A permanent precedent

by Martin Wolf

Financial Times
May 17, 2012

The irritation of the eurozone with Greece is at extreme levels. After all, 80 per cent of Greeks say they are in favour of staying in the euro, but then they fail to elect politicians prepared to implement the agreed programme. This drives creditors crazy. Increasingly, the latter are inclined to accept Greek exit, even welcome it. But they should be careful what they wish for.

A departure would create severe dangers. The danger of contagion is obvious. The long-run danger is more subtle. But the eurozone either is an irrevocable currency union or it is not. If countries in difficulty leave, it is not. It is then an exceptionally rigid fixed-currency system. That would have two dire results: people would not trust in its survival and the economic benefits of the single currency would largely disappear.

These perils are not of concern to the eurozone alone. Taken as a whole, this is the world’s second-largest economy, with the largest banking system. The risk that a bigger eurozone upheaval would cause a global crisis is real. As frightening is the likelihood that eurozone crises would become permanent features of the world economy.

What, then, are the dangers?

Start with Greece. It is in a doom loop. Unemployment soared from 7 per cent of the labour force in May 2008 to 22 per cent in January 2012, while the unemployment rate of people aged under 25 jumped from 21 per cent to 51 per cent. Worse, despite fiscal austerity and debt restructuring, the International Monetary Fund estimates that gross public debt will be 160 per cent of gross domestic product in 2013, 50 percentage points higher than in 2008. Moreover, the IMF forecasts that the current account deficit – the balance of trade on goods and services – will be more than 7 per cent of GDP this year.

Thus, the economy will be uncompetitive and depressed for years, if not decades. Not surprisingly, a dysfunctional Greek polity has collapsed. Politicians who believe they can obtain better terms are edging closer to power. This, in turn, creates a big potential dilemma for Athens’ outside supporters: either give Greece more money to alleviate pain, or stick to the programme and risk its collapse.

So what might a collapse entail?

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