Markets are panicking. It’s important to understand that this is not a verdict on the new Greek government, or at any rate only the new Greek government; it’s a judgment that the risk of no agreement, and a disorderly breakdown of the whole process, is high.
I think it’s important to be as clear as we can about the stakes and the real interests here, lest players stumble into a disaster they could and should have avoided. So, some points about where things stand:
1. We are not talking about whether Greece will pay its debt. As I tried to explain the other day, the headline Greek debt number is more or less meaningless. The question is how much Greece will transfer to its creditors by running primary surpluses — and yes, at this point that’s the question, there’s no possibility that the creditors will transfer more resources to Greece.
2. If Greece were to adhere totally to the previous terms, over the next five years it would make resource transfers of about 20 percent of one year’s GDP. From the point of view of the creditors, that’s a trivial sum. From the point of the Greeks, however, it’s crucial; the difference between a primary surplus of 4.5 percent of GDP and, say, 1.5 percent of GDP for the Greek economy and the welfare of its citizens is huge. The only reason for the creditors to play hardball would be to make Greece an example, to discourage other debtors from trying to negotiate relief.
3. If the creditors do play hardball, their leverage does not come from the ability to refuse new loans to the Greek government. With Greece running a primary surplus, all new loans — and then some — are going to pay principal and interest on old loans, with less than nothing going to the Greeks. There was modest de facto aid to Greece in 2010-2012, but no aid is currently flowing, nor will it.
4. Instead, the power of the creditors over Greece comes via the ability to crash the Greek banking system, which is heavily dependent on the ability to borrow at need from the ECB. Cut off that support, and Greece suffers banking collapse. So yes, the creditors have a large club they can use on a recalcitrant Greece. But do they really want to do that? Within a European Union supposedly dedicated to democratic ideals? Actually, you have to wonder whether the ECB, which surely understands the stakes, would even be willing to go along. If the situation continues to look like unraveling, I would expect Draghi to say something to reassure the markets that a Greek bank cutoff is not on the table.
5. Ideals aside, the consequences of playing hardball with Greece over its banks could very easily be immense. Up until now, the euro has proved very durable, largely thanks to the point Barry Eichengreen emphasized: any country that even hinted at the possibility of leaving would face the mother of all bank runs. But as I worried some time ago, this argument becomes moot if the banking system has already collapsed. Grexit — the often speculated about, never so far materializing Greek exit from the euro — becomes a very real possibility if European creditors try to exert leverage by taking away the safety net for Greek banks.
6. And if Greece really does leave the euro — if it turns out that the single currency is not irreversible — do you really think there would be no contagion? Wanna bet on it?
7. In particular, think about what happens if Greece leaves the euro and then manages to find its footing — which it probably would after a chaotic year or two. The EU could prevent that by deliberately undermining the post-euro Greek economy. But that would be a betrayal of European principles.
8. At the moment, Germany is talking as if it intends to follow the Michael Corleone strategy. But do we really think that Syriza will or even can retreat with its tail between its legs immediately after winning a dramatic election victory? Again, wanna bet on it?
Daniel Davies tells us that “European policy makers aren’t stupid.” But they do say stupid things, still talking about expansionary austerity, still treating debt as a purely moral issue. Can and will they be realistic, accept that they can’t extract blood from a stone — at any rate not at the rate of 4.5 percent of GDP — in time to avert a spiral into disaster?