Greece's economic tragedy is approaching its final act.
The joint eurozone/ International Monetary Fund loan package activated by Athens last week is clearly too little too late as far as investors are concerned. Yields on two-year Greek bonds have soared to 18 per cent. That is unsustainable. Athens simply cannot live with rates of borrowing that high. Greece now faces a public debt spiral which, unchecked, will end in default.
Three policy options now present themselves. First, the eurozone nations could give Athens a blank cheque in order to convince investors that they will never lose money on Greek debt (and to make it clear to speculators that they will lose money if they continue betting against the will of European politicians). Second, Greece could attempt to restructure its debt (an effective default), forcing investors to take a "haircut" on their original investment. Finally, Greece could leave the single currency, in the hope that this will deliver the economic boost that it needs.
All three are profoundly unappealing. An open chequebook could create a political crisis in the eurozone. German voters and politicians are already deeply averse to transferring any public funds to support Greece. The prospect of writing unlimited guarantees to what many of them see as their profligate southern neighbours could well prove too much.
A haircut for investors in Greek bonds might sound attractive, but it would mean losses for French and German financial institutions, which are thought to hold up to 70 per cent of Greece's €300bn debt. Writedowns on this scale could trigger another banking crisis on the continent. The same malign consequences would result if Greece left the eurozone, leaving banks across Europe nursing serious losses.
Such a dramatic move could also easily cause investor panic to spread to the markets for other eurozone bonds, particularly those with weaker public finances and economies such as Portugal, Spain, Ireland and Italy. There are already signs of this happening, with the interest rate on the borrowings of these countries spiking in recent days. Yesterday's downgrade of Spain's credit rating by Standard & Poor's will certainly not help calm these waters.
The benefits of leaving the euro are not even clear cut for Greece itself. The inevitable low exchange rate for the new currency relative to the euro would make Greece's exports more competitive. But there would also be a disastrous run on the Greek banking system.
Greece's meltdown could yet create another nasty twist in the global economic crisis which began two years ago. And we in Britain should not imagine that we would be immune from the consequences. Europe is our largest trading partner. Without robust economic growth on the Continent, our own growth is likely to be far below what we need it to be to get our own public finances in order.
Britain could suffer from a new flight to safety in the bond markets, too. Comparisons between our own economic situation and that of Greece are exaggerated. Our stock of public debt is lower and we issue our own currency. But the bond market is perfectly capable of panicking over our large deficit as well. Such issues should to be at the very heart of tonight's debate on the economy between the three main party leaders.
As for Greece, whatever the course European leaders decide upon, it needs to be done quickly and decisively. It should be obvious that the wait-and-see approach has only succeeded in making this crisis far worse, to the extent that the very viability of the eurozone is now in doubt. European policymakers have been playing catch-up from the start on the Greek crisis. Now, more than ever, they need to get ahead of the game.Reuse content