The Greek endgame

20.06.15 Publication:

Well, the Greeks have always been famous for their tragedies as well as their theatrical prowess, so we should not be surprised that the long-running play about Greece’s membership of the euro is heading towards a tragic end. Does this mean that Greece is going to default on its public debts and leave the single currency? Yes it probably will, is the answer, perhaps within days. But the future is likely to be tragic whether or not a last-minute deal is done to keep Greece in.

The problem has not been one of economics or finance: if it were, then since only a little more than 7 billion euros is needed to keep Greece in the euro by financing its imminent obligations, such a sum could easily have been found. This is less than many big global banks pay each month in fines to European or American regulators. The problem is one of politics. And bridging political gaps is much harder.

Germany, backed by other members of the Eurozone including most crucially poor countries such as Slovakia, feels obliged politically to insist that the fiscal rules of the euro must be obeyed. The Syriza-led government in Greece, a coalition of a far-left party and a small nationalist party, promised voters before and after its January election victory that those rules would no longer be enforced for Greece. And as time passed and the negotiations proceeded, these incompatible political positions became more entrenched, not less so.

As they became entrenched, and as it became clear that no deal was in sight, so Greece’s economic situation has got worse. Economic output has been falling again, following 2014’s brief and mild period of growth. Government revenues, vital to pay pensions and wages as well as to meet debt obligations, have been falling too, as many Greek individuals and institutions have been withholding tax payments. Depositors have been withdrawing billions of euros from Greek banks.

In short, Greece has been bleeding to death. In such circumstances, time is not on its side. That is why the likeliest outcome over the next few days, or at most by the end of this month, is that the Greek government will have to introduce emergency controls to stop the flow of capital out of the country, probably also nationalizing the banks or at least declaring them closed to withdrawals until further notice.

Such a move might be presented as a mere suspension of financial flows while negotiations continue. But in reality it will either be the beginning of Greece’s withdrawal from the euro or it will lead to the overthrow of Alexis Tsipras’s Syriza government. For again, time is not on Greece’s side. Some Greek citizens may celebrate at first when their young prime minister stands up against the German bullies. But once people stop being paid, or cannot get hold of their savings, or realize their savings in euros are going to become worth a lot less in new Drachmas, politics will turn nasty. Violence, or new elections, or both are likely to be the outcome.

The experience of Iceland, which went bankrupt in 2009 but has since recovered, does show that a country can live through bankruptcy, can devalue its currency sharply, and eventually restore its economic and social health. But it is painful while it is happening, which brings big political risks. Law and order could break down. Parts of Greek cities, including Athens, may come to be controlled by gangs or the extreme right Golden Dawn party. The dangers are considerable.

For that reason, if Greece finds itself out of the euro it will probably at least receive some financial support from Mr Tsipras’s good friend Vladimir Putin and Russia. Which means that the United States may well also step in with “emergency” financial support. The former would worry the European Union. The latter would humiliate it.

Inside the Eurozone, the direct economic effects of a Greek emergency leading to exit are likely to be small: the European Central Bank can make sure of this by flooding bond markets with money. But it is the political effects that will matter most, in the longer term. The Greek drama will strengthen anti-euro parties such as the Lega Nord, the Front National in France and probably Syriza’s Spanish sister party, Podemos. Denmark’s elections on June 18th, with the rise to second-place of the anti-immigrant Danish People’s Party, shows how insurgent populist parties remain strong.

As a result, the best response by Germany and other creditor nations within the euro would be to follow Greek exit by launching a new initiative to bind the remaining euro members closer together. Ideally, this would consist of a big package that would combine a fresh push for single-market based liberalization, a much enhanced public investment programme to build infrastructure, and, crucially, the introduction at last of collectively-underwritten Eurobonds to replace at least part of countries’ sovereign debts.

By making the euro at long last a genuine monetary union, in which all members share collective responsibility for public debts, such an initiative would serve to preserve and strengthen the euro. But it would take great political courage on the part of Chancellor Angela Merkel in Germany – which so far she has failed to show, during the long Greek tragedy.