What is going to happen with Greece? Nobody knows. That does not mean nobody cares. On the contrary people care passionately, in directly conflicting directions. On both sides are participants determined not to concede. This impasse illustrates the folly of creating a currency union among sovereign states that lack common political institutions, powerful emotional bonds or strong economic similarities. The marriage is ghastly but divorce is scary.
Greece is now on the brink of default. It owes €1.5bn to the International Monetary Fund this month; another €452m to the IMF and €3.5bn to the European Central Bank next month; and a further €176m to the IMF and €3.2bn to the ECB in August. Without a deal with the rest of the eurozone to release €7.2bn in the remaining funds from its bailout agreement, Athens will be forced to default. It has no other source of money. Its access to markets is closed.
If a deal with the eurozone is not reached, Greece will default. The ECB would then reconsider the acceptability of claims on the government (be they direct liabilities or guarantees) as collateral for its lending to banks. Haircuts would certainly be raised sharply. The ECB would find it particularly hard to lend against collateral supplied by a government that has defaulted to itself. The knowledge that default is imminent has already accelerated a run on the Greek banks. Without a deal, therefore, banks will soon be forced to halt withdrawals.
The mood music coming from those engaged in these discussions is highly discordant. Alexis Tsipras, Greek prime minister, has accused bailout monitors of making “absurd” demands. On the other side are those equally determined not to grant concessions, foremost among them governments of member countries that have stuck to harsh commitments or are poorer than Greece. Meanwhile on the sidelines Jack Lew, US Treasury secretary, is reduced to pleading for flexibility, terrified of the consequences of another upset.
It is not hard to see why it has proved so hard to reach a deal. As Goldman Sachs notes, the European authorities are negotiating on the basis of three principles: first, staying in the euro requires further economic adjustment by Greece; second, additional support must be conditional; third, external oversight is required to ensure compliance with those conditions. Yet the Greek government was elected on a promise to stay in the eurozone but without austerity, adjustment or external oversight. These positions are irreconcilable. Either one side gives in or Greece defaults. If Greece defaults, it will have a second round of decisions to make: namely whether to try to remain inside the eurozone, even without normally functioning banks.
Reaching a deal is not in principle inconceivable. While the eurozone will insist on monitored conditions, it has some flexibility on which conditions to insist upon. But Greece is viewed as a serial backslider. Some — the government of Spain, for example — are terrified that concessions would strengthen the credibility of domestic radicals. Thus, trust and tolerance are both exhausted. Meanwhile, the present Greek government might have to collapse and another one be formed before the country can make concessions.
So what might happen next? On the assumption that a deal cannot be agreed before midnight, so to speak, the Greek government will default, at least technically, and so the liquidity squeeze on the economy (and the recession) will intensify. The fiscal situation — already weakened by spending commitments, falling revenue and a weakening economy — would deteriorate further. This year, the primary fiscal balance (before interest) might be a deficit of about 1 per cent of gross domestic product, worse than the IMF forecast in April.
An important question is how to sustain the economy until either new agreements are reached or the Greeks abandon the euro. Adam Lerrick of the American Enterprise Institute suggests how liquidity might be sustained even if the banks were closed. Under his scheme, people would be able to use claims on deposits, to be called “deposit receipts”, in place of the euro notes and coins they would no longer be able to obtain from their bank. This would sustain spending in such a cash-dependent economy. These deposit receipts would be established as legal tender. Within Greece, therefore, these deposit receipts would be money.
Under this proposal there would be a limit on issuance, since receipts would be backed by existing deposits, one for one. Greeks would still have to make external payments in euros. The value of deposit receipts — a sort of Greek euro — would float against the euro as the demand for the latter rose and fell.
Such a scheme could cushion the Greek economy against a total collapse. It could also be a precursor to full exit, should a workable deal not be reached. Given the current political impasse, such an expedient may soon be needed.
It has long been my view that if a deal can be reached at all, it will take time. It will also require big concessions on both sides. But I believe that a deal should in principle be possible. It is also hard to exaggerate the significance of an exit — even of a country as small and annoying as Greece — for the euro project (however misguided) and so post-second world-war European integration. Once the euro is seen to be reversible, the economic forces driving integration reverse. Every crisis will become potentially lethal. The efforts of the ECB to eliminate exit risk will have been almost for nought.
This must be seen as a long game. All involved made mountainous mistakes in the run-up to the Greek crisis and again since then. To fail now would be to pile a new mountain of error on the old ones. They need instead to recognise and learn from those past blunders.