Imagine that other European governments tried to sabotage Britain’s upcoming referendum: cut off negotiations, withdrew their earlier offers, declared that they couldn’t trust David Cameron’s government and encouraged Britons to form a different one. The response, rightly, would be outrage. Yet that is not a million miles away from what eurozone governments have just done to Greece. Put aside your distaste for Syriza’s leftist politics for a second: surely Greeks have a democratic right to a say over their future?
It has been a momentous weekend in the seemingly never-ending Greek drama. Presented with a final offer from its creditors – who refused to offer Greece the debt relief that its depressed economy desperately needs to recover (as I explained recently in CapX) – prime minister Alexis Tsipras called a referendum for next Sunday, 5 July, on whether the Greek government should accept the offer. He urged Greeks to vote No, but said he would sign the deal if they voted Yes.
As recently as 11 May, Germany’s finance minister, Wolfgang Schäuble, had suggested that a Greek referendum on the creditors’ offer would be acceptable, even desirable. But instead of welcoming the Greek move, eurozone finance ministers cut off negotiations with Greece. They also refused to extend the EU loan agreement, which expires tomorrow, for a short period beyond the referendum date. So, assuming the referendum does go ahead on Sunday, Greeks will be voting on whether to accept a creditor offer that has been withdrawn, to unlock funds from a loan agreement that has expired. So much for democracy.
Greeks have been gradually withdrawing cash from their bank accounts in recent months. That has left Greek banks reliant on a steadily increasing supply of emergency liquidity from the European Central Bank. But with that ‘bank jog’ accelerating to a run over the weekend, the ECB yesterday refused to extend additional liquidity to cash-starved Greek banks. That has forced the Greek government to limit cash withdrawals to 60 euros (£42) a day and to impose capital controls to prevent euros draining out of the economy – although it remains to be seen how effective they will prove.
What happens next is unpredictable. Nothing is set in stone: what officials say is not necessarily what they will do. Negotiations may restart. Decisions may be reversed. Compromises may be found. In this game of brinkmanship, both sides have one foot off the edge, but nobody has yet fallen off.
As it stands, the EU loan agreement will expire tomorrow and Greece will fail to make the 1.5 billion payment due to the International Monetary Fund. Being in arrears to the IMF is regrettable, but not the end of the world.
Assuming the referendum goes ahead as planned on Sunday, there is a good chance Greeks will vote Yes to the creditors’ lapsed offer. Exaggerated fears of the consequences of default and Grexit combined with an emotional association between euro membership and being part of modern Europe make many Greeks willing to endure extraordinary suffering to stay in the euro. Even though the economy has shrunk by 21% over the past five years of EU-IMF programmes, and 26% of Greeks are unemployed, a majority of Greeks still want to stay in the euro.
A resounding Yes vote could lead to fresh elections. These would need to be held within a month, although the opposition is in such disarray that Syriza could win again. More likely, Tsipras would try to cobble together a new coalition encompassing To Potami, a new centrist party, and Pasok, the much-diminished social democratic party, that would support signing up to the creditors’ demands. But the president of the Eurogroup of eurozone finance ministers, Jeroen Dijsselbloem, has indicated that he couldn’t trust Tsipras to implement any deal, so this might not resolve the deadlock.
The creditors clearly want the elected government replaced with a more pliable one – perhaps a coalition headed by a technocrat, like the one formed in November 2011 when they unseated the then-prime minister for similarly having the temerity to offer Greeks a referendum on the EU-IMF loan agreement. But a Yes vote might also bring the creditors back to the table and a new EU loan programme from the European Stability Mechanism (ESM), the permanent bailout fund, might be drawn up.
The consequences of a No vote are also unpredictable. The Greek hope is that this would strengthen their negotiating position, spurring the creditors to make further concessions. But the creditors have shown no signs of backing down so far.
Yes or No, without additional funds, Greece would be forced to default on the 3.5 billion euros it owes the ECB on 20 July. The ECB might then pull the plug on Greek banks. Greece would then be stuck in limbo, still in the euro but with capital controls, no doubt forced to issue a parallel currency to make domestic payments and prevent a depression. That parallel currency could eventually become a new drachma.
Whatever happens, Grexit is far from a certainty. Officially, neither side wants Greece to leave the euro – and if Grexit does occur, they want to be sure that the other side is blamed for it. There is no legal provision for euro exit, so Greece cannot be forced out for failing to respect eurozone rules, contrary to what is often asserted. With capital controls and a parallel currency, Greece can struggle on in limbo almost indefinitely. Sooner or later, though, this would probably lead to Grexit.
Ideally, the creditors would offer Greece substantial debt relief so that it could remain within the euro without requiring additional funding from them, with all the strings that come with it. But faced with a choice between debt bondage and Grexit, Greece should take the plunge, default and leave the euro.
In the immediate term, Grexit would be painful. But since Greece already has capital controls and limits on bank withdrawals, the additional pain of leaving is smaller than it was. Freed of debt, with a cheaper currency and with much greater policy freedom, the economy would doubtless soon recover. Greece could thus regain its freedom, constrained by market discipline rather than political Diktat from Berlin and Brussels. The Syriza government would be responsible for whether or not they reformed the economy, and Greeks could hold them accountable at the next election. It’s called democracy.