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Greece: The Confrontational End-Game Is Here



Now that Greek Prime Minister Alexis Tsipras has alienated the European Commission, which is his government's only potential ally in the creditor group known as the Troika—European Commission, European Central Bank (ECB), and International Monetary Fund (IMF)—no credible bridge-builders are left to save Athens from itself. Further confrontation and escalation seem most likely (60 percent).

Tsipras's angry denunciation of the Troika's most recent proposals as "unacceptable, extreme, and illogical" effectively rules out concessions on his part. Striking a deal acceptable to the Troika would now be tantamount to performing the dreaded Greek political "somersault," always denounced by Tsipras and Syriza.

The IMF's appropriate decision to pull out of negotiations in Brussels this week makes it politically impossible for Chancellor Angela Merkel to give Greece a better deal. Greece may be able to meet its next payment to the IMF in late June by cobbling enough cash together by not paying suppliers and confiscating working capital at state-owned enterprises (SOEs) and local governments. But without an enforceable deal with Athens,  an eventual nonpayment to the ECB in July now looks increasingly likely.

Such a nonpayment, as discussed previously, would scale back emergency lending to the Greek banking system, precipitating a banking holiday or immediate controls on access to the €133.7 billion in bank deposits,1 dooming the summer tourist season and plunging the economy into a severe recession, with obvious political impact on Syriza itself.

Default cannot be declared without a political decision by the IMF Board or the ECB, which the Obama administration and the IMF Board dominated by the Europeans would likely oppose. Instead, Greece's creditors are likely to sit back and watch political turmoil engulf Greece.

Sorry to say, Syriza deserves such a fate. It has never presented a credible alternative set of reforms and policies to the proposals it has rejected. Had Syriza struck a deal in March by agreeing to a goal of a primary surplus of 1 percent, it would have been able to get through 2015 with extra money to spend. Agreeing to a 1 percent primary surplus target now would require more fiscal consolidation than a few months ago, as the economy has been allowed to deteriorate dramatically.

Syriza's diplomacy in Europe (and beyond) has only isolated Athens further. Combining leftist rhetorical antiausterity with a right-wing nationalist coalition partner, and making overtures to Russia and Vladimir Putin, have not delivered one euro to its books. Even fellow far leftist parties around Europe now avoid Syriza and its model. Tsipras' threatening assertion that a Greek bankruptcy "would be the beginning of the end for the eurozone" and roil markets in Spain and Italyis seen as noncredible trash talk. It has only played into the hands of German finance minister Wolfgang Schäuble, who correctly said recently that Greece had removed any doubt that its own conduct is to blame for its predicament.

Three scenarios appear possible in this situation.

Spread the Blame. Theoretically Tsipras could submit a package acceptable to the Troika to the full Greek Parliament, inviting the opposition to help secure its passage. Such a step would release Troika funds in a matter of weeks and normalize the country's financial system. Tsipras could remain prime minister in this scenario, despite the economic costs, though it would divide Syriza. Any such deal would also require more intrusive creditor inspections, undercutting Syriza's nationalist credentials. Another crisis would be likely within a few months.

Unless, as part of this scenario, Tsipras reconfigures his governing coalition to include more centrist parties (or perhaps a national unity government), it is difficult to see the longer-term benefits of this solution.

Consult the People Directly. The Greek government might call a national referendum on a deal acceptable to the Troika in order to legitimize the political somersault its acceptance would represent. Any referendum would be de facto about whether the Greek people are willing to put up with the costs of staying in the euro. Such a referendum taking place in another accelerating economic emergency would most likely be approved (98 percent). But Greece's economy would deteriorate in the weeks running up to the vote.

Syriza's governing majority would almost certainly splinter in the process, with some MPs campaigning for and others against the referendum passing, so it is far from obvious whether Tsipras would have a governing parliamentary majority afterwards. As in the previous scenario, holding a referendum without also reconfiguring the governing coalition seems of limited long-term value.

Early Elections. Calling new parliamentary elections would be logical but unpredictable, and Syriza would probably be thrown out. On the other hand, with the main opposition New Democracy still led by the unconvincing former prime minister, Antonis Samaras, Tsipras might be able to convince voters that he remains their best option. New elections could empower some of the newer centrist parties. Given the ultimately risk-averse nature of aging electorates, however, a dramatic strengthening of the anti-euro fringe parties in KKE on the left and Golden Dawn on the right does not appear likely. There is therefore no real reason to fear new elections, due to the very small risk of "an even more extreme outcome."

Through leadership control of electoral lists, new elections might produce a less radical group of Syriza MPs, but its smaller coalition partner ANEL (Independent Greeks) might falter in the voting. An election would thus result in prolonged haggling over formation of a government, causing more economic suffering. Once again, such a scenario would devastate the critical summer tourism season.

What are the options and costs for the euro area of these choices?

First, the deteriorating Greek economy will—eventually—require additional funding in the short term and likely a deeper further restructuring of the euro area's Greek debt. Syriza has already cost other euro area taxpayers a lot.

Second, Tsipras' failed personal diplomacy will have caused the scales to fall from the eyes of Merkel and French president Francois Hollande. They have no real incentive to spend domestic political capital to strike a deal advantageous to Greece to coax him toward the political center, now that it is increasingly obvious he is not even a closet centrist but largely seems to agree with the left wing of his party. The euro area thus has no real choice but to seek regime change in Athens.

Such a hard line would drive home the costs of Syriza's failures to the Greek electorate, in the hope that new elections would deliver a new government in Athens, even if the cost is a deep recession from the ensuing deposit controls and financial chaos.

Would the Greek population then vote for parties more friendly to the euro area? Most likely, yes. The prospect of Greeks punishing Syriza for its deceitful promise to end austerity and reforms while other Europeans pay their bills is not guaranteed, of course. But Greeks are not likely to look kindly at leaders putting euro membership at risk.

The risk of a Greek crisis spreading contagion to other parts of Europe remains low. A regional recovery is under way, and the ECB is heavily intervening in bond markets. Syriza does not seem to have understood the hollowness of its threats to bring Europe down with it. In some ways there has never been a better time for Brussels, Paris, Berlin, and Frankfurt to nail a recalcitrant member state like Greece than now. The risks associated with more lasting instability in Greece will arise only as the end of the ECB's asset purchase program draws closer in September 2016. The ECB's exit from its quantitative easing (QE) bond purchases will become more tricky, as markets may at that time price new risks into other euro area bonds, however.

What are the risks of the so-called Grexident—something going wrong and Greece exits the eurozone and adopts a new currency in this confrontational scenario? Not zero for sure, but actually very close to zero. Introducing a new currency is no trivial matter, especially for an incompetent government like Syriza, but the threat of massive capital flight would likely stop the process before it started. As discussed before here, Greek public sector workers and retirees are not likely to accept being paid in a piece a paper (IOU) signed by Finance Minister Yanis Varoufakis. And certainly the foreign suppliers of essentials like food, medicine, and energy to the Greek economy would balk.

The most likely "Grexident scenario" is therefore not a new Drachma, but Montenegro—i.e., Greece becomes just another relatively poor unilaterally euroized non-EU Balkan economy. In Montenegro, the euro has been the only legal tender since 2002. But Montenegro has no access to the ECB or the EU budget and has a GDP per capita of just over €5,000—less than a third of Greece's. Whatever the appeal to national dignity, the Greek electorate is not likely to allow such a calamity. Of course, the Greek people might democratically choose to become much poorer. But even this extremely unlikely scenario (2 percent) would not necessarily doom the euro area. Other euro members would suffer large financial losses (from loans to Greece and the losses on now-defaulted Greek collateral held by the ECB), which is the main political reason that departing from the European System of Central Banks would invariably mean also an exit from the European Union. Electorates elsewhere in the euro area would demand it. Such large and certain financial losses might, however, be acceptable, though it would obviously be irresponsible of Merkel and Hollande to even allow the slightest risk of a euro collapse.

Many academics and non-European central bankers assume that a "Grexident" would destabilize the euro and encourage more countries to drop out, turning Europe's common currency into just another fixed exchange rate regime. Euro area politics would work to prevent such a development, however, because the remaining 18 members and their central bank would move to make it impossible for more members to quit. The economic devastation within Greece resulting from an exit from euro area institutions (but not as mentioned the euro currency itself) would by itself dissuade other countries from following its example. More likely, the remaining 18 members would opt for a new integrationist "Euro Area Treaty" for themselves. Such a salvaging effort would be difficult, but the experience of the last five years suggests that euro area countries would pull together and save their union. Had Greece been pushed out of the euro area, instead of leaving voluntarily against the will of other members, a new drive for euro area integration would probably fail.  

More such integration could include conversion of the European Stability Mechanism (ESM) into a euro area budgetary entity with limited direct taxation powers. The ECB could decide to exit QE only by selling some longer-dated sovereign bond holdings back to the market as outright eurobonds, rather than as individual country bonds.

These steps add up to the likelihood of Europe pushing Greece to make the hard decisions about what they really want.


1. April 2015 data are from the Bank of Greece [xls].

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