Sent: 19-06-2012 08:57:02
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Europe Tastes Reality
The willingness of economists to accept a Greek exit from Europe seems to have increased, despite the acknowledged possibility of ensuing Lehman-style knock-on effects.
My meetings with economists in London in the past week highlighted a change in attitudes about a Greek exit from the European monetary union and reform of the currency arrangements.
The prevailing mood appears to have shifted from fear about the potentially catastrophic consequences for the Greek economy if it was to swap euros for drachmas to one of reluctant resignation to the possibility.
The change reflects a dawning realisation that no single policy option currently on the table can command sufficiently widespread support. Neither the program of fiscal austerity advocated by Germany nor the more growth oriented policies promoted by those on the left of the political spectrum has enough support to carry the policy agenda.
The emerging thought is that a Greek exit from the euro could be a catalyst to break the current policy logjam and set in train the sequence of adjustments that will be necessary for Europe to put itself on a sustainable path to recovery.
No-one thinks the result of a Greek exit will be pretty. Devastation of the Greek banking system will most likely accompany high unemployment and falling living standards. Richer countries may or may not take enough pity on the Greeks to offer financial support. Some are talking about the subsequent possibility of a Marshall Plan type of intervention but, China, the only possible source of finance for this, is non committal.
A forced adjustment would give Greece a chance to restructure its economy in a way that delivers a more economically sustainable outcome in the longer term. Economists always understood this adjustment mechanism but feared the likelihood of similar pressures applying to the much larger and strategically important Spanish economy from where capital is already fleeing in anticipation.
There will be a stouter defence of Spain, in the emerging scenario, in the hope that its fundamentals are sounder than those of Greece. But the capacity or willingness of governments to draw the line here is unclear. At this point, economists are talking more in hope than expectation.
Underpinning the growing preparedness among economists to sacrifice Greece is scepticism, now being more widely expressed, about whether the euro was ever going to be a viable currency. Hindsight now makes clear that the idealism driving countries toward a common currency was too deeply steeped in politics and insufficiently aware of the economic implications.
Some European observers believe policymakers were willing to take the Greeks (and the rest of the world) to the precipice, let them look over the edge, reconsider and swing back to the centre in the weekend election.
Abandoning the euro entirely, seen as a low probability event at the beginning of 2012 when government leaders of nearly all persuasions were arguing for its retention, now seems a much more likely outcome and even one that might be greeted with a sigh of relief among some policymakers. Some are figuring that the huge upheaval in financial balance sheets implied by such a radical step may still prove easier to manage than any of the alternatives.
For markets, the short term dangers are intensifying. While markets had been bracing themselves for more than two years, crunch time is closer at hand possibly bringing with it an equity market plunge of the sort that occurred in 2008. That is unnerving equity investors in north America and Europe.
Whether non European advanced country bond markets correlate with these moves in the short term is less clear because of the demand for quality assets from funds fleeing Europe. The higher bond prices rise while this is happening the greater the likelihood of a swift bursting of the bond price bubble at some time in the future possibly as early as the second half of 2012.
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