A diet can't save them now. Time to get that defibrillator ready.
- By Mohamed A. El-Erian<p> Contributing editor Mohamed A. El-Erian is CEO and co-chief investment officer of global investment management firm Pimco and author of When Markets Collide. </p>
Imagine being told that you will likely suffer a heart attack, yet not how big it will be or how serious. If you could get your arms around the enormity of the news, you’d want to know whether your body could stand the shock and what the aftermath of the attack would look like.
This is exactly what is going on today in policy circles — and beyond — as the world monitors the developments in Greece with a growing feeling of helplessness and concern. Recognition is spreading that Greece faces the rapidly rising probability of another default and, critically this time around, a potential exit from the eurozone. And governments in Europe, and increasingly elsewhere, are wondering what this means for them.
Turmoil in Greece is, of course, nothing new. For more than two years, this once-proud member of the eurozone has stumbled from crisis to crisis, with mounting social costs and deepening economic and political dysfunction. That said, the situation did take a nasty turn for the worse last week as reports surfaced of ordinary citizens rushing to pull their money out of domestic banks, fearing for the safety of what remains of their savings.
The question now is whether the policy response is able to step up to this further twist in the protracted Greek tragedy, especially as bank runs can easily get out of control. If policies lag again, this will increase the probability that Greece would be forced not just to default again but also to exit the eurozone — what is now called a "Grexit." If that scenario unfolds, Greece will face the prospect of an even deeper and longer economic, financial, political, and social implosion — and the world would face significant risk of collateral damage.
In public at least, European governments are standing firm about their desire to avoid a Grexit. This sentiment was stated again during last weekend’s G-8 summit. But words are not enough. The governments of Europe must urgently find a way to reassure Greek depositors that their country’s continued membership in the eurozone is not just desirable but also, and critically, feasible. After all, it is hard for these depositors to believe even the most reassuring words at this point — when national politics is so messy, jobs are rapidly disappearing, and European partners are visibly and repeatedly hesitant about sending the country checks.
And the dangers are real. Should Greece be forced to exit the eurozone, it would do so without a mechanism or a precedent. Indeed, with its probability continuing to increase, a Grexit would likely prove expensive and disruptive — and not just for Greece. Virtually every other country in the world would feel an impact — economic, financial, or both.
A Grexit would be sure to contract further European demand, increase risk-aversion, and raise serious questions about the health of some banks and their customers. It would be a shock that would certainly dampen global growth — but right now, it’s still hard to make accurate predictions about what its magnitude and duration would be. Thus, given the degree of uncertainty, it’s critical that governments — and not just those in Europe — make arrangements to minimize and absorb the external disruptions that could stem from a disorderly Greek exit.
Unfortunately, many countries’ defenses, both monetary and fiscal, are already run down as they continue to deal with the domestic aftershocks of the 2008 global financial crisis. This is especially true for the larger European economies that are struggling with their own debt and banking challenges (such as Italy and Spain). It is also the case for the United States, where hesitant growth and political polarization undermine the safe de-levering of still-overindebted segments of the economy. Even China is slowing — due to both immediate overheating and longer-term institutional and systemwide economic transitions.
Should Greece exit the 17-member eurozone, it is disconcerting that no other part of the global economy is in a position to step in and fully offset the resulting waves of disruptive global contagion. Meanwhile, neither regional nor multilateral coordination mechanisms can fully compensate. That said, there are a series of steps that can and should be taken now to make sure that the shocks are both temporary and reversible.
Europe needs to urgently find ways to fortify internal circuit breakers that reduce the risk of Grexit contagion becoming a self-reinforcing phenomenon, with key leadership provided by the governments of the four largest economies (Germany, France, Italy, and Spain). This involves urgently strengthening internal firewalls, enlarging emergency financing windows at the European Central Bank, establishing the basis for eurozone-wide deposit insurance, and providing a proper institutional framework and plan for channeling co-financing from the rest of the world. In addition, to simultaneously secure the underpinning of what would remain of the eurozone (which could possibly be fewer than 16 countries), fiscal and growth compacts would need to be accompanied by a better policy mix at the national level as well as a more sustainable regional political integration process that lifts damaging leadership and legitimacy constraints. Finally, should Greece exit the eurozone, Europe must find a way to keep the country within the 27-member European Union, providing it also with stabilization funding and technical assistance.
Political leaders have little time to waste if they wish to reduce the immediate disruptive impact of a Grexit — which, increasingly, seems inevitable — and to make the messy aftermath more manageable. Recent history suggests that they are not nearly as prepared for this eventuality as we might think. Indeed, with European leaders having spent so many summits and meetings thinking about the eurozone’s ill health, they won’t have anyone to blame but themselves if they’re not ready with the defibrillator when the heart attack does occur.