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The Moral of the Greek Story

Megan McArdle is a Bloomberg View columnist. She wrote for the Daily Beast, Newsweek, the Atlantic and the Economist and founded the blog Asymmetrical Information. She is the author of "“The Up Side of Down: Why Failing Well Is the Key to Success.”
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I can't shake the feeling that I've spent the last five years watching the Grexit Special Edition Director's Cut, and now the finale music is finally swelling. The problem is, I've felt like this before, because this crisis seems to be directed by Peter Jackson. That's not unusual for financial crises, mind you; to haul out a Rudi Dornbusch quote I've used many times before: "The crisis takes a much longer time coming than you think, and then it happens much faster than you would have thought. ... It took forever and then it took a night."

So is this the actual end, or do we still have more sessions with Aragorn and the elves standing around looking soulful? Greece is reportedly going to miss its next payment to the IMF. Of course, it wouldn't be the first time that a nation has temporarily defaulted on an IMF loan. The larger question is the outcome of the referendum the prime minister has called for next Sunday, aka the #greferendum. Polls seem to show that 56 percent of Greeks want to stay in the euro, even if it means more austerity. But those polls were taken before the greferendum was called; now that they are voting on a specific proposal, how many people are actually going to vote yes? Perhaps even more importantly, who goes to the polls? Certain groups stand to disproportionately lose from further concessions, such as public sector workers. They will make darn sure they head to the polls on July 5.

This is, after all, the country that just elected Syriza to send a message to the eurocrats. Have Greeks worked out their anger, or are they still in altruistic punisher mode? We'll know next weekend.

However, here's the pregame: If Greece votes no, it's hard to see how it avoids leaving the euro, because if the country reopens its banks without converting the accounts to some currency other than the euro, all the euros in them will start sprouting little wings and flying abroad. And while we may argue about whether it is better to leave the euro or embrace austerity, trying to operate a modern economy with the banks closed would be indisputably worse than either of those two alternatives. So at this point, we seem to be down to one of two outcomes: Alexis Tsipras wins the referendum, and Greece exits the euro; or Tsipras loses, at which point either he takes the deal or his government falls and is replaced by a less obstreperous crew that takes the deal. 

If they leave the euro, well, you've read the columns. It will be ugly. It will be very ugly. Just printing and distributing the banknotes will be quite a logistical hurdle, but that's the least of the issues. Everything from bank accounts to contracts will have to be redenominated, and this will cost people years of savings, as well as disrupt business activities. The best case scenario is a very deep, but relatively short, recession. The only people this will be good for is people who long to vacation on the Greek islands. If Grexit actually happens, book those plane tickets now, but hold off on the hotel. It will be cheaper in six months. Then try to enjoy it as you remember that those fabulous savings are someone else's whole life evaporating.

If they stay in the euro, what happens? Fellow columnist Mohamed El-Erian argues that at this point, the effects of a "sudden stop" of the payments system are likely to be "a cascading sequence of closures, shortages, defaults and dislocations," and ultimately, "these highly likely developments will make Greece's continued membership of the euro zone extremely difficult, if not impossible." That seems right to me, as it has always seemed right to me, because Greece fundamentally just does not belong in the euro zone. On his Facebook page this morning, economist William Easterly also cited Dornbusch, who "would have said on Greece, when a fixed exchange rate can't be sustained, a fixed exchange rate won't be sustained." Or as the late Herb Stein once said, "If something can't go on forever, it will stop." Greece doesn't have the wherewithal to share a currency with Germany except at the price of continued misery.

It's easy to moralize Greece's feckless borrowing, weak tax collection and long history of default, and hey, go ahead; I won't stop you. But whatever the nation's moral failures, what we're witnessing now shows the dangers of trying to cure the problems of weak fiscal discipline with some sort of externally imposed currency regime. Greek creditors and Brussels were not the only people to joyously embrace the belief that the euro would finally force Greece to keep its financial house in order; you hear the same arguments right here at home from American gold bugs. During the ardent height of Ron Paul's popularity, I tried to explain why this doesn't work: "You don't get anything out of a gold standard that you didn't bring with you. If your government is a credible steward of the money supply, you don't need it; and if it isn't, it won't be able to stay on it long anyway."

This goes double for fiscal discipline. Moving to a fixed exchange rate protects bond-holders from one specific sort of risk: the possibility that inflation will erode the real value of your bonds. But that doesn't remove the risk. It just transforms it. Now that the government can't inflate away its debt, you instead face the risk that they are going to run out of money to pay their bills and suddenly default. That's exactly what happened to Argentina, and many other nations on various other currency regimes, from the gold standard to a currency peg. The ability to inflate the currency had gone away, but the currency regime didn't fix any of the underlying institutional problems that previous governments had solved with inflation. So bondholders protected themselves from inflation, and instead took a catastrophic haircut.

In financial markets, it is easy to move risk around and change who is bearing it. On the other hand, it's very hard to actually get rid of the risk. The biggest problems come when we think we have -- when we mistake risk transformation for risk avoidance. That's what happened in 2008, and that's what happened with Greece: Creditors acted like the risk that Greece wouldn't be able to pay its bills had somehow been eliminated once it moved to a harder currency. When everyone starts pretending that we've suddenly stumbled onto a sure thing, the safest bet is that we're in for a lot of drama.

This column does not necessarily reflect the opinion of Bloomberg View's editorial board or Bloomberg LP, its owners and investors.

To contact the author on this story:
Megan McArdle at mmcardle3@bloomberg.net

To contact the editor on this story:
Philip Gray at philipgray@bloomberg.net