The elections in Greece and France have brought yet another bout of euro crisis. It had been so far a game played between policy makers (EU, ECB, IMF) and markets (especially bond markets), in which policy reacted with bailouts and political agreements to every bout of market pressure. There is a new player now, which adds even more noise and coordination failure: the people.

Greece is now closer to a serious crisis (euro exit, default, etc.), but the risk for the global economy is not there. The risk remains the fundamental flaws of the euro institutions and the coordination problems that they produce. Coordination failure across economic policy decisions, crisis management, as well as street politics can definitely lead to a disorderly outcome for the euro as a whole. A complete unwind of the euro is still a low probability event and it would take time, but it cannot be ruled out.

As we stated many times before, the euro has some basic fundamental flaws (no central fiscal authority backing the monetary union is the key one), and then the nature of the ad hoc political union provides for coordination failure every time markets require a drastic and quick policy response. To this dangerous combination we now add more noise and un-structured debate, with the people expressing anger through votes/parties that lack a coherent alternative plan.

One possible response to the events in Greece could be a managed exit of Greece from the Eurozone. But EU politicians seem incapable of thinking through such scenario. They think of the Eurozone as a one-way street. This is a big mistake. The euro has to be a two-way street. A political ideal cannot violate basic economic rules for a long period of time. Countries that repeatedly become un-competitive and fiscally insolvent cannot stay in a monetary union with richer, solvent and more competitive partners. The less disciplined members had repeatedly relied on monetary and FX degrees of freedom to adjust, and the euro shut down those release valves. If EU policy makers do not want to think and plan for this scenario, the Greek people will do it for them, most likely in a costlier fashion for all. We acknowledge the difficulty in designing and then implementing an exit, as well as the difficult political game now played between the extreme left in Greece and the EU. The Syriza Party argues Greece could renege on the recent agreements and default on debt, but remain in the euro. And EU officials are reluctant to expel a member country, though they are now openly accepting a country could choose to leave. Greek politics, as opposed to careful policy considerations, are bound to decide the fate of Greece and its euro-membership. Whether this is a minor or a major shock depends on how the EU and the ECB protect the rest of Europe.

The French elections, and now one key regional election in Germany, disrupt the political support for fiscal consolidation, as well as structural reforms, and this is more important than what happens in Greece. The euro can definitely survive Greece and other small countries failing and leaving the monetary union. But the euro cannot survive lack of action on fiscal consolidation and structural reforms in the key countries (Germany, France, Spain and Italy). These four form the core of the euro because of their size, and these four should work towards the sustainability of the monetary union scheme, which means fiscal consolidation and integration, as well as economic efficiency that produces the necessary gains in competitiveness. Severe political disagreements between and within those four countries undermines the euro project, as they are happening in a critical moment for such project, when time and decisiveness matter more than ever.

On the positive side, the recent debate on a ‘growth pact’, which some even labeled a new ‘Marshall Plan’ could be read as an indication that fiscal integration is gradually happening. Last year Merkel and Sarkozy ruled out the so-called ‘eurobonds’ because they said it was still too early, that richer countries could not backstop poorer ones before they reformed. But using the EIB (European Investment Bank) for an investment push for growth funded with debt issued under the name of the union is a step in the direction of ‘eurobonds’, at least a transitory one.

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