Welcome To The Eurozone … Now Empty Your Pockets

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The dubiously elite continental currency club admitted a new member over the holidays:

On Thursday, Lithuania became the 19th country to join the euro zone. The move made it the last Baltic nation to adopt the currency, and the timing was inauspicious—the euro looks more and more like an economic death sentence as depressions spread across the continent. Proving skeptics right, less than 24 hours later, the currency’s value dropped to a four-year low after European Central Bank President Mario Draghi seemed to suggest that the bank might start printing money to combat what he called “excessively low” inflation. The Financial Times noted that with the latest dip, the euro’s value “has fallen by 12 percent against the dollar in the past six months.”

Matt O’Brien calls Vilnius’s gambit “another reminder that the euro, which isn’t so much a currency as a doomsday device for turning recessions into depressions, has always been much more about politics than economics”:

In Lithuania’s case, those politics come down to four words: breaking free of Russia.

That, after all, sums up their last 100 years of history. … Indeed, it’s no coincidence that Lithuania’s support for joining the euro has gone from 41 percent in 2013 to 63 percent today in the wake of Russia’s incursion into Ukraine. Freedom, in other words, is worth a euro-induced depression. It’d better be, because that’s what Lithuania has gotten. It pegged its currency to the euro back in 2002, you see, so it’s been importing the euro-zone’s monetary policy for over 12 years now. And, like the other Baltics, that’s ended quite poorly for them. Lithuania went on a borrowing binge — its current account deficit reached a staggering 14 percent of GDP in 2007 — as rates that were too low for its still-catching up economy pushed housing prices if not into the stratosphere, at least into the lower level clouds.

At the same time, Mike Bird notes, the chances the Greece will take the heretofore unthinkable step of exiting the euro have increased:

That’s because Syriza, the radical leftist coalition that wants to tear up the country’s bailout rules, looks likely to win [the general election on Jan. 25]. That means a game of chicken with the EU institutions and International Monetary Fund. If either side refuses to back down, there could be market chaos, bank runs, and a forced exit from the euro. … It’s not Syriza’s official policy to leave the euro, but a solid portion of the group are happy that route, and others may join them — if pushed.

The Greeks’ disillusionment with the currency stems largely from the European Central Bank’s unwillingness to take steps to boost employment in peripheral countries at the risk of increasing inflation, which Germany (the eurozone hegemon) fears. However, David R. Kotok thinks that’s about to change:

The economies of Europe are on a very flat growth path. They have high unemployment, large structural impediments, no apparent inflation, and either extraordinarily low growth or actual shrinkage, depending on which country we examine. The tool of European fiscal policy is hampered by huge deficits and lots of unfunded social liabilities.

Monetary expansion is the only game in town. Interest rates have already fallen to levels below zero in some shorter-term instruments and near zero in others. We expect a large monetary stimulus to originate from the European Central Bank as early as the end of this month. Markets are building this expectation, which will mean a huge market disappointment if the ECB does nothing.

(Chart via xe.com)

The New Greek Drama


Yesterday, Greece’s Prime Minister Antonis Samaras called snap elections after the parliament rejected his candidate for president a third time:

The trigger for the elections was the failure at the third and final attempt of Samaras’s bid to push through his nominee for president, Stavros Dimas. Dimas attracted the support of 168 lawmakers in the 300-seat chamber, short of the 180 votes required. Under the constitution, the legislature must now be dissolved and a date for elections set. Samaras said he’ll meet tomorrow with the incumbent president, Karolos Papoulias, and ask for the election to be held on Jan. 25. That’s just weeks before Greece’s 240 billion-euro ($293 billion) bailout expires.

Mark Gilbert explains why Greece’s political crisis could have ramifications for the entire Eurozone:

Polls suggest that the opposition Syriza party may win power in Greece; its leader, Alexis Tsipras, wants to unwind government spending cuts to halt what he calls a “humanitarian crisis” in his country. If he does win the prime minister’s job on Jan. 25, the EU will need to take his concerns seriously, recognize that fiscal backtracking is preferable to seeing Greece exit the euro, and concede that the unfortunate solution to the nation’s unsustainable debt is to forgive some of it. …

The EU’s apparatchiks will need to take seriously Syriza’s demands for an easing of Greece’s economic strictures — or risk turning the political drama into an economic crisis. If Greece were to abandon the common currency project, it would call into question the membership credentials of other euro nations. (Note that Portuguese bonds are also taking fright today.)

Danny Vinik also warns of a Eurozone crisis if Syriza wins:

[M]arkets are nervous. Germany has an outsized influence at both the ECB and European Commission, and is determined to use its financial leverage to force Greece to make structural changes to its economy. If Germany becomes determined to hold a hard-line negotiations with the Syriza-run Greek government, the odds of a “Grexit” could rise substantially. Already on Monday, yields on 10-year Greek bonds rose nearly 1 percentage point, to 9.7 percent. That could provoke similar fears in other periphery nations in the Eurozone.

That is all months off. Greek attitudes toward Syriza may shift if the party’s chance of gaining control of the government increases. There may be another political stalemate with parties unable to form a governing coalition. But the risks are realnot just for Europe’s economy, but the world’s.

Yglesias runs down some other possible outcomes:

One can also imagine a scenario in which parties of the far-left and far-right (including the fascist Golden Dawn) gain enough votes that no politically viable coalition is mathematically workable. In that case, well, it’s not really clear what would happen. Something along these lines occurred briefly in 2012 leading to a short-term “caretaker” government of Brussels- and Frankfurt-approved technocrats. That could happen again, or you could have the kind of more severe political crisis that sometimes occurs when a country endures a years-long spell of unemployment over 20 percent.

But Douglas Elliott downplays the potential for a Greek tragedy:

It is quite unlikely that Greece will end up falling out of the Euro system and no other outcome would have much of a contagion effect within Europe. Even if Greece did exit the Euro, there is now a strong possibility that the damage could be confined largely to Greece, since no other nation now appears likely to exit, even in a crisis.

Neither Syriza nor the Greek public (according to every poll) wants to pull out of the Euro system and they have massive economic incentives to avoid such an outcome, since the transition would almost certainly plunge Greece back into severe recession, if not outright depression. So, a withdrawal would have to be the result of a series of major miscalculations by Syriza and its European partners. This is not out of the question, but the probability is very low, since there would be multiple decision points at which the two sides could walk back from an impending exit.

Likewise, Neil Irwin sees no signs of a periphery-wide panic:

[W]hat we’re not seeing is the kind of contagion that was widespread from 2010 to 2012. At that time, any sign that the crisis was worsening in Greece immediately translated, through the financial markets, into greater panic about the much larger European economies of Spain and Italy. … But Greece’s latest troubles don’t seem to be adding much to economic and financial uncertainty beyond Greece. Spanish and Italian bond prices fell a bit Monday and their yields rose a bit, but Spain’s 10-year borrowing costs are now at 1.67 percent and Italy’s at 1.98 percent, much closer to Germany than to Greece.