Even if Greece were soon to be given real and significant relief on its public debt, it cannot return to growth unless competitiveness is rapidly restored. And without a return to growth, its debts will stay unsustainable. Problematically however, all of the options that might restore competitiveness require real currency depreciation.
The first of these options, a sharp weakening of the euro, is unlikely while the US is economically weak and Germany über-competitive. A rapid reduction in unit labour costs, through structural reforms that increased productivity growth in excess of wages is just as unlikely. The third option is a rapid deflation in prices and wages, known as an “internal devaluation”. But this would lead to five years of ever-deepening depression, while making public debts more unsustainable.
Logically therefore, if those three options are not possible, the only path left is to leave the eurozone. A return to a national currency and a sharp depreciation would quickly restore competitiveness and growth, as it did in Argentina and many other emerging markets that abandoned their currency pegs. The most significant problem would be capital losses for core eurozone financial institutions. Overnight, the foreign euro liabilities of Greece’s government, banks and companies would surge. Yet these problems can be overcome.
Realistically, collateral damage will occur, but this could be limited if the exit process is orderly, and if international support was provided to recapitalise Greek banks and finance the difficult fiscal and external balance transition.
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