Events in the eurozone have quickly moved from threats to market shock. But Wharton management professor Mauro Guillen still sees a better than 50% chance that Greece will still be a member of the eurozone a month from now. Either way, the euro and rest of the eurozone itself are likely to remain intact for the foreseeable future, he adds.
In this Knowledge at Wharton podcast, Guillen discusses how events are likely to unfold. “There is no other way to describe the situation except as chaotic. This is almost like The Twilight Zone.”
An edited transcript appears below.
Knowledge at Wharton: It’s been a hectic weekend. The Greek banks have closed. The ECB began to freeze lending to the banks, and that’s what forced that issue. There’s now a referendum in Greece scheduled for next Sunday to decide whether it should stay in the eurozone or not. And of course, markets are reacting.
Some are saying that this could even be the beginning of the end for the eurozone, and even the euro. Whether or not that’s going too far, there are others who are saying, “No, no. We’ll be able to contain this to Greece, because we’re much better-prepared to face this kind of emergency than we were in Europe four or five years ago.” What’s your view on that?
“The monetary union in Europe as we knew it is over.”
Mauro Guillen: My view, I think, is very clear– which is that the monetary union in Europe as we knew it is over. It’s over once one of the member countries establishes capital controls, and establishes restrictions on how much money people can withdraw from the bank. Just imagine if Texas and the United States have to put in place those measures, right? That would mean that we would no longer have one single monetary space in the United States.
So the monetary union is gone. That doesn’t mean that the euro is gone, as a currency. But what I think is very clear, is that Europe now has become a regime in which we have fixed exchanges. We no longer have a monetary union. And you know, we’ve never really had a monetary union in Europe — because other elements have always been absent, such as a banking union and a fiscal union.
So I think for now, the euro as a currency will survive…. And within a few years, I think there’s going to have to be a redesign of the thinking of the whole monetary union, the whole euro system in Europe.
Knowledge at Wharton: So far, there’s not been huge contagion. Of course, it’s early in the process right now, and that could change fast. The referendum isn’t for a few days. But right now, what do you see happening as far as contagion goes? That’s been a big worry all along — what will happen to bonds in Spain, Italy and Portugal.
Guillen: There’s been some of contagion already, meaning that the spreads over the German bond have already increased. In Italy, in Spain, in Portugal, even in Ireland. And there’s also been contagion in the sense that stock markets have reacted very negatively, especially financial stocks.
Greece is going to have these measures in place for a week, and then there is this weird referendum that is going to take place over the weekend, in which two questions are posed. The questions are exceedingly complicated, and they’re asking people to read a couple of documents and then say yes or no, which is unprecedented in the history of referendums. I think the whole thing is a tactic on the part of the Greek government to try to keep more pressure on the troika — on the IMF, the European Union and the Central Bank — so that they accept the restructuring of the debt. And that is one possible outcome: That Europe might, in the end, give in to the Greek demands, and restructure the debt, with a haircut.
Another possibility is that before the weekend, Greece is out. We don’t know. That’s why there is so much uncertainty. They’ve given themselves one week now — with capital controls, and with a bank holiday. What has happened in most other situations such as this is that the country, essentially, goes off the grid. And in this case, what I believe is that they would abandon the euro and reintroduce their own currency, at a very, very large devaluation.
Knowledge at Wharton: Do you think Tsipras was right to walk away from the talks when he did?
Guillen: Well, you know — put pressure on the rest of Europe; this is one way of doing that. If you want to also convey to the Europeans that Greece cannot be trusted for the next 20 years, he’s also been very effective.
He may accomplish his short-term goal of putting pressure on Europe. But at the same time, I think he has given a devastating blow to the credibility of Greece — to be negotiating in Brussels and then get on a plane and arrive in Athens and then announce a referendum, without having told anybody in Brussels about it. That is something that doesn’t promote confidence and trust.
Knowledge at Wharton: If Greece had agreed to the deal that was on the table, which involved many things but it could be characterized as being more austerity, how do you think the Greek economy would perform under those conditions? How long would it take it to get back to health?
Guillen: Austerity in its current form is not working. This is a problem. The problem is not only in Greece. The problem is also the impositions that are coming from Germany and the other surplus countries. Austerity cannot work quickly; it takes time for discipline to have its effect. And you’re beginning with unemployment at 25%, and 50% among the young. And with an economy that has been contracting — an economy that doesn’t have a sound basis for competing in the global marketplace.
So it would be far better, I think, to relax the austerity conditions, but especially to do so in the surplus countries. What doesn’t make any sense is for Germany to be running a budget surplus, right? What doesn’t make any sense is for Germany to be containing their wages. What we need, what Europe needs, is more demand from Germany — whether it’s coming from the government or coming from the private sector, and from households.
When you have a set of countries in Europe that are so tightly integrated in terms of trade, that means that they depend on each other for growth. And therefore, if everyone at the same time implements austerity policies, that’s a recipe for disaster. I’m not the first person to point this out.
“When you have a set of countries … that are so tightly integrated in terms of trade … if everyone at the same time implements austerity policies, that’s a recipe for disaster.”
But apparently the Germans don’t get it. So they need to be reminded about this — that they need to stimulate their economy, to stimulate their spending through some more deficit spending on the part of the government, and through wage increases. They’ve done a little bit of the latter over the last year, but not enough.
Knowledge at Wharton: Given where things are right now, what do you think would be the best outcome for the Greek people?
Guillen: Well, in the short run, obviously, it would be that they get a debt restructuring. That goes without saying…. That would be the best possible outcome for Greece.
But that raises another issue: What about Portugal and Spain and Italy, and all of the other countries? They’re going to start wondering, “Why don’t we get a debt restructuring ourselves as well.” The problem is that you cannot set a precedent with Greece, because then everybody else will feel, “Oh, I can just continue doing things as normal. Hey, they bailed out Greece, they gave them a haircut. They gave them debt restructuring. So therefore they will also do that for me. All I need to do is just [exert] enough pressure.”
The problem is that in Europe, the troika now gives into the way in which Greece has set the terms, for the rest of the week. They’re setting an awful precedent. You cannot do that in a monetary union. You just cannot do that. It’s a slippery slope.
Knowledge at Wharton: Is the alternative, though, that the European creditors are willing to see Greece exit in order to make an example of them and say, “If you don’t cooperate, this is what’s going to happen,” to the others?
Guillen: This is my opinion: I think there are only two possibilities here that make sense both in the short run and in the long run. Possibility number one is: You keep Greece in the euro, but the surplus economies commit to spending more, which should help the Mediterranean countries get out of the problem. Once again, there’s a lot of trade integration. So, Germany buys more things from Greece or from Spain or from Portugal….
The second possibility — which is not very attractive but works eventually — is that Greece gets out of the euro at this point, before the end of the week. Essentially, what that would mean is that there would be a big mess in Greece. A lot of people would lose a lot of money. And there would be some repercussions throughout Europe, and even throughout the global economy. But if it is announced in such a way that there is a clear timetable as to how the whole thing is going to happen, then I think the markets would eventually adjust.
Two or three years from now, Greece would probably be growing very quickly. Because again, with that devalued currency, that economy would be very competitive once again.
Knowledge at Wharton: But under your first scenario, without that extra spending from countries like Germany into the Mediterranean area, then Greece would not be able to grow itself out of this problem. At least not very quickly.
“What doesn’t work right now is that both Germany and Greece are getting their way. Essentially, they are incompatible at this point.”
Guillen: Correct. What doesn’t work right now is that both Germany and Greece are getting their way. Essentially, they are incompatible at this point. Their preferences are incompatible. The German government would like austerity, would like discipline, would like no changes in policy. Greece is asking for something that Europe shouldn’t give Greece, which is a debt restructuring. And it’s also asking for other benefits, right? They want to enjoy all the benefits from the euro, but they don’t want to actually do their homework.
So those two things are totally incompatible. And that’s why I’m proposing the other two solutions. One of them, I think, is far more attractive – the first one is far more attractive than the second one — a Greek exit. But, you know, before the end of the week, we could well be in a situation in which Greece is technically out of the euro.
Knowledge at Wharton: And then it would be an interesting situation, to say the least, if in the referendum the Greek people voted to stay in. In fact, from the polls I’ve seen, that seems to be the most likely outcome — that the public would vote to stay in. And yet if they were somehow forced out, that might be the worst outcome of all.
Guillen: But that would also destabilize the government. The Prime Minister has said that he would like to vote no at this point. If the Greek population says yes to the bill, but the government is saying no to the bill as presented by the European union and the troika, then the government would have lost the referendum. So, what kind of legitimacy would that government have?
Remember also that you have the entire Greek opposition – all of the opposition parties are united against what the government is doing right now. So there’s no other way of describing the situation [except] as chaotic. This is almost like The Twilight Zone. And they have five days to figure it out.
We’ll see what happens. I don’t have a crystal ball. All I can tell you is that I would prefer the Germans to change their attitude towards austerity policies, and the Greeks to agree to the deal. For me, that would be the best outcome.
Knowledge at Wharton: What do you think are the odds that Greece will still be part of the eurozone a month from now?
Guillen: I think it’s better than 50%. But there’s a significant probability, at least 20% or 30%, that it will exit. The problem with exiting is that this has never happened. We have no experience, because the European monetary union is an experiment. It was an experiment to form it; it is an experiment now to manage it. And to engineer the exit of one of the member countries would be, again, an experiment.
Knowledge at Wharton: Are there any issues that we haven’t asked about that would be important to cover here?
Guillen: I would only add my usual statement about Europe — that what is going on in Europe right now is just giving the rest of the world the impression that Europe’s decline is irreversible. Over the last couple of years, I think Europe has already demonstrated that something is going awfully wrong. First was the Ukrainian crisis, where Europe was totally paralyzed and unable to act against Russian aggression.
Second is the crisis with immigration in the Mediterranean — the immigrants coming from Africa. Hundreds of them are dying every year, and Europe has not been able to handle that. And now, we have the tenth or the 12th episode in the southern debt crisis, in which again, they agreed to something, and then somehow, you know, nobody lives up to the agreement.
Europe, I think, is projecting an image of itself to the rest of the world that is inimical to the generation of confidence and trust. You can imagine that investors really don’t want to touch Europe. And the problems with unemployment, with everything, will get worse if investors don’t want to bet on Europe’s future.
So, this is just one more event in, unfortunately, a long series of missteps on the part of Europe’s leadership.