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16 March 2012

Staring at the abiss with Paul Krugman

Paul Krugman was in Lisbon last week to receive three honoris causa PhD and openly advise Greece to leave the Economic and Monetary Union, something taken as a smooth advice to Portugal in the same direction. This is something that can only be accomplished by using the Lisbon Treaty mechanism to leave the EU. One must simply acknowledge this reality: many people would like to see the shattering of the Eurozone and the EU. Some of them wish it for pure xenophobic reasons; others would take it as the ultimate proof that the social state doesn't work. Others simply do not want what they see as a direct concurrent to the US dollar ever to succeed. And others still, simply do not understand the EU, and particularly the Eurozone. I like to think that Krugman, someone who contributed so much to Complexity Science, one of the fields on which I do research, falls in the latter class.

Paul Krugman: Grécia deve sair do euro e Portugal permanecer
17:29 Segunda feira, 27 de fevereiro de 2012
A probabilidade de a Grécia sair da zona euro é muito elevada, mas Portugal tem "75%" de possibilidades de se manter na moeda única, disse hoje em Lisboa o economista norte-americano Paul Krugman. The changes of Greece leaving the Eurozone are high, but Portugal has "75%" chances of remaining in the single currency, said today in Lisbon the north-american economist Paul Krugman.
"Ninguém sabe ao certo" como vai evoluir a crise financeira da zona euro, disse Krugman numa conferência de imprensa. "Acredito bastante que a Grécia vai abandonar o euro. Portugal deve ficar? depende do que se passar nos próximos dois ou três anos", disse o prémio Nobel da Economia de 2008. "No one knows for sure" how the Eurozone financial crisis will evolve, said Krugman in a press conference. "I strongly believe that Greece will abandon the euro. Should Portugal stay? it depends of what may happen in the next two or three years, said the 2008 Economic Nobel prise winner.
To the case, the motivations behind Paul Krugman's call to a break of the EU are largely irrelevant. What is important is to understand what a course of action like this would entail. This post is an anticipation exercise, or on more human wordings, a prediction, like those made by astrologers; take it as likely as you wish.

There have been many cases of countries defaulting on external creditors and/or experiencing hyperinflation; there are some folk swift in making comparisons with previous cases to defend particular views. The reality is that no country ever left a monetary union like the Eurozone, after an exceptional period of 25 years of economic transformation towards the tertiary sector and at a time when oil prices are at 90 €/b.

Following is a ran down of how things could develop in a smaller Eurozone state that decides to leave the EU. It is slightly inspired on a poem by Robert Calvert entitled “The ten seconds of forever”, which by some reason always comes to my mind whenever I reflect on this subject it.

Day One – Run on the Banks

To this most economic analysts are arriving too. Facing the hypothesis of a devaluation of their savings, citizens try to get their money out of the bank or out of the country, into a currency insulated from the downward spiral, inevitably the Euro itself. Things like this happened in Argentina and Mexico, and notably last year in Iran. By the end of the day capital controls have have to be fully re-established, most banks are forced to close doors and whatever value the government fixed the new currency on is now irrelevant.

If this happened in Greece, for instance, it would spread the same day to Portugal, or vice-versa. Ireland would be the next in line, then Spain and after Italy; the EU institutions would face great difficulties to deal with the pace of events.

Day Two – Bankruptcy tsunami

The following consequence of the re-introduction of an old currency is a massive bankruptcy. Most banks and companies have now assets denominated in the new currency, which lost the largest part of its value, but are indebted to foreign banks in Euros; they all became insolvent overnight, even if not officially. This is something the mainstream economic pundits are also able to get to, though in lesser numbers than to the all out bank run.

Most folk have become unemployed, or otherwise have lost a real salary. Outside, most other Eurozone members have had to impose some sort of capital controls too; even if succeeded, they wont prevent every trade deficit and surplus in the Eurozone to close.

Day Three – Economic paralysis

Most economic activity is gone. Internally most companies are now insolvent, and from abroad no one is willing to negotiate while the new currency doesn't stabilise. Capital controls themselves impose a serious barrier on foreign trade that can't be overcome fast enough. The break away state understands that it is now an island, and an isolated one.

Fresh fruits and vegetables start to disappear from store shelves; they are just a pronounce of what's to come.

Day Four – The Panic

Its hyperinflation, but bread prices have gone up much faster than anything else. Some call it speculation, but on the internet some folk are pointing to the fact that the regular imports of flour from the larger states have stopped flowing; it is just a matter of time. Folk start rushing into stores to stock up, and soon there's nothing left to buy. Opportunistic speculation and long queues lead to the first serious break ups of civil order.

On their way back from the supermarket to home folk notice that long queues have also formed on every service station. But it is too late, in a few hours there's no road fuel left in and around large cities. Emergency and Security services are overwhelmed, both by the number of occurrences and the lack of fuel; civil order is just a memory now.

If you think something like isn't possible consider that late last year, in the wake of the creditor haircut and the aborted referendum, Greece was only being able to get petroleum from Iran, a country living similar foreign confidence issues.

Day Five – The last day of forever

Mass transit has completely stopped, but most folk are not venturing to go outside anyway. There are news of looting everywhere; security forces and medical urgency seem to be largely inoperative. All sorts of rumours spread and trust on the media wanes; the internet seems to have gone schizophrenic; religious temples are packed. In practice the government doesn't exist any more.

When the evening comes the electricity supply goes down; the bright lights of the city are all gone and moonshine is all that's left. TV and the internet are gone, a few radios survive but they cannot provide any relevant information. Hours later tap water stops running in some parts of the city. It will be a long night.

This is a doom story. There are many other possible outcomes, dependent on prompt action by the government, like it was made in Iran. Capital controls introduced in advance, curfew, rationing, all can help avoid this worst case scenario. But none of it is good, more than that, none of it would leave the break away state better than in the EU.

Being part of the EU is not the problem for Portugal or Greece, but rather the lack of solidarity, vision, and courage of those that command it today.