Rather than wondering when Greece will renege on its debts and what the consequences would be, try the opposite question: what would have to happen for Greece to avoid default? The essential condition would be that the forthcoming general election, the second in a space of six weeks, would lead to the formation of a government capable of negotiating a less onerous refinancing deal with the country's eurozone partners. What is not widely understood is that such a Greek government would get a sympathetic hearing.
Admittedly, the signals are mixed. On the positive side of the balance, Jean-Claude Juncker, the Luxembourg Prime Minister who chairs the meetings of eurozone finance ministers, argued on Monday that he didn't envisage, "not even for one second, Greece leaving the euro area. This is propaganda." He added that he would be open to debating easing terms of the €174bn bailout, including extending dates to meet fiscal and economic reform by one year. Angela Merkel, the German Chancellor, said that "of course Greece can make it".
But, more negatively, her finance minister, Wolfgang Schäuble, perhaps playing "hard cop" to the Chancellor's "soft cop", warned that Greece would have to stick to its hardline austerity programme in order to continue to receive the bailout cash needed to pay government salaries and support troubled banks.
That is the most favourable scenario. There is, however, a darker version. In it, a new, aggressive Greek government would argue that letting Greece go would be "too dangerous" for the rest of the eurozone. This is because of the risk of contagion. If you let Greece go, then Spain would totter and perhaps Italy also. Where would it end? How many dominoes would fall? In this second scenario, the new Greek government would dare the eurozone finance ministers to cut off the supply of credit if the country failed to meet its obligations. This approach has been openly discussed by some of the leaders of Greece's political parties. Actually, I think there is quite a good a chance that the bluff would work.
For the political colouring of the eurozone's leaders is rapidly changing. Ms Merkel has just suffered what she described as a "bitter and painful defeat" in an important state election. Her Social Democratic opponent argued that absolute austerity was wrong. Then on Tuesday, the new French president, François Hollande, turned up in Berlin to meet the German Chancellor saying much the same thing. And in the Netherlands, traditionally a defender of financial rectitude, the tide is turning. Dutch voters, shortly to go to the polls, are becoming disenchanted with austerity.
Suppose, though, that no credible Greek government is formed and the "too dangerous" bluff fails. Greece does default on its debts and crashes out of the eurozone. We can now rephrase the question: what would have to happen for the risks and pain of this outcome to be mitigated?
As far as Greece is concerned, retaining the euro as legal tender alongside the drachma would slightly improve what would indeed be, from almost every point of view, a frightful situation. In fact in two of its neighbours, Montenegro and Kosovo, the euro circulates in parallel with the local currency and has provided a stabilising influence. A second essential measure would be to nationalise Greece's banks – which would have been rendered insolvent – so that money transfers could still be conducted safely and some flow of credit maintained.
With both these measures in place, Greece's problem of having to buy certain essential goods such as foodstuffs, medicines and oil on international markets with only a devalued drachma to offer in exchange might be eased. But for the majority of the population, life would become very grim.
For the rest of Europe, the first part of the answer to my question above is that, for some time, business executives, bankers, bondholders and investors have been acting as if a Greek default would happen in the very near future. Financial markets never hang around. They always rush towards the entrance or the exit according to which seems the more appropriate. In other words, we have already seen some of the consequences of a Greek default and got them out of the way.
Many banks, for instance, have cut their direct exposure to Greece and other peripheral countries. This is a no-brainer really. It comes under the heading of risks that you do not need to take, particularly when the upside is small and the downside calamitous. At the same time, many foreign holders of government bonds issued by the two countries next in line following a Greek exit, Spain and Italy, have already sold stock. It is calculated that they have lightened their holdings by nearly 20 per cent. At the same time, regulators have insisted that banks undertake contingency planning that models the wholesale collapse of the eurozone. Wouldn't sensible institutions do this any way? Yes, but regulators' tests are often exceedingly strict – which, in the end, turns out to be no bad thing. It forces radical thinking.
So the last question is this. All precautions taken, all mitigating factors recognised and planned for, would the shock absorbers put in place by the European institutions – with some financial contribution from the UK – work as hoped? First in line is a €500bn eurozone rescue system, the European Stability Mechanism. The problem is that while big enough to give support to Spain should it be forced to the brink of default, it could not cope with Italy as well.
At this point, all eyes would turn to the European Central Bank (ECB). But that, in turn, would mean looking towards Berlin. For the various rescue measures that the ECB could take would require German support. It could buy Spanish and Italian bonds, for instance, when otherwise there would be no ready market. It could again flood European credit markets with liquidity as it did a few months ago. Classically, such actions would weaken incentives to reduce government borrowing and would give a boost to inflation over the long term. Both outcomes appear as nightmares to the Germans, but in the end, I believe, they would go along. If it were necessary, they would bend their principles to save the euro.
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