Barring an unimaginable act of statesmanlike generosity on the part of the core, Grexit looms
By R.A. | LONDON
GREECE'S back is to the wall; its time has run out; it is stuck between a rock and a hard place with other rocks waiting to fall on its collective head; etc. Europe's response to Greece's overwhelming "no" vote on July 5th came through late last night. There will be no concessions made to Greece. On the contrary, by early Friday morning Greece must submit to its creditors a new bail-out proposal, which contains more cuts and more significant reforms than those in the offer voters rejected last Sunday. If it does, Greece's European partners will decide on Sunday whether to accept or reject the plan. If they accept it, or something like it, new discussions on a long-run bail-out programme (lasting 2-3 years) can begin, and the European Central Bank (ECB) will presumably step in to prevent Greek banks from collapsing. If they reject it, the ECB will withdraw all emergency liquidity aid to Greek banks, essentially forcing the Greek government to issue an alternative currency to prevent a massive collapse of the banking system. That's assuming Greece's troubled banks don't begin failing between now and Friday.
And so now the possible scenarios become clear. In or out, Greece will face the need to make further budget cuts. If they were to make the leap into the void and wave goodbye to the euro area, then they would be able to face those budget cuts with some monetary flexibility, a devalued currency, and (one assumes) a much smaller sovereign debt burden (having massively defaulted on its creditors). The road would be rocky. The economy is already facing a nasty economic end to 2015, thanks to the effect of the immediate crisis on tourism, investment and domestic consumption. Capital controls, financial instability and social unrest may accompany an exit. Yet if the Greek government can manage the exit capably a year or so of nasty recession should be followed by a strong recovery. Greece has made a fair number of reforms, after all, and a devalued drachma would make Greek resorts an attractive alternative to those in Italy or Spain.
Yet as recent weeks have shown, Greek government competence cannot exactly be taken for granted. Grexit could alter the domestic balance of political power in unexpected ways; angry voters who did not anticipate that their vote would lead to ejection might take to the street. If the government defaults on its creditors but cannot keep its budget gap closed then it may find itself monetising too much debt, leading to runaway inflation. With too little foreign exchange to finance its imports, Greece will soon find store shelves in supermarkets and chemists emptying out, sparking a humanitarian crisis. Greece might become a failed state, as all those with talent flee the country while those left behind fight an increasingly bitter battle over the division of the meagre spoils left in a post-euro Greece.
And if Greece stays in? It will face painful budget cuts with no monetary flexibility and without the opportunity to devalue. Its debts will still be there, pending some future act of German magnanimity that may or may not be forthcoming any time soon—not, one suspects, before the Greeks demonstrate that they can adhere to the programme they've agreed. And continued membership in the euro area will have been bought with an absolutely humiliating surrender to creditors' demands. Greece will be in, and full of seething, underemployed Greeks. Europe will be left to see whether a new bout of Grexit fears or the election of a Golden-Dawn government happens first.
None of these options are good for the euro area's core economies. In or out, a Greece sinking deeper into economic and political disaster is toxic (not to mention a human crisis for which the core would bear significant moral responsibility). A successful Greek exit is just as bad, from the core's perspective. It will demonstrate to anti-austerity parties around the periphery (and possibly even in parts of the core) that there is life, possibly a rich one, after exit. Even if pro-exit parties never gain power, rising support for them will cause jitters in markets and place pressure on elected governments to demand more from the core: more say, more debt relief, less fiscal nagging. That road leads toward a much less German euro area, or to outright break-up.
Germany is therefore left in a situation in which its preferred outcome is one in which things go very badly for Greece, but not so badly that it becomes another economically and politically broken Russian satellite. That is an awful place for Germany to be, both because it may not get what it wants, and because it finds itself needing Greek people, who are fellow Europeans and humans, to suffer quite a bit more than they already have, which is quite a bit. No one, least of all the Germans, should want the German people to be in that position.
One can imagine another scenario—though only just, given its utter political implausibility. The core, led by Germany, could itself accept a humiliating climbdown—could, for the good of the euro area, embrace the humiliation—and tell Greece that the strong "no" vote has convinced it that large-scale, conditional debt restructuring should be a part of an agreement to keep Greece in. It could re-offer the proposal Greeks rejected on July 5th, with the promise of debt forgiveness as reform goals are met.
That would allow Alexis Tsipras to claim an overwhelming victory. It would be extraordinarily unpopular in almost every euro-zone country. It would probably be illegal under existing EU rules. But it would be statesmanlike, it would keep Greece in, and it just might keep the Greek economy from imploding. The euro zone could even go further; rather than hoping that the rest of the periphery fails to notice the gift being given to Greece, it could regularise the policy and make a similar offer to all economies with debt-to-GDP ratios above a certain level, as part of a significant step toward euro-area fiscal integration.
It would be ugly and would create all sorts of knock-on incentive effects that would need to be dealt with down the road. But that's how states are built.
But that won't happen. Greece will probably leave the euro area. And the state probably won't get built. These are not the birth pangs of a new pan-European state; they are the struggles of an economic bloc made up of disparate polities that no longer believe (if they ever did) that they are all in it together.
