Greece vs Europe: who will blink first?

5/1/2015

By Ambrose Evans-Pritchard

The eurozone stands on the brink of another crisis as Athens confronts Brussels and Berlin

There is a whiff of 1914 to the latest Balkan showdown. Everybody thinks everybody else is bluffing, all of them betting that a calamitous chain reaction will be averted.

In Germany, Der Spiegel reports that Angela Merkel thinks Greece can be ejected safely from the euro, if the rebel Syriza party wins the elections on January 25 and carries out its pledge to tear up Greece’s hated “memorandum” with the EU-IMF “Troika”. The German Chancellor’s team are blanketing the airwaves in what looks like a campaign to drive the threat home.

“We are past the days when we still have to rescue Greece,” said Michael Fuchs, the parliamentary leader of Mrs Merkel’s Christian Democrats. “The situation has completely changed. It is entirely different from three years ago when we didn’t have the backstop defences in place. Greece is no longer 'systemically relevant’ for the euro.” He added wickedly that the single currency might actually be stronger without the Balkan troublemaker.

It was revealed last week that Germany offered Greece a “friendly” return to the drachma in 2011. Months later, Mrs Merkel was prepared to eject Greece from EMU altogether. Tim Geithner, the former US Treasury Secretary, said the Europeans seemed determined to teach Greece a lesson: “They lied to us, and we’re going to crush them,” was the gist of it. Mrs Merkel retreated only after it became clear that Spain and Italy would be engulfed by contagion if Greece was thrown out.

This time, Berlin seems almost eager to finish the job. Yet Syriza’s ice-cool leader, Alexis Tsipras, is equally convinced that the EU elites will back down, knowing that they have invested too much political capital in Greece’s salvation to walk away. After all, the sums involved now are tiny compared to the €245 billion in loans already dispersed since the crisis erupted in May 2010. Surely, after having claimed so confidently that the crisis was essentially over, Mrs Merkel can hardly admit that her strategy has failed?

Syriza itself is a neo-Marxist mélange, an ideological work in progress. Mr Tsipras no longer has a picture of Che Guevara in his office and has quickly mastered the Brussels vernacular – so much so that EU leaders and City economists presume, rightly or wrongly, that his rhetoric is just for domestic consumption. Yet the ultra-Left Aristeri Platforma still holds the biggest bloc of votes on Syriza’s central committee, and has stated that the movement must “be ready to implement its progressive programme outside the eurozone” if the EU refuses to yield.

Mr Tsipras clearly wants Greece to remain in the euro. But he continues to insist on terms that negate that. He says: “We will cancel austerity. Under a Syriza government Greece will exit the bailout. This is not negotiable.” Twisting his knife into the German psyche, he wants the same level of debt relief – 50 per cent – that Germany secured in 1953, which Greece signed up to despite the death of some 300,000 of its citizens under Nazi occupation.

As a result of this crisis, the head of the European Central Bank (ECB), Mario Draghi, is caught in a horrible bind. He is itching to kick off a trillion-euro blast of quantitative easing on January 22 to head off the deflationary forces that threaten to lock the eurozone into a Japanese-style trap. To make any difference, this must entail the purchase of sovereign debt. Yet Mr Draghi can hardly agree to buy Greek bonds three days before the likely election of a party that has vowed to repudiate that same debt. Nor can he exclude Greece’s bonds from the purchases, for to do so would be to pre-empt democracy.

The German Bundesbank, and a core of ECB hardliners, are seizing on the unfolding drama in Athens to demand a further delay to QE – a policy that they view as fiscal union by the back door. But meanwhile, the eurozone is tipping into outright deflation, with the oil price crash almost certainly having pushed inflation below zero in December.

In normal times, cheap energy would a “positive supply shock” akin to a tax cut. But these are not normal times, says Peter Praet, the ECB’s chief economist. He warns of a “very high risk” that a deflationary psychology will take hold, causing firms and households to delay spending.

The lesson of the Thirties is that this ugly dynamic feeds on itself. Deflation makes it ever harder for borrowers to overcome their debts, pushing them further into the compound interest trap. For example, for southern Europe’s crisis states, the debt burden has risen, while nominal GDP remains flat, or has even shrunk. The more they slash spending to balance the books, the more the economy contracts. Italy’s debt ratio has spiked from 116 per cent of GDP to 133 per cent, despite austerity and meeting EU deficit rules. The Bank of Italy warns that any further drift towards deflation could have “extremely grave consequences”.

The “Latin Bloc” has enough votes within the ECB to force through QE against German resistance. But to do so would be risky at a time when Germany’s anti-euro Alternativ fur Deutschland party is nipping at Mrs Merkel’s heels. The sacred contract of monetary union is that Germany should never be outvoted on critical issues. To breach that would jeopardise German consent for the whole euro project.

The crisis may come to a head in March when Greece is due to run out of cash. The ultimate showdown could come in July and August, when Greece must repay €6.7 billion to the ECB. Mr Tsipras’s advisers say he is already braced for a fateful call from Frankfurt threatening to cut off support for Greece’s banking system unless he backs down. Such a move would force Greece out of the euro within days – but Mr Tsipras has told his inner circle that he intends to call the ECB’s bluff, insisting that the verdict of the voters cannot be overturned by “threats of Armageddon”.

Nobody disputes that Greece abused its euro membership. What is in dispute is to what degree the northern creditor states were equally complicit in flooding southern Europe with capital before the crisis – and whether austerity overkill has been an unforgivable mistake. The “snowball” effects of the cuts saw a fall in Greek GDP of 25.7 per cent and a youth unemployment rate that peaked at 62 per cent. Austerity failed even to achieve its key goal of reducing debt, which has spiralled to 177 per cent of GDP.

The leaked minutes of an IMF board meeting in May 2010 admitted that what took place was not a “rescue”: Greece should have been given debt relief, but was instead sacrificed to save the euro – and the banks. It is the failure of Brussels and Berlin to acknowledge this that makes Greeks so bitter, and this crisis so politically explosive.

Berlin still insists that Portugal, Spain and Italy are strong enough to withstand the shock of “Grexit” from the euro, and that the new banking union and new rescue tools stand ready to halt any contagion. But Peter Bofinger, one of Germany’s five “wise men” economists, says this “would let a genie out of the bottle that would be hard to control”.

Even as the US is booming, the eurozone is close to a triple dip recession. Output is still below its pre-Lehman peak. Italy’s industrial production is back to levels reached in 1980. Europe’s purported “reforms” have not raised its future growth rate, and therefore its ability to repay debt. Any gains have been overwhelmed by the malign effects of mass unemployment.

Markets have been calm about this only because the ECB saved the day in July 2012, pledging – finally – to act as a lender of last resort to Italy and Spain. But Germany’s top court has ruled that this “manifestly violates” EU treaties, so it cannot be done again. Nor does the “banking union” create a proper, pan-EU defence: each state is still responsible for bailing out its own lenders.

The worry is that a Greek exit from the euro would rip away the façade that covers all of these problems, exposing the reality that EMU is less economically viable than ever, more indebted than ever, and scarcely a step closer to a genuine fiscal and economic union.

Mr Tsipras has his fingers on the pin of a pan-European grenade.

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