There comes up a day

FEW countries put sufficient store in rejecting things to have a national “No” day. But every October 28th Greece’s Oxi Day holiday commemorates the No with which it replied to a humiliating Italian ultimatum in 1940, a refusal to acquiesce that led to invasion.

The snap referendum that Alexis Tsipras called on June 26th after walking out of negotiations with the country’s creditors looks like the Greek prime minister’s attempt to stage another defiant rejection. He has urged Greeks to use the vote on July 5th to say Oxi to austerity and the “blackmail” of Greece’s creditors. The leaders of the European Union, for their part, are hoping for a resounding Nai: Yes to remaining within the euro and the wider European family.

On the face of it Greece and its creditors were not far apart on the substance of how to extend the bail-out that the country needs to keep paying its bills. But trust between the two sides has broken down almost entirely, and room for manoeuvre has run out. On June 30th Greece failed to make a €1.55 billion ($1.72 billion) payment to the IMF, the biggest default in the fund’s history. Five years into the debt crisis, the country has suffered a loss of 25% of its GDP and a debilitating rise in immiseration and the unemployment rate—which now stands at over 50% among young people. Its soup kitchens are open but its banks are closed; the country is close to collapse. The default on its IMF loan does not have immediate consequences, but that would not be the case if it failed to make the payment of €3.5 billion due to the European Central Bank (ECB) on July 20th. Greece is likely to leave the euro, and possibly the EU, if it does not vote Yes on Sunday.

The miserable banality

For something so pivotal, the referendum itself is wonky to the verge of obfuscation. Its 72-word question makes no explicit mention of the euro; it asks whether the voters will accept a reform and fiscal-adjustment programme drawn up by the European Commission, the ECB and the IMF, comprising two documents submitted on June 25th. To muddy things further the measures it refers to were superseded by a later proposal which in turn lapsed when the bail-out deal expired on June 30th. On July 1st Mr Tsipras said a No vote would strengthen Greece’s negotiating hand, not push it out of the euro. But he has twisted and turned so much that Greeks find it hard to know how to take what he says. Some wonder whether he will hold the vote at all—his leftist Syriza party is split on the matter.

European leaders hope that, faced with a hard choice, the Greeks will stick with the European project. They take reversals earlier in the crisis as cheering precedents. In late 2011 the Socialist prime minister, George Papandreou, announced a referendum on a bail-out, changed its terms, cancelled it and promptly lost power. In 2012 the voters strengthened anti-austerity parties in a first round of voting but, spooked by the real prospect of “Grexit”, swung back to more EU-amenable parties in the second.

The same dynamic may be at work this time. The Yes camp is fragmented, but some polling suggests it is pulling ahead. Capital controls and limits on ATM withdrawals—€60 a day, far less than Cypriots were entitled to at the height of their banking crisis in 2013—concentrate the mind. Pensioners without cash cards are hit badly; some banks have opened for pensioners alone, under police guard and with withdrawals limited to €120 a week. There have been queues at petrol stations and hoarding at supermarkets. Sheltering from the rain under a Greek flag at a Yes rally in Syntagma Square, one voter said he turned out “because voting yes is the only way to get rid of this catastrophic government and to stay in Europe…We belong in Europe and we do not want to become third-world citizens.”

Many have had a hand in creating this mess. The founding fathers of the euro launched a single currency so flawed as to risk becoming, in the words of the British Conservative leader of the time, William Hague, “a burning building with no exits”. European leaders allowed a woefully unprepared Greece to join the currency in 2001; France and Germany broke and rewrote the budget rules in 2003, weakening their authority. Until the global financial crisis made its deficit impossible to hide Greece’s leaders misled the rest of the euro zone about their country’s finances.

As rising bond yields threatened to push Greece to default, creditors botched the first bail-out in 2010 (see chart 1) by imposing too much austerity too quickly. For all of their railing against austerity, Greek leaders mostly cut deficits instead of promoting growth. For too long, the ECB resisted any notion of imposing losses on private bondholders even when it was obvious that Greece was bust. When haircuts for bondholders, known as “private sector involvement”, were agreed on in 2011 they were too late to do the trick.

In 2012 European leaders promised in the future to look again at the sustainability of Greek debt, but never wrote any of it off. It now stands at 177% of GDP. The failure by the creditors to face reality helped Mr Tsipras to a resounding election victory in January on the contradictory promise both to end “barbarous” austerity and to keep the euro.

Time has gone by quickly

For a while, it looked as if Mr Tsipras might eventually yield. On February 20th Yanis Varoufakis, the finance minister, agreed to an extension of the bail-out agreement then in place and to negotiations on further reforms, saying reassuringly that he was in favour of 70% of them. Then things went downhill. Mr Varoufakis’s penchant for lecturing his fellow finance ministers got him sidelined. A new Greek negotiating team resisted VAT increases and pension cuts—both “red lines” for the government—while producing budget figures reliant on unlikely improvements in tax-collection. The government rehired sacked workers and declared a new tax amnesty.

On June 21st, only nine days before the bail-out’s extension was due to expire, the Greeks at last produced a plan that European leaders thought worth serious discussion. But the IMF disliked its emphasis on tax rises, and European officials crossed out several sections with red lines, rewriting them to their taste like teachers dissatisfied with a pupil’s shoddy homework. Negotiations continued; at one point only €2 billion seemed to separate the two sides. But just when it seemed a deal was in the offing, Mr Tsipras walked out of the negotiations and called his referendum. A slow bank-run in Greece accelerated (see chart 2) and the ECB froze the level of emergency liquidity it was prepared to offer Greek banks, leading the government to close them for a week. Mr Tsipras made several eleventh-hour offers. In one plea, he again asked for an extension, and the start of negotiations on a third bail-out, lasting two years. In another, he said he accepted almost all of the creditors’ conditions. But the creditors said there would be no more games, and no more negotiations, until the Greek people had spoken.

If this hard line does bring about a Yes Mr Tsipras and his ministers will probably prefer to resign than to submit to a deal they have so roundly denounced. That could lead either to the formation of a new government of national unity from the current parliament, or to fresh elections. If those elections were to give Syriza a fresh mandate there is no telling what might happen—something which would also be true if Mr Tsipras were to stay on in spite of a Yes. But if, as seems more likely, Greece ends up with a non-Syriza government it will be able to expect some political goodwill from its creditors during the negotiation of a third bail-out, and to get some sort of promise on restructuring Greece’s vast debts. The goals of such a deal might not differ substantially from those of the creditors’ previous offer, but reaching them could be significantly more painful. The economic damage of recent months may mean more tax rises and spending cuts.

There is no way that such a bail-out can be put into operation before the July payment to the ECB comes due. But if the negotiations are going well, the ECB could tide the country over by temporarily raising the amount of money that Greece can raise through issuing short-term debt and the amount of that debt that Greek banks can purchase. One way or another, something could be worked out: “It’s an open door to be creative,” says a senior Eurocrat.

Nervous about the oracle

The ECB would also have to attend to the role it took on in late 2014 as the ultimate supervisor of Greek banks. When Greece’s financial sector emerges from its current induced coma it will be in even worse shape than before; given the economic shock of the past week, non-performing loans are likely to soar from an already high 34%. Fresh capital may once again have to be provided by the government (and thus by loans from the creditors).

A No vote would see the same milestones reached, but without the goodwill. Some observers think that the ECB—which could, by removing support after a July default, let Greek banks fail in a way that makes Grexit certain—might instead keep them on life-support so as to let the politicians take the final decision. But having told the Greeks that a No vote would be a vote to leave the euro, many leaders would see no benefit in stopping the process. In recent weeks Angela Merkel’s much-used motto—“If the euro fails, Europe fails”—has been respun to distinguish defending the euro from keeping Greece in the euro zone. A YouGov poll shows 58% of Germans now favour Grexit; less than half as many want to keep Greece in the club.

Conceived as an “irrevocable” monetary union, the euro has no official exit routes. But two are plausible in practice. If it chose not to keep the country on life support for a political coup de grâce, the ECB would cut Greece out of the TARGET2 payments system, which would separate it from the euro area. It might also be obliged to stop providing liquidity to Greek banks. With no euros available, Greece would have to fund its banks in a new currency.

Even without a banking crisis, an unsupported Greek government would have to start using scrip—in effect new IOUs—to pay bills, and maybe pensions. If the Greek government decided to make this parallel currency legal tender then once again the ECB would almost certainly have to act.

On the face of it, there is nothing to prevent Greece from remaining in the EU if it stops using the euro. Nine other countries have national currencies. But because the euro was meant to be a one-way street there is as yet no legal path by which Greece can bring that number up to ten. And it is possible that, in the turmoil of Grexit, the country would be unable or unwilling to abide by the rules of the single market, or that other countries would start to impose controls on the movement of goods and people from Greece.

The financial consequences of Greece leaving the euro can now be considered with much more equanimity than previously because the risk of contagion looks much smaller than it used to. When the earlier bail-outs were agreed to, it was feared that Grexit would cause so much panic in the markets that other vulnerable countries might also be pushed into default. But since then the ECB has put in place a programme of quantitative easing that has kept bond yields low, and has indicated it will take further action if renewed contagion from Greece starts driving up yields elsewhere. Markets believe that Mr Draghi will carry through on his promise, made in 2012, to do “whatever it takes” to save the euro.

That does not mean no pain. News of the referendum and the subsequent capital controls caused a sell-off in world markets on June 29th, with the DAX index of German stocks falling by 3.6%, France’s CAC 40 falling by 3.7% and the S&P 500 in New York falling by 2.1%. But things might have been a lot worse. On June 29th Portuguese government-bond yields rose by a third of a percentage point, but the spread (or excess rate) over German yields is still only a sixth of its level in June 2012. This does not just reflect the ECB’s new powers. Portugal, Ireland and Spain, once grouped in with Greece as the PIGS, are doing better than they were—as indeed was Greece, before Syriza. Whereas in 2012 capital fled other southern European countries when Greece was ailing, there is no such exodus happening at the moment.

Europe’s banking system, a likely vector for contagion in any financial crisis, is in better shape than at the outset of the crisis. Euro-zone banks have raised some €250 billion in capital since 2008, bolstering once-shaky balance sheets. And banks once heavily exposed to Greece have had ample time to reorder their affairs. European lenders’ claims on Greece, which once topped €300 billion, now stand at just €54 billion, according to Deutsche Bank. Most of the outstanding Greek debt is now owed to governments and international institutions, which could handle the cost of default, rather than to banks, which would struggle to do so. The overall cost of Grexit might be €230 billion, according to Alberto Gallo of RBS, another bank: hefty, but only about 2% of euro-zone GDP.

They’ll do the legislating

But if the short-term consequences of Grexit seem manageable, the long-term effect of an irrevocable union being partially revoked is unpredictable. A crisis over Grexit may yet spur the euro zone to take another step towards integration. The currency’s weaknesses—a lack of risk-sharing mechanisms, of a common safe asset, of a central budget and other means to help absorb economic shocks in one or other country—are well rehearsed. Common deposit insurance, more integrated capital markets and common Eurobonds would tie things together better. But as sensible as economists may deem them, and as ardently as integrationist Europeans may wish for them, they will be difficult to enact. Mutualising liabilities touches the core of national sovereignty. Populist anti-EU parties make any move towards “more Europe” risky for mainstream politicians. Yet even if financial contagion is limited, there will be spillovers elsewhere.

There are Eurocrats who fear that Grexit might compound Europe’s migration problem. Over 63,000 migrants (mainly Syrians) have arrived in Greece this year; the EU relies on “frontline” states like Greece to fingerprint and register as many such people as possible. This co-operation, never solid, could break down entirely.

Geopolitical concerns loom large, too. For months some Europeans have feared that a Syriza-led government might seek to strengthen Greece’s long-standing ties with Russia. So far those fears have proved unfounded; Greece has not, for example, attempted to block the EU’s sanctions over Ukraine. But its calculus may change if it finds itself bankrupt and isolated. Mrs Merkel is one of those who fear the consequences of the EU abandoning a country with a history of coups in a part of Europe with a particularly unstable history. Some European institutions are already drawing up plans for humanitarian assistance packages for a post-Grexit Greece.

And there could also be knock-on effects on Britain’s position in the EU. The more time and effort Europe’s leaders invested in the Greek crisis, however it develops, the less they will have available to deal with the renegotiation that is to preface Britain’s forthcoming referendum on EU membership. A chaotic Grexit would also strengthen the hand of British Eurosceptics by reflecting poorly on all involved; and if it accelerated fiscal integration among the 18 remaining members of the euro zone it would deepen British concerns about the gap between euro-zone “ins” and “outs”.

To lose one EU member might look like misfortune; to lose two would look like carelessness. A Greek departure would surely make much of Europe more determined to keep Britain in. The problem is that, as Greece’s botched and blame-filled story shows, Europe is not adept at getting the results that it wants. And for now, what it gets next depends on Sunday’s voters. Some of them, as they make their decision, will doubtless recall the words of the poet Konstantinos Cavafy:

For some among us there comes up a day
When either the great Yea or the great Nay
Must needs be spoken…

For many the heart will say Nay and the head command Yea. Which wins will determine the course of their country, and perhaps of much else besides.