Europe's Collision Course With Greece

17 APR 22, 2015 2:00 AM EDT

By Clive Crook

Bloomberg

The brinkmanship over Greece and its debts continues. A meeting of finance ministers in Riga on Friday is likely to pass, like many previous make-or-break moments, without resolution. The European Union isn't deviating, and neither is Athens. Before much longer, though, something really will have to give -- and it seems ever more probable that, when it does, the news will be bad.

Confidence has firmed across Europe that a Greek default won't much harm any other country -- indeed, that the rest of the EU might actually be stronger if the Greeks are taught a lesson. This theory is wrong. If it's pressed into action, Europe will come to repent its biggest miscalculation since the creation of the euro.

EU governments are hardening their insistence on an overt Greek surrender. The terms of the existing bailout program, they say, must be honored in full before talks on a new one can start -- and meanwhile, there'll be no more money. In plain terms, the Syriza government led by Prime Minister Alexis Tsipras must not only break its promise to voters but be seen by all to have broken it.

Tsipras, to be sure, commands little sympathy. He has served his country poorly. His government's initial take-it-or-leave-it posture looked calculated to offend. Having started badly, how to make matters worse? Press for war reparations from Germany --  an altogether strange way for a distressed borrower seeking new debt relief to approach its creditors. Athens thought it was negotiating from a position of strength -- that Europe wouldn't dare call its bluff. This now looks like a losing bet.

So, yes, Syriza got every last detail of this negotiation wrong. The only thing it got right was the main point: The Greek economy, crushed by Europe's economic crisis, cannot recover without relief from the self-defeating fiscal austerity imposed by the European Commission, the European Central Bank and the International Monetary Fund. The tactical incompetence of Tsipras and his ministers is a pitifully lame excuse for the failure of those institutions to achieve this outcome -- a remedy, by the way, that's in the interests of the wider EU.

Unless Athens is granted some of the 7.2 billion euros still pending in the existing bailout program, it can't make payments falling due in May and June. The IMF has said that it won't tolerate a delay. Default is staring Greece in the face. Exit from the euro system would likely follow default -- if not explicitly, then tacitly, through the creation of a parallel currency that would enable the government to meet its domestic obligations.

If all this comes to pass, Europe will have shown it meant business. That's fine. Aside from scoring this gallant victory over mighty Greece, what will it have achieved?

If Greece defaults, the IMF and the ECB will lose more than if they agreed right now to forgive much of the debt. That's to say nothing of the risk of contagion, and a widening crisis of confidence. Governments and the ECB seem to believe that this danger is contained. The U.S. Treasury and the Federal Reserve thought the same about Lehman Brothers.

Grexit would compound the risk. The prevailing view that Greece can be pushed out of the euro system with little collateral damage, together with the moves the ECB has made to partition the underlying system of national central banks, have already weakened the system's credibility. The euro looks less like a single currency and more like a fixed-exchange-rate system. In the end, fixed-exchange-rate systems collapse. Grexit, if it happens, will emphasize the point.

Europe's economy shows signs of dragging itself off the floor, thanks to a devalued euro and lower energy costs. But Europe has addressed few of the structural and institutional failings that made its recession so deep and persistent. The EU's economy is still fragile. The last thing it needs is a shock like Grexit.

Suppose, though, that the recovery strengthens and Europe does take Grexit in stride. Europe's policymakers should look ahead to the next crash. Post-Grexit, markets will know that countries with unsustainable debts can be ejectedfrom the system. This raises the risk of capital flight and makes self-fulfilling panics more likely.

Tsipras has climbed a long way down from his initial demands. A new bailout program could well strike a workable compromise between, on one side, Greece's need for debt relief and fiscal moderation, and, on the other, a commitment to monitored and sustainable long-term public finances. Yet to get to that new program, you have to lift the threat of immediate financial breakdown.

Europe and the IMF have chosen not to lift that threat unless Tsipras surrenders unconditionally. It is Europe, not Tsipras, that has set its face against compromise -- by enshrining the current bailout program, which its own authors acknowledge to be a failure, as a sacred object. Instead of helping Greece to its feet, Europe is telling Greece to kneel. Instead of helping Tsipras to climb down, the EU demands he abase himself. Instead of expressing solidarity with the Greek people, who have suffered inordinately, Europe says: "Election? What election?"

Tsipras has done a terrible job. Compared with the rest of Europe's leaders, he looks like a statesman.  

To contact the author on this story:

Clive Crook at ccrook5@bloomberg.net

To contact the editor on this story:

James Gibney at jgibney5@bloomberg.net