some respects this is becoming more and more of a political matter.

Allen: Yes, I think if it was just economics as it has been mostly in the past in these kinds of situations, it would be fairly easy for them to come up with a deal. But both sides have got to be able to walk away and tell their political constituencies that they haven’t given in on the key points. And I think that’s very difficult for them to come up with, a set of words that is going to allow them to do that.

Knowledge@Wharton: Can we learn anything from the fact that the most recent discussions ended so quickly? Or are we still in some respects in a bit of a feeling out process?

Allen: I think we’re in a feeling our process of quite how far each side is willing to go. But I think there’s a good chance that we’ll have some kind of agreement in the end. But there’s also a significant chance that we won’t.

Knowledge@Wharton: If we don’t have an agreement, what ends up happening?

Allen: There are a number of suggestions being mooted in the press about what may actually happen if we don’t have an agreement. So one is talk of a dual currency. And then the other is talk of a “Grexit.” And I’m not sure that they’ve thought enough on the Greek side about which one of those options, or what are the other options that might be available to them that they would eventually do.

Knowledge@Wharton: What do you think then is the most important thing that Greece is trying to accomplish right now from their perspective? What is the number one and maybe number two things that they want to get out of these negotiations?

Allen: That’s a very difficult question to answer. In the short run they seem to be wanting to be able to say that they have ended the current agreement in some sense. And that they’re fulfilling their campaign promise. And quite the set of words that are used to say that, I think, is one of the sticking points at the moment. In economic terms I think it’s very difficult to know what they want beyond the four or six month extension to negotiate some future agreement. It’s difficult to imagine exactly how they’re going to sell this to both sides.

Knowledge@Wharton: The new gentleman running the Greek government, [Greece’s Prime Minister, Alexis Tsipras], he came off to me, and in seeing some of the news media reports, as somebody that would seem to be a very strong willed individual and one that obviously, in his case, he’s going to try to get the best deal he can, get the most that he can on his end. But at some point does he have to almost take a bit of a conciliatory tone, understanding how much of an issue this is right now on the eurozone?

Allen: Well, that’s the thing. I think we don’t know because if you look at his speeches in the Parliament over the last few days, what you see is a very defiant tone whereby they’re going to start passing laws that push back what’s been done so far. And yet what you read in the newspapers is they’re talking about keeping a large number of the current agreements in place. And quite where they go from there, it’s difficult to say. If he has to back down in a dramatic way on what he’s been saying in Parliament then I don’t think he’s going to have much of a future in terms of elections and maybe even in terms of Parliament. So again, it’s extremely difficult to know where they’re going to end up.

As I say though, I wouldn’t rule out that they adopt a plan whereby they simply exit. But they may do a deal.

Knowledge@Wharton: Well, and that’s a great question because that’s been talked about for some time, going back to the election process, is whether or not Greece would go out on their own and leave the eurozone. And that obviously would obviously trigger quite a few changes in terms of monetary policy all across Europe because of the fact that Greece would be basically running on their own currency again.

Allen: Yes. My own view is that Greece would probably come out of it in the medium term okay. I think in the short term there would be a lot of uncertainty, but in the medium term they could default on the debt. They’ve got a primary surplus. And a lot of the uncertainty would be gone in terms of how things are going to play out. But I think it’s really the eurozone that would have the big problem because there would be a lot of political contagion in terms of politicians in other countries arguing that they might also leave and negotiating harder and so forth. And that– that may well cause enormous problems for the eurozone. If people think other countries might leave there’s going to be capital flight and so on. And I think what the Greeks are trying to do at the moment is to push the limits of that, and that’s why we see this tremendous uncertainty about exactly how things are going to play out.

Knowledge@Wharton: It doesn’t seem like either side really has an advantage at this point. Both are obviously trying to play their specific angles. But there doesn’t seem to be any one side or the other that has an advantage.

Allen: That would be my view, that both sides have got very strong cards to play and they’re both pushing and it’s not clear where we’re going to end up.

Knowledge@Wharton: I guess officially they are going to make the push forward to try and extend their loan agreement tomorrow, from what I’m seeing in a lot of the media outlets. Do you think that that is going to end up being something that the eurozone will accept, at least right now? And obviously from the other perspective, I guess the eurozone is asking for certain conditions. One, I read that kind of caught me off guard, was that they want to have certain control over the types of legislation that get passed, or at least have a say in the legislation that gets passed within terms of economic policy.

Allen: These are the kinds of things which I think it’s going to be very difficult for the Tsipras government to accept because it’s precisely this kind of detailed management that they’ve been reacting against and they based their election campaign on. On the other hand, if the eurozone doesn’t have any control it’s not clear how it’s going to play out…. So my own view is it’s going to take a lot longer than tomorrow. They may do some kind of preliminary deal, but these negotiations over the next four months or six months, even if they do the deal, are going to be extremely difficult.

The real problem is that they [Greece] just simply don’t have the financial resources to pay back the money. And they can do this extend and pretend game, but there’s a limit to that if they’re going to try and keep to … the fiscal compact treaty and so forth that they’ve all signed up to. So this is the problem, I think, at the moment and going forward.

Knowledge@Wharton: And obviously they also have another big issue in that their levels of unemployment are unbelievably high. I think they’re up in the 20s [25%] in terms of percentage of people unemployed. And that has an effect on the tax revenue that Greece could potentially pull in and help their cause.

Allen: They have tremendous problems that way. They’re in the midst of something which is comparable to the Great Depression in the U.S. in the 1930s. And the real problem is that they started to grow, but their growth has been very anemic. And until they start growing strongly again these problems aren’t going to go away. They’re going to keep on coming back unless they write off the debt in some way.

Knowledge@Wharton: And that is … kind of the big gorilla in the room — that Greece would like to be able to write it off, period, end of sentence. And the eurozone does not want to let them get away with it. But in some respects writing off that debt would certainly be a big step forward in terms of getting Greece’s house in order, in some respects.

Allen: Yes. I think inevitably that’s going to happen at some stage because I don’t think they’re going to start growing strongly again, as long as they’re in the eurozone. And that’s the basic problem. Now they can keep adding it on, but as I say, this goes against a lot of the treaties that they’ve signed. So this is the problem that they’re struggling with, I think.

Knowledge@Wharton: This process of this bailout and Greece trying to get its affairs in order has been going on for quite some time. Why is it that it has taken this long just to get to this point and we haven’t seen more progress from the Greek government in terms of trying to get the unemployment numbers down and trying to get the general overall economic view of Greece in a much better situation?

Allen: Well, they don’t have any fiscal room to do any of the things that one would think of to try…. And until something happens, I don’t think it’s going to change that much. And this is why from my perspective the “Grexit” is probably something that would end the uncertainty and they could start growing again. But it would cause huge problems for the eurozone and that’s what they’re trying to push against, and use as a bargaining chip to get some concessions.

Knowledge@Wharton: It seems … this is going to go right down to the political wire, much like we see here in the United States with so many things going on in Congress, trying to get deals passed.

Allen: Yes, I think it will go down to the wire and I think it may just, like it has done in Congress, may well go beyond the wire. And in this case, I think that they may well just not reach an agreement and we may see something we haven’t seen for a while.

Knowledge@Wharton: Which is?

Allen: That the parties simply don’t reach agreement and they walk away and they do a “Grexit” or they do something else, which is outside what is expected. And it’s a while since we’ve seen that kind of thing. But I think it’s a good chance it could happen here.

Knowledge@Wharton: What would be the result of a Greek exit from the eurozone?

Allen: From the Greek side, they can write off most of the debt. I don’t think they’d default on the IMF debt and I don’t think they’d default on the private debt. But then they can default on the rest which is a significant amount. They can start running their own affairs again. They can start running the banks themselves. They can start printing money. And if you look at what happened with Argentina, they actually started growing again in a few months. And within a few years they doubled their GDP. Now who knows what will happen with Greece, but their GDP is about 25% below what it was at the start of the crisis. So they’ve certainly got potential to grow. And they might do that.

I think for the eurozone this creates all kinds of uncertainties about the nature of the euro project and would be problematic. But it certainly is an option for the Greeks just to simply exit the Euro.

Knowledge@Wharton: Yes, because in the end they have to worry about trying to get their own affairs in order. And that’s one of the things we’ve mentioned on this show and I think with you as well, is the fact that when you look at the recovery of the European economy as a whole, it is a much different situation when you compare it to the recovery of the American economy. Because of the fact that the U.S. is obviously one entity, basically running under one ideal, whereas in Europe you have a variety of different countries and a variety of different ideas of how to go forward….

Allen: And that’s the big problem, I think, in the eurozone. They’re simply not growing. And the problem is that they’ve been making policy decisions based on growth forecasts which have turned out to be ludicrously optimistic and completely out of line with what has actually happened. And this is the sense in which the policies have failed. And I think this is why the Greeks voted to change them in a dramatic way.

Knowledge@Wharton: So then what ends up being the future of the Euro and the eurozone if Greece does decide to exit? Obviously you said it does present some problems in the short term. But does it present issues longer term?

Allen: Yes. And I think whatever happens those issues are still there in a dramatic way. So this is the first time we’ve seen a far left party openly challenge austerity and all of the things that that involves. But if you look at what’s happening in France, for example, the national front is doing very well politically and we saw that. They almost won the bi election recently. They failed by just a few tenths of a percentage point to win that. They won the European elections in a sense, getting the highest vote. And they’re a strongly anti-euro party. If they were to gain more power or to start influencing the center right parties in a more dramatic way, who knows where we can end up. But that’s just one example.

And I think that this is the real problem, is that until the eurozone starts growing strongly again, there are going to be lots of political questions about whether the euro is a good idea still. And it may be that the centrists agree, but the far right and the far left, it’s not at all clear that they will keep supporting this.

Knowledge@Wharton: We have right now the discussions are being held by the finance ministers of all of these countries. Getting the political leaders involved, would that have any significant change in terms of trying to get a deal done? Or will they basically just follow the suit, follow the lead of their finance ministers from each specific country?

Allen: I think if a deal is going to be done, ultimately they will have to get involved. If a deal’s not going to be done they may get involved. But they may decide to stay out of it.

Knowledge@Wharton: But getting the political leaders involved, how much does that muddy up the waters in some respects?

Allen: I think that’s muddies up the waters a great deal. That’s the sense in which is there this way of coming up with a set of words where everybody can claim victory. If the finance ministers can do that, then that’s a huge achievement. But my own view is that’s going to be extremely difficult for them.

Knowledge@Wharton: And we’re talking about any potential deal that would be done in a relatively short amount of time because … isn’t it early March or mid-March where a true decision would have to be made by Greece one way or another?

Allen: I think there’s tremendous uncertainty about what those dates are. If people think it’s going to unravel then there’s going to be a run on the banks, and it’s a slow run, but not a fast run. And it could happen very quickly. On the other hand if they think it’s not going to happen it could go on for quite some time. There’s also the issue of, can they raise money from the Russians? Can they go to the Chinese? There are lots of other possibilities which at the moment are not very discussed in the press, but there are a whole range of things. And so I think that there aren’t any real hard deadlines out there at the moment and it could take a long time. But it could all be over in a few days too, it’s just the uncertainty.

Knowledge@Wharton: If there started to be a run on the banks, that would be a very concerning thing for the Greek economy.

Allen: It will force them into “Grexit” because if they’re going to save the banks, they need to have their own monetary policy and start being able to provide liquidity assistance themselves. So that’s the sense in which it could all happen very quickly. But if things go on the way they are currently, it could take a while.

Knowledge@Wharton: In some respects we’re talking about a different set of standards right now between the countries in southern Europe and the countries in northern Europe.

Allen: Yes. And in much of northern Europe now we have these negative interest rates, a lot of money flowing in and relatively strong economies. In southern Europe, some of the countries like Spain are doing reasonably well. But it’s mixed.

Knowledge@Wharton: As somebody who’s been teaching and been around economics and finance for quite some time, does what is going on in Greece and with the eurozone even befuddle you a little bit?

Allen: Oh yes. Well, it’s now down to politics, I think, more than economics and finance. And that’s the problem. As I say, as we started out, really both sides have to politically walk away saying they were winners, and that’s tough.

Knowledge@Wharton: That ends up being a big hurdle to try and climb over the next couple of weeks — to try and get a deal done. So then your general opinion is that we’ve got so many unknowns here you could easily just as see Greece leave the eurozone as we could see a deal get done in the span of a couple of days?

Allen: Yes, these are all possibilities I would say.

Knowledge@Wharton: Okay Franklin, thanks very much for coming on the show. Greatly appreciate the time.

Allen: Thank you, my pleasure.

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