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Greece's Future Is in Greek Hands



The Greek government has dug itself and its people into a hole over the last week, as Prime Minister Alexis Tsipras has reversed himself on an ever growing list of key issues. His government is now suddenly in favor of a third bailout from the euro area (though excluding the International Monetary Fund this time), and has more or less accepted the very proposals he labeled an insult to European democracy a few days ago. On the other hand, he is still calling for rejection of the referendum on whether to accept the terms of international creditors in return for a bailout.1

The referendum must qualify as one of the most bizarre twists in the Greek story of the last five years. Europe's independent human rights overseer in the Council of Europe has already declared that it falls short of international democratic standards—and no wonder. Greek citizens are being asked to vote on a 57-word resolution asking them whether to accept the outline of a proposed agreement that has officially expired—one that most Greek voters will not have read. The government in Athens has posted a 34-page translated version of the agreement online, but news organizations have found errors in it.   

With its erratic behavior the Greek government has thus destroyed the last remnants of trust among its potential partners in Europe, i.e. the so-called Troika of the European Commission, the European Central Bank (ECB), and the International Monetary Fund. As previously predicted here, the euro area's emerging strategy now is implicitly to seek regime change in Athens.

Tsipras repeatedly maintains that he has a mandate to get easier terms from Greece's creditors. In the eyes of his creditors, however, he has no mandate to spend their money. Whatever the outcome of the referendum on July 5, in other words, voters in other euro area countries will hardly feel bound by it. The vote is really about whether Greece continues to function as a member of euro area and EU institutions.

A "no" on the referendum will end financial and economic support from a full range of lifelines that Greece needs to pay its bills and its workers. These are the lending facilities provided by the European Central Bank, the Emergency Financial Stability Fund, the European Stabilization Mechanism, and the European Union budget.  The first consequence will be that Greek banks become insolvent, unlikely ever to reopen in their current form because the Greek government lacks the money to recapitalize them. In addition, Greece will lose 3 percent of its GDP worth in annual net transfers from the European Union (mainly agriculture subsidies and funding for infrastructure2), aggravating Greece's ruinous path toward self-destruction. As discussed earlier, efforts to reintroduce the drachma are bound to fail. Despite what some economists speculate3, a real exchange rate depreciation is a chimera. The prospect of economic disaster will probably lead to a yes vote on the referendum, but even such an outcome will not roll back the clock for Greece. If there is a yes vote, Tsipras will almost certainly have to resign as a prerequisite for reopening negotiations with its creditors, taking solace perhaps in the prospect of his replacing Che Guevara as a favorite image on the t-shirts of revolutionary hipsters around the world.4  

Only a national unity government committed to implementing the Troika program can in the short term renew the dialogue with Europe and increase the emergency lending provided by the ECB  to enable the banks to reopen. It is doubtful that a unity government with Tsipras's  Syriza party in it could accomplish that goal. For the Greek banks to reopen, a new government is likely to be required.

An obvious path toward stability would be to hold new elections. But there would be a danger of Syriza doing well and even returning to power. In addition, an election campaign would take weeks, raising a host of problems. For example, €2 billion in Greek T-bills fall due on July 10. Greek banks hold nearly all this debt. Could the banks roll them over while remaining closed? Could the Greek government legally "voluntarily" extend them?5 To ease pressure on Greece's overburdened domestic banks, considerable flexibility and leniency by the ECB and its single supervisory mechanism (SSM) would seem essential, but it is far from certain that such help would be available with the political situation in turmoil.

More important is the €3.5 billion bond redemption to the ECB due on July 20. Failure to pay would likely amount to potential monetary financing charges against the ECB and a  severing of ties between the central bank and Greece. These steps would end the emergency lending to Greek banks and push them into insolvency and potential liquidation. One way to avoid that disaster would be for the euro area owners of the ECB to provide some emergency fiscal aid. For example, they could pay off the ECB with ESM money or profits from the security markets program (SMP) of bond purchases over the last several years. But such aid would not likely be forthcoming without a new government in Athens and would in any case only cover the payments to the ECB in July, leaving the question open about what would happen when the next payment to the ECB falls due in August.

Whatever happens, Greece faces another major recession, only six months after it seemed to be crawling back toward growth. The argument about how much of a primary surplus Greece should run will now become how much of a primary deficit must be tolerated by Athens and its creditors. Tsipras will then get his wish for countercyclical stimulus in Greece, having destroyed the economy in order for Europe to save it.

Even so, the euro area must stand ready to provide the Greek economy with a major multiple-percent-of-GDP economic shot in the arm following a yes vote. Again, such an outcome seems politically impossible without a new government in Athens.

A yes vote, even if it is followed by more sacrifice in Greece and Europe, will have one major benefit. Such a vote should effectively end the ever present debate about the long-term political sustainability of the euro area. Greece has set an example of reckless behavior that no other country in Europe would want to emulate. A yes vote would prove the political and democratic irreversibility of the euro beyond any reasonable doubt. No matter how bad things may get inside the common currency, the costs of departure will always exceed them and—through a process of financial sector freeze, as opposed to armed intervention—be revealed to voters ahead of their time of decision.

Political fringes everywhere  always dream of independence and dignity, but the prospect of a Grexit has proven so costly that it is no more politically likely than a  Texit by Texas from the United States.


1. There certainly are amendments, additions, or clarifications from Alexis Tsipras to his acceptance of the Troika staff level agreement, but their financial value appears to quite small and ultimately bridgeable. See June 30 letter from Tsipras to the Troika .

2. Greece receives about €2.5 billion annually in EU agricultural support and about €4 billion annually in structural and cohesion funds. See European Commission data [xls].

3. See for instance a post by my colleague Joe Gagnon, who though sensibly inserts a host of caveats to this endeavor.

4. I am indebted to a long-term investor in the rest of the Balkans for this career forecast for Alexis Tsipras.

5. I am indebted to Rob Kahn of the Council on Foreign Relations for bringing this option to my attention.

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