Greece: Going Argentine?

by Andrew Stuttaford

Writing in the FT (subscription required), Nouriel Roubini, Dr. Doom himself, explains that it’s time for Greece to quit the Eurozone:

Even if Greece were soon to be given real and significant relief on its public debt, it cannot return to growth unless competitiveness is rapidly restored. And, without a return to growth, its debts will stay unsustainable. Problematically, however, all of the options that might restore competitiveness require real currency depreciation.

That’s right. And so long as Greece remains in the euro, that option is unlikely to be available (and is, of course, by definition excluded as against Greece’s partners in the currency union). As an alternative, the country is taking the harsh medicine of ‘internal devaluation’, but for that to do the trick, the dose may have to be so high that it risks killing the patient. Unsurprisingly, therefore, Roubini looks back to an increasingly relevant parallel, the time when Argentina broke its peso/dollar peg and notes:

Of course, this process will be traumatic. The most significant problem would be capital losses for core eurozone financial institutions. Overnight, the foreign euro liabilities of Greece’s government, banks and firms would surge. Yet these problems can be overcome. Argentina did so in 2001, when it “pesified” its dollar debts. America actually did something similar too, in 1993 [sic - 1933, presumably] when it depreciated the dollar by 69 per cent and repealed the gold clause. A similar unilateral “drachmatization” of euro debts would be necessary and unavoidable.

Major eurozone banks and investors would also suffer large loses in this process, but they would be manageable too – if these institutions are properly and aggressively recapitalised. Avoiding a post-exit implosion of the Greek banking system, however, may unfortunately require the imposition of Argentine-style measures – such as bank holidays and capital controls – to prevent a disorderly fallout.

“Traumatic” is an understatement. And Dr Roubini dismisses the prospect of “contagion” a little too lightly:

Those who claim contagion will drag others into the crisis are also in denial too. Other peripheral countries have Greek-style debt sustainability and competitiveness problems too; Portugal, for example, may eventually have to restructure its debt and exit too.

Well, yes, which is exactly why there is every reason to suspect that a Greek default, if accompanied by Greece’s withdrawal/expulsion from the euro, will set off a panic, as “who’s next” becomes the question of the day. If, on the other hand, Greece defaults but remains within the Eurozone, the longer-term competitiveness problem will remain, with all the malign consequences that entails, but some of the edge may be taken off any panic to come.