The Greek government finds itself trapped between Scylla and Charybdis. The European Union and the International Monetary Fund are demanding drastic spending cuts and large tax rises in return for their emergency funding. But those austerity measures have brought tens of thousands of protesters on to the streets of Athens. And those protests have turned violent. The pressure from above and below is in danger of crushing George Papandreou's government to death. One attempt by Mr Papandreou to get his new budget through parliament has failed. With a revolt in his own Socialist party and a refusal from the opposition to co-operate, it is unclear whether a second will succeed.
The Greek state certainly needs to reduce its spending and to curb its borrowing. Successive governments overspent during the boom years. They also faked their national accounts in order to conceal the true level of public borrowing. There are also huge structural problems in the Greek economy (from excessively early retirement for state employees, to endemic tax evasion) that must be addressed.
But by demanding austerity on such a massive scale – and over such a short period of time – the IMF and EU leaders are playing with fire. The fiscal consolidation imposed over the past year has already pushed Greece back into a painful economic slump. Industrial production is down 11 per cent. Unemployment has risen to 16 per cent. It is this agony that has provoked the street-level opposition. And the EU/IMF wants to pile more austerity on top.
This is not only unreasonable; it is likely to prove self-defeating. Normally a relatively small economy in Greece's dire situation would see the value of its currency plummet. This depreciation would increase the cost of imports, but also give exporters a large boost. Thus the pain of the necessary economic correction would be muted. But since Greece is locked into the European single currency, this cushion is absent.
The more painful European policymakers contrive to make this necessary correction, the greater grows Greece's incentive to default on its sovereign debts and perhaps even to leave the single currency (which is the very last thing EU policymakers want). Default and a eurozone departure would certainly be painful for Greece. Athens would still have to cut spending and it would be shut out of international debt markets. Yet life in the single currency is looking still more painful at the moment. Mr Papandreou will stage a vote of confidence in his government on Sunday. But solutions to Greece's plight cannot only come from Greece. Europe needs to face up to some harsh realities too. Successive Greek governments were profligate. But so were the banks, from all around Europe, which lent to the Greek state on the idiotic assumption that its debt was as safe as that of Germany. Greece is heading for a level of debt – 160 per cent of its total annual output – that it cannot reasonably be expected to repay, and certainly not while its national growth prospects are so weak. Yet instead of working with European private banks to ease Greece's debt burden, the European Central Bank and the IMF are demanding that Athens repays in full, no matter the short-term impact on the Greek economy.
European leaders were far too slow to recognise the need for a Greek rescue last year. And now they are failing to recognise that the original rescue package is not working. They have set their face against a managed Greek default, but that means they are heading for a chaotic one. And that could easily lead to contagion across wider European debt markets. Ireland, Portugal and Spain are all in a similar boat to Greece. European leaders need to get up to speed with this crisis. Otherwise the single currency itself could come under unbearable pressure.