Andrew Lilico: The state of play on Greece and the wider Eurozone crisis

By Andrew Lilico

Events have really kicked off in Greece in the past day or so.  On Monday the Greek Prime Minister announced there would be a referendum in January over whether Greece should accept the new Eurozone deal.  Opinion polls suggest 80% of Greeks oppose the deal, but 70% want to stay in the euro.

The barriers to actually having a referendum should not be underestimated.  First, it was widely rumoured on Tuesday that the Greek government was about to fall, as at least one ruling party MP resigned and others were said to be about to follow.  However, this evening it appears that the government has survived for now.  But even if the government survives, there might be a constitutional challenge as to whether a referendum on austerity or euro exit would constitute an “important social matter”, as opposed to a purely fiscal matter, with an adverse judgement implying that 60 per cent of Greek MPs would have to support the measure — see article 44 here.  Historically, there have been quite a number of referendums in Greece  in 1862, 1920, 1924, 1935, 1946, 1968, 1973, and 1974.  But in the modern Greek republic, there has been no referendum since that in 1974 on abolishing the monarchy and forming the modern republic and the status of referendums may not be completely clear.

But let us suppose that the government gets the measure through (the debate is due to start on Wednesday) and a referendum is announced.  What then?

Well, it is widely assumed that a No vote (i.e. a rejection of the Eurozone deal) would imply Greek exit from the euro.  The form that appears most likely to take would be a redenominating of all Greek law contracts from euros into the new Greek currency — the New Drachma or whatever it would be called.  The New Drachma would then, presumably, be devalued overnight by some 70% or so.

One example of a debt contract under Greek law is the loans made to Greek banks by their depositors.  So in the event of a No, Greek bank depositors would lose about 70% of the value of their deposits — perhaps more.  There would be similar consequences for all other Greek law euro-denominated contracts.  In the event of a Yes vote, matters would proceed much as now.

So from the point of a Greek depositor or holder of almost any other liquid Greek asset, there is a one-way bet: if the vote goes No in January, you will lose 70%+ of your money.  If the vote goes Yes, you will gain almost nothing.

Now it’s not quite true that you will lose nothing if you take your money out and there is a Yes.  There is presumably the outside chance that, in the event of a Yes, the government will take a dim view of those attempting to repatriate funds they had taken out during the referendum.  There might, for example, be special taxes applied to repatriate funds, and maybe the European Union would “overlook” this in its Single Market rules.

So provided that the referendum result seemed reasonably likely to go Yes, there would be some chance that not all capital would flee.

However, opinion polls do not suggest that a Yes is terribly likely.  And a Yes would need to be very likely indeed for capital flight not to occur.

Let’s suppose the referendum campaign got underway, and a few polls came out suggesting the vote would go 60% for No.  That would presumably trigger mass withdrawals from Greek banks and liquidation of other Greek assets as those that could got out.  To prevent this the Greek government would need to impose capital controls, nationalise the banks, declare “bank holidays” — i.e. shut the banks down for a few days whilst practicalities were sorted — and when the banks were opened again, there would be strict limits on withdrawals.  Furthermore, if Greek euro exit beckoned, it would be very difficult for the ECB to justify providing any liquidity support to Greek banks — even nationalised ones.

At this point, Greece would be de facto no longer part of the euro currency union.  At best, it would be a kind of euro-ised economy.  During the “bank holidays” the government would need to impose martial law to maintain order and prevent people rioting outside the banks or looting for what they could not obtain cash to buy.  Foreign companies could become very reluctant to provide goods and services other than for cash, if euro exit would mean a loss of 70% or more of the value of goods sold.  That could induce shortages and might even necessitate rationing of certain products.  It would also, of course, have ceased, de facto, to be a part of the Single Market in almost every respect.

It would thus be very important to maintain the support of the military during this phase.  In a perhaps not-unconnected (but certainly unannounced) move on Tuesday afternoon, the Greek government fired the chiefs of the General Staff, the Army, the Navy, and the Air Force.  It is unclear whether it was more worried about a coup if it attempted euro exit, or if there were chaos after euro exit, or if it didn’t attempt euro exit – all paths are bad from here.  Perhaps it simply wanted to be confident that those at the top would implement government orders with full cognisance of the political sensitivities involved, and so sought staff it could trust absolutely.

Another source of military nervousness is an escalating dispute with Turkey over the Greece-Cyprus-Israel Exclusive Economic Zone, connected with exploration of potentially huge gas reserves.  It could be extremely destabilising, during a referendum campaign, if military tensions were heightened.  Maintaining very strict military discipline, and acceptance of political authority, would be paramount.

So now we have a country that is de facto no longer a member of the euro, has martial law, and may have rationing — and that is all just a consequence of the referendum being announced, rather than its producing a No result!

In truth, it seems highly implausible that the referendum itself would ever be reached.  The mere act of organising it could well be sufficient to force euro exit — no No vote required.

And that is, of course, assuming that the euro itself would last that long.  The past couple of days have seen huge falls in the prices of Italian bonds, with the triggering of margin calls avoided only by concerted ECB action.  Ten-year Italian government bonds were yielding above 6.3% at times on Tuesday – well above the levels they reached in August before the ECB started to intervene, and some 0.3% above where they were only yesterday morning.  Whereas for Ireland and Portugal the “point of no return” was reckoned at about 7 per cent, that point is likely to be lower for Italy – perhaps just 6.5%.  Two more days of carnage like the past couple, and there could be mass capitulation from Italian bonds, on a scale beyond ECB resources to resist.  That could force some very hard decisions upon an Italian political system that seems ill-equipped to deal with anything trickier than a lap-dancing scandal (and struggles even with that).

Even if Italy scrapes through — and Italy does not, in fact, have especially serious government deficit or total societal debt problems compared to most of the rest of the EU — there could be greater issues in other parts of the Eurozone.  If mass capital flight from Greece induced capital controls, would capital stay in Portugal to find out if they were next?  What about Spain?  How would under-capitalised French banks cope with further rounds of market chaos?

A pre-announced referendum, some months in advance, effectively upon whether to stay in the euro, is one of the more bizarre ideas floated for resolving the euro crisis.  Of course, a Yes would provide a huge mandate for imposing further austerity.  Perhaps Greece could finally tackle some of its serious structural issues.  There could be a flood of capital back into Greece, as those that have already “priced in” a Greek euro exit would repatriate their funds.  If all went like a dream, a Yes vote could be the turning point for the Greek society and economy.  (Or perhaps it would be the moment the seeds of eventual civil war were sown – who can say?)

But, for myself, I find it very difficult to imagine that a referendum vote could ever be reached.  More likely, with the social and economic consequences of the situation made very plain, and with the economy de facto already outside the euro and the Single Market, the public and political classes would accept the inevitable and euro and European Union exit would come long before the referendum were held.