Is Grexit a mere bluff?

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In a September 14 interview with Thomson Reuters, Vítor Constâncio, the vice-president of the European Central Bank, provided the following reply to a question about the doubts surrounding the euro (emphasis is mine):

It raised doubts for the markets that countries like Greece could cope with the challenges of monetary union. There was never any doubt among the majority of member countries. We maintain that the euro is irreversible. Legally, no country can be expelled. The actual prospect of that happening was never for real.

I do agree with Mr. Constâncio on the technicalities. Indeed, there is no effective legal framework envisaging an orderly exit from the Economic and Monetary Union (EMU). Had there been such a piece of law, it would directly contradict the notion that the single currency is “irrevocable”.

However shrewd lawyers, or those who are willing to think a bit more creatively, can always find ways around legal constraints that clearly arise from the lack of foresight.

The architects of the euro had not thought about the modalities of dealing with such a financial shock as the so-called “Great Recession”, just as they had not considered establishing a fiscal backstop for the single currency from the beginning.

The very bailout to Greece (among others) is an instance of an ad hoc response that was not envisaged in the EMU’s rules, and which directly defied the spirit of the “no bailout” clause.

Legal exit from the euro

To that end, an exit from the single currency can happen. In terms of legislation, we have Article 50 of the Treaty on European Union (TEU), which states the following:

  1. Any Member State may decide to withdraw from the Union in accordance with its own constitutional requirements.

What Ar. 50 TEU suggests is that nation states acceding the Union are agreeing to a division and subsequent transfer of part of their sovereignty to the Community level. Yet “transfer” does not amount to “forfeiture”, meaning that provided some requirements, a Member State can restate its claim on its sovereign authority, withdraw all of its commitments to the Union, and gain full independence from it.

This is one way of exiting the euro: exiting the EU altogether.

There is another lawful route, which may not lead to a full EU-exit. It is found in Article 352 of the Treaty on the Functioning of the European Union (TFEU), and is known as the “flexibility clause”:

  1. If action by the Union should prove necessary, within the framework of the policies defined in the Treaties, to attain one of the objectives set out in the Treaties, and the Treaties have not provided the necessary powers, the Council, acting unanimously on a proposal from the Commission and after obtaining the consent of the European Parliament, shall adopt the appropriate measures. Where the measures in question are adopted by the Council in accordance with a special legislative procedure, it shall also act unanimously on a proposal from the Commission and after obtaining the consent of the European Parliament.

The tricky part here is the need for unanimity, which means that Greece would have the power to veto the decision. Understandably, such a voting strength is meaningless if continued membership in the EMU has deleterious effects on the domestic economy and social fabric.

Engineered necessity

Which brings us to the factual side of the issue: that of a de facto Grexit or the engineered necessity for providing assent to a plan for exiting the EMU.

There are, as I see it, a minimum of three inter-locking and inter-operating conditions for forcing a country to seriously consider reconstituting its national currency or, at the very least, seek ways to introduce a parallel currency. These are:

  1. insolvent banks;
  2. severe monetary contraction (liquidity shortages);
  3. insolvent sovereign with debts denominated in a foreign currency.

These three can all apply to Greece, especially since its fragile financial system is heavily dependent on the ECB’s operations. As was made clear during the summer, Greek banks are undercapitalised, are not robust to capital flight, and cannot continue their operations without having access to the Emergency Liquidity Assistance (ELA) mechanism.

Also, part of their core tier capital is made up of Greek sovereign debt, which is considered a valuable asset only under the assumption that Greece’s creditors continue to furnish funds.

This means that a combination of factors can render Greek banks first illiquid and then insolvent, while forcing the Greek government to seek monetary solutions beyond and outside the scope of the euro. What may lead to such a scenario are at least the following:

  • growing uncertainty—”loose talk”—over Greece’s euro membership, which will continue to hamper investments as well as sustain capital flight;
  • disbelief in the given government’s capacity to guarantee political stability, necessary for enacting reforms, and for improving the creditworthiness of the state;
  • political rapture with Greece’s official creditors, which will jeopardise the bailout programme and, therefore, make Greek sovereign debt a more-or-less valueless asset;
  • a decision from the ECB to cut ELA provisions and suspend the TARGET2 payment system, effectively insulating the Greek central bank and banking system from the rest of the eurosystem.

Some of these happened during the first six months of Mr. Tsipras’ administration, culminating during the summer in the closure of domestic banks. It thus was no surprise that Mr. Varoufakis had prepared a “plan B” for the introduction of a parallel currency.

An agreement was eventually reached, otherwise Greece’s de facto exit from the euro would have occurred. It is this eventuality, in conjunction with the lack of a credible alternative, that forced the Greek government into submission.

Grexit is still possible

An exit from the euro area is still possible, especially since conditions may be formed in such a way that the events of the summer will be repeated. Besides, Mr. Juncker, the President of the European Commission, had this to say during his State of the Union speech (pdf):

I told Alexis Tsipras that I was not a magician who would pull a rabbit out the hat if things didn’t work out. He knew, he had to know and he did know that Grexit was an option but not one to be spoken of publicly. (p.55)

I would like to see the programme we agreed being respected by every Greek government, past, present and future. If the rules we agreed on jointly are not respected this time round, the reaction of the European Union and the euro area will be different. This time the agreements must be implemented. (p.55)

Grexit is no mere working hypothesis, nor some vague threat towards the Greek government. It is—and has always been—the catalyst in the negotiations with the country’s creditors.

Mr. Tsipras was not the first prime minister to perform a spectacular U-turn. His predecessors did pretty much the same: Mr. Papandreou used to be an anti-austerity social democrat who wanted to hold a referendum on the first bailout to Greece, while Mr. Samaras was among the most vociferous critics of the “memorandum” while he was in the opposition.

All Greek prime ministers from the beginning of the crisis hitherto have defied their popular mandate and caved in to their creditors’ demands. I contend that the ultimate reason for this is the presence and use of Grexit as a negotiating instrument.

We can infer thus thanks to, inter alia, Mr. Schäuble’s gambit for a “time out” from the euro. The German minister of finance did not discover Grexit, he simply rendered official, concrete, and immediate what appeared to be tacit, abstract, and remote.

No delusions

It is a pernicious folly to hide behind legalistic arguments, claiming that an exit from the euro is not legal and believing that threats towards that end are mere bluffs.

Syriza’s egregious error during the first half of 2015 was to think of Grexit as some mere hypothesis, as some concept used by financiers to speculate against the euro. Further, Syriza thought that Grexit was not real because a single country’s exit would create a domino effect that would unravel the single currency.

Such tissue of fallacies was, among others, put to rest by the ECB’s Expanded Asset Purchase Programme (Quantitative Easing) as well as Mr. Schäuble’s proposal for an orderly Grexit.

The political capital invested in the euro should not be underestimated. If the single currency falls, a whole range of notions for “ever-closer union” and the like will be brought into question. The demise of the euro would provide a powerful impetus for reverse integration—disintegration—on issues where EU involvement seems to be doing more harm than good or at least not delivering the expected results.

The government that will run Greece in the coming months has to faithfully implement the third bailout programme. Failing to do so would bring forth the prospect of Grexit.

One had better learn from past mistakes. The threat of exiting the euro, was, is, and will always be used as a negotiating instrument; one that can be actualised if necessary.

In this milieu of political realism, those who wish not to be bullied around have a duty to formulate a concrete and coherent alternative, even if that requires defying certain taboos, such as publicly discussing the merits of the euro or contemplating the need for eventually reintroducing a national currency.