Why is a Grexit now likely?

Greece owes the IMF 1.6 billion euro that it doesn’t have but is supposed to pay by tomorrow. Unless the ECB lends it to the Greeks, effectively converting the IMF debt into an ECB debt, Greece is bankrupt tomorrow. In months to come, much bigger debt repayments are scheduled to the ECB-IMF in tranches of 4 billion, and Greece won’t have that money either as its economy is still contracting.

Greece didn’t have the money to pay off the previous debts in the last 5 years either though, and that just lead to more debts in return for symbolic reforms that weren’t implemented.

Why not muddle through then and let the Northern European politicians present a pretend-reform package to their population as a victory? And why would bankruptcy force a Grexit, given that there is no official mechanism to force any country out of the Euro, once it is in?

What is forcing it is the combination of the referendum on the symbolic reforms, together with the bank-run on the Greek banks that has this morning lead to capital controls. Let me explain how the two force a Grexit.

The referendum is called for this Sunday, one day before the banks re-open. The idea is that Greeks vote on whether to accept the current set of symbolic reforms, which would entail cuts to pensions and loss of employment of many civil servants. The government will campaign against them, and most of the Greek parliamentarians are with the government, successfully whipping the country into a ‘no austerity’ mood. There is hence no way that the Greek population would vote ‘yes’. And even if they did, the Greek government then would not implement reforms as its own backers would constitute the ‘no’ vote.

But the referendum also makes it impossible to agree on something symbolic beforehand: it binds the hands of the Greek politicians who called for it (almost surely so they wouldn’t be blamed for the coming Grexit). This means nothing can be offered to them that would prevent bankruptcy tomorrow.

Previous symbolic reform packages were not implemented, partly because the Greek governments didn’t want to implement them and partly because they couldn’t even if they wanted to. Tax collection, for instance, would take many years to clean up and, as a Greek economist told me recently, it is still normal to send Greek tax collectors home in an election year! But to the Northern Europeans, the Greek politicians at least pretended they were going to pay back the loans and reform. The referendum is now expressly fought on a platform of not even pretending either, taking away the much-needed fig-leaf that the Northern Europeans wanted.

Worst of all, the referendum is a slap in the face of the other politicians who were negotiating at this late hour with the Greek politicians on the terms of the next symbolic set of reforms. It is part of the rules of the game in Brussels that this was a real deadline that forced everyone to agree to some face-saving formula. The referendum has made this impossible: the Greek politicians won’t play by the European rule-book. No face saving, just Greek theatrics and grand-standing.

So the other European politicians have been sufficiently humiliated that they feel they need to be tough, an attitude you see most clearly in Christine Lagarde from the IMF who made it clear tomorrow’s deadline is not negotiable.

Hence the referendum will be followed by a continuation of the bank run next Monday by Greeks who calculate their country’s approaching bankruptcy, and this time there cannot be a bailout: the only bailout that is now possible within the Greek political system is one whereby the ECB lends money without symbolic reforms, an open loss for the Northern Europeans. That means there will be no bailout. In concrete terms, the Greek central bank will not be getting any more Euros to distribute amongst its banks. The Greek government wont be able to pay to its employees, welfare recipients, and other recipients of state money.

So the day after the referendum, neither the Greek central bank, nor the Greek government has money to prop up the Greek commercial banks nor pay its own workers. That is what will force the Grexit, I think, not the inability to pay back loans to non-Greeks: the slow bank-run, in which billions in deposits are withdrawn weekly from Greek banks, will force them into it.

If the Greek government does not introduce a new currency then it will have no means to prevent the bank-run and the Greek banks will run out of money and go bankrupt themselves. Without an intervention, that will wipe out all the savings in those banks and lead to a major disruption of the Greek financial sector and the Greek economy. Tax avoidance will go up as the visible money streams that go via the banks will stop and the remaining economy will go via invisible money streams that are harder to tax. Greek civil servants will not get paid, nor will welfare recipients get their payouts, meaning they will have no money either, forcing them to join the bank run to pay for groceries.

So the Greek government will face financial collapse the day after the referendum. Capital controls will slow the collapse down, but the only thing it can do, really, is to take over the obligations of the commercial Greek banks and pay its employees and welfare recipients with something else. That something else is a new currency, whether it starts life being called an I-Owe-You (IOU) or a Varoufakis-florint: it will have to be declared legal currency inside Greece so that one can make payments with it. Hence in order to save its own banks and thereby its depositors, Greece will have to Grexit.

Now, no-one can force Greece to give up the Euro, so Greece can in principle maintain a dual currency system for a long time, having both the Euro and the new currency. This is not abnormal, as Hong Kong airport has shown you can run a 3-currency system indefinitely: you can pay there with Honk-Kong dollars, Euros, and US dollars. Yet, if the state sector runs on fast devaluing drachmas and the rest on stable Euros then the Greeks will be incurring a lot of transaction costs.

It will not really matter whether Greece hangs on to two currencies or just the new one: with the re-introduction of a separate legal currency, Greece will have effectively left the Euro and become like Macedonia and Bulgaria, where you can also pay in lots of places with Euros but that are no longer official members of the Eurozone.

I wouldn’t be surprised if stacks of the new currency are already in Greece, ready to replace the Euro as the official currency, with contingency scenarios now being taken off the rack in the main financial European institutions (EIB, ECB, EU-C). This means a Grexit is also a physical possibility now whilst it probably could not have been done 5 years ago.

Is there a way to prevent the coming Grexit? Normally, I expect the political system in the EU to come up with a watery compromise at the last minute. The Greeks politicians have however, I think, made this impossible with a referendum that takes away the ability for compromises to be offered and accepted. Time will tell though.

Will the Grexit be good for Greece? In the medium-run, I do think so as the state-related sector takes a much needed price-correction vis-a-vis the exporting sector. In the short run, pain is coming though, I am afraid, particularly for the old and infirm in Greece dependent on the state. And the recovery will be hampered by the fact that the Greek economy is tied to the rest of Europe, whom they have just had a falling-out with.

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11 Responses to Why is a Grexit now likely?

  1. john Walker says:

    Paul what do you see as the likely consequences of a Grexit for the EU’s finance and banking sector (and in general for the EU)?

    • paul frijters says:

      Two major channels: the debt itself and knock-on from what happens to Greek banks.
      On the first, it depends on the ECB reaction. If the ECB just prints the short-fall, I think the short-run effects are minimal, though the moral hazard problem then becomes tremendous in the longer run. If the ECB tries to get governments to cough up the shortfall, there is going to be trouble.
      The second wont be too bad, I think. The private loans have been socialised in recent years.

  2. Chris Lloyd says:

    I assume that Greeks have all their savings in Greek banks in Euros. If Greece runs two currencies, would there be a chance for ordinary folks to get their money out and into a safe foreign bank? I was thinking that if the government pays their day to day obligations in Drachmas they can provide what Euros they do get to the banks who will also be getting some Euros from sources like tourism. So there might be some capacity to allow a process of orderly withdrawals.

    • paul frijters says:

      that is what the bank-run has been about, with lots of Greeks having parked their money abroad in the last few years. Without a bank-run, one would think Greece could default and just mostly live with the Euro, more or less by the government postponing payments in Euro until it gets enough taxes to pay its bills. In a bank-run situation though, the banks wont be solvent and the deposits would need to be converted to something else. The expectation that this would happen is partially what is causes the current run.

  3. conrad says:

    If you are saying that a Grexit might be good in the medium term, and this turns out to be true, then wouldn’t this lead to many countries leave voluntarily? It wouldn’t be hard to see all the anti-Euro parties using this as political fodder (including important ones like the NF in France) which would mean the end of the Eurozone as we know it as more moderate parties tried to nullify them by taking on the same views.

  4. john Walker says:


    While I understand the issue of ‘how would they pay their pensions and public sector’: What would happen if they default and , refuse to exit?

  5. paul frijters says:


    what is true for Greece is now no longer obviously true for other countries. Greek politics has resisted the price correction and reforms that were needed to be be compatible with the rest of the Eurozone. Spain, Portugal, and even France, are however growing again and would gain much less in the medium term from leaving the Euro whilst they too would suffer pain in the short-run.

    Putting it as simple as possible, the other countries have germanified a little in the last 5 years, Greece has gone in the opposite direction and is now less compatible with the Eurozone than ever.


    as I said above, there is no legal mechanism to kick Greece out, but it will still have left in a de facto sense. And I think the ECB can be quite creative about how it interprets membership of the euro-area.

  6. John Walker says:

    Paul thanks

  7. derrida derider says:

    Yet Greece is now running a primary surplus – the government is now raising more than enough in tax to pay its domestic bills (one reason I doubt your claim that they haven’t cracked down on tax evasion). This puts it in a far better position than 3 years ago to go down the dual currency route because it no longer needs to borrow for day to day expenses; borrowing is only needed to pay back the German banks. Whom it will gleefully tell where to go..

    The point is the Greek bargaining position is actually stronger than it was a few years ago – which the Troika seem not have realised.

    • Paul Frijters says:

      until recently I thought so too, but the bank run and a couple of recent Greek government decisions change things a bit: the capital controls and the non-payment of lots of internal bills (the government is postponing as many payments as it can) will push the economy into another recession, reducing the tax receipts again. On top of that, this Greek government is re-hiring a reported 40,000 civil servants that were retrenched in previous years. Hence I now suspect that primary surplus is a phantom and will in fact be a primary deficit, meaning the Greek government will not be able to bail out its banks without introducing a new currency.

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