Stumbling Towards the Grexit


How is that Greece, which represents a tiny percentage of the European economy, has become the litmus test of the viability of the euro? This was one of the questions addressed at a special session organized by IESE’s Public-Private Sector Research Center yesterday in Barcelona.

The session, titled “The Euro Crisis and Greece. What is Next?”, was opened by Prof. Xavier Vives, professor of economics and financial management at IESE, who presented a picture of GDP growth, balance of payments, debt  and competitiveness across the euro area.

He then introduced Gikas A. Hardouvelis, professor of finance and economics at the University of Piraeus, Greece, and former director of the economic office of the Greek prime minister Loukas Papademos of the coalition government. He titled his contribution “Grexit: a possibility that carries significant costs” and said that “Greek vulnerabilities could lead to an involuntary exit from the euro.”

In general he took the view that the EU had mishandled the situation. “If we keep cutting and cutting there is no way we’ll get out of recession,” he said. “In Greece the cost of labor is not the problem but the Europeans were obsessed with cutting labor costs. You can always cost costs, but raising money is another matter.”

Hardouvelis added that the banking problem in Greece was not caused by banks but by government. However, debt overhang persists, unemployment is rising, companies are closing and there is possible social upheaval. Confidence is very low, both domestic and foreign.

On the issue of the possibility of a bank run, he said that Greeks are not confident they will stay in the euro so they are hoarding them. “The smart money leaves first,” he said. “A bank run is the last thing that happens in a crisis. A bank run will happen in Spain if people here see Greeks lining up to withdraw their deposits.”

He added that the lesson for Spain is that the politicians have to be credible and show that they understand the problems and the solutions.

Taking up the theme of whether Spain’s crisis mirrors that of Greece, Morten Olsen, assistant professor of economics at IESE, commented Spain has an immediate problem of flight of capital, especially out of government bonds which Spanish banks are buying. As yet there has not been a major run on deposits. In the medium term, Spain needs to be more competitive and to do so it needs an internal devaluation of 20-30%, Olsen said.