No Exit

Greek Prime Minister Alexis Tsipras’ decision to call a referendum on the latest plan for handling Greek debt—to which his government is urging the public to vote “no”—brought to a shocking end a week that started with high hopes of a compromise agreement between Greece and the European Commission, the European Central Bank (ECB), and the International Monetary Fund (IMF). Many observers had long seen a referendum in the cards, but they expected Tsipras to call one in order to seek public approval for an agreement that he actually backed in order to outflank the far left within his own Syriza party. Instead, the man who argued for months that an agreement with Europe was the only possible path forward appears to be declaring “game over” with time left on the clock.

The odds of Greece leaving the eurozone have now substantially increased. Throughout the talks, Greece and its creditors have been desperately seeking ways around the political roadblocks in front of them. Syriza has promised that Greeks won’t have to choose between ending austerity and remaining in the eurozone. That, the politicians reassured voters, was Greece’s “democratic choice.” But the country’s principal creditors—other European governments—also face political pressures, and Syriza has done little to assuage concerns in Europe’s parliaments about throwing good money after bad and creating a moral hazard for future debtors. 

With those two positions fundamentally at odds, and neither side willing to budge, a clean break between Greece and the eurozone might seem like the best option for Syriza and for many eurozone finance ministries. But the possibility of a clean break is an illusion.

Geography is particularly important. Greece lies at the heart of southeastern Europe, Europe’s least stable neighborhood. There are already signs that Bulgaria and Serbia are vulnerable to contagion from the failure of Greek banks. Instability in the Balkans was part of the rationale for Greece joining the eurozone in the first place. Full integration into the European Union, it was believed, would stabilize Greece and, in turn, have positive geopolitical effects on the region. The converse remains true as well—failure in Greece will exacerbate growing tensions in southeastern Europe. Thus, the ties that bind Greece to Europe, and vice versa, are unlikely to break.

No one understands this better than German Chancellor Angela Merkel, who has been resolute in her commitment to keeping the eurozone intact and coming to an agreement with Tsipras. She remains acutely aware of Greece’s long flirtation with Russia and of Russian President Vladimir Putin’s continuing efforts to sow discord in the EU. As the dominant political figure in the EU’s preeminent country, Merkel (not ECB President Mario Draghi, IMF head Christine Lagarde, German Finance Minister Wolfgang Schäuble, or Eurogroup chief Jeroen Dijsselbloem) remains the most important decision-maker on the creditor side, and she will try to prevent a quick Grexit after what looks like an inevitable default by Greece on its 1.5 billion euro ($1.6 billion) payment due to the IMF this week.

Merkel’s task will not be easy. During a talk at Brookings Institution last week, Emmanuel Macron, France’s minister of the economy, described Europe as being in a religious war. On the one side, he said, are Calvinists, led by Germany, who want those who made bad economic decisions to suffer. On the other are Catholics, who want to go to church and start off with a blank slate. There is truth to Macron’s analogy. And the thing about religious wars is that they tend to last a long time. Europe’s economic conflict is no different.

TACTLESS TACTICS

Ultimately, hard negotiating lines on both sides will lead to a long and drawn-out economic conflict, sustained by religious-like certainty, in which European integration will be the biggest loser.

As we described in an earlier article for Foreign Affairs, the Syriza government started with a strong negotiating position but squandered it early on. It chose the wrong coalition partner; alienated its allies in Europe, which played into Germany’s hands; and made serious economic mistakes that weakened it at home. Add Tsipras’ referendum stunner, and it becomes hard to think of a recent democratically elected government that has blundered more. 

However, the eurozone has also pursued a risky strategy—one that can only be described as regime change. Eurozone financial leaders find Syriza impossible to deal with, and so they have (almost openly) hoped that a deteriorating economic situation in Greece, including the near collapse of the banks and the drying up of the money supply, would cause the Greek people to turn on their government. The result would be either full capitulation by the Greek government, new elections (which Syriza would lose), or a new coalition with the pro-European party Potami.

European leaders’ decision on Friday to put the weekend negotiations in the hands of finance ministers (rather than in the heads of government) may well have been the straw that broke Tsipras’ back, because he knew full well that significant new compromises were unlikely.

There is little doubt that some eurozone leaders and finance ministers will be secretly hoping for a “no” in next weekend’s referendum. They must expect that the eurozone can simply cut Greece loose with great cost to Greece but with little or no contagion to others. The rest of Europe can then move on without the distraction of the Greek drama. In fact, the euro should be stronger without its main delinquent, or so the argument goes. 

Based on recent interviews one of us conducted in Berlin recently, this argument has apparently come to dominate the German Finance Ministry. Schäuble probably holds it, too, as evidenced by reports that he believes policymakers should prepare for an orderly Greek exit from the euro. One German newspaper, Bild, even suggested he was on the verge of resigning over differences about how to handle Greece. Now, Tsipras’ decision to call a referendum will probably reinforce that line of thinking, making it even harder to grant Athens any new concessions.

Those in favor of regime change forget, though, that financial crises are notoriously unpredictable, especially in their political effects. A Greek collapse and large-scale default would result in unprecedented financial losses for the IMF and European governments, which could have a significant knock on effect. Moreover, those outcomes would poison the well between Greece and the rest of Europe, even though the two sides will have to cooperate with each other in the years ahead.

Moreover, if the world has learned one thing from financial crises over the past two decades, it is that governments must stop thinking in terms of moral right and wrongs. Sometimes, to save the system, they must help the irresponsible banks and financial institutions at the heart of the crisis. If they don’t, as happened in the 1930s, the crisis will deepen, contagion will spread rapidly, and democracy itself will come under serious strain.

END OF THE LINE?

Tsipras’ strategy of scheduling a referendum after the deadline for Greece to repay the IMF is similarly risky. In anticipation of a very turbulent week in Greek politics, the government has already declared a bank holiday and the onset of capital controls.

Should the “no” vote win, it is unlikely that Tsipras has any plan for the day after, not only because the deal upon which Greeks were voting would no longer exist but also because, even if it did, it is very unlikely that creditors would be willing to reopen discussions of its terms. And even if they were, within Greece, Syriza’s far left would be emboldened and Tsipras would have even less room to make any additional concessions. In this scenario, Greece would default on its ECB payment and would be forced to quickly issue some form of pseudo-currency to finance the banks and internal obligations.

A “yes” vote appears to be the more likely outcome of next weekend’s referendum, not least because recent public opinion polls have showed increasing support for staying in the eurozone. That doesn’t mean that Tsipras (or Greece) will be out of the woods, though. Should there be a “yes” vote, Syriza’s standing within Greece would be diminished, hurting its legitimacy in negotiations with creditors. It isn’t at all clear whether or how a new coalition government would form.

Should Tsipras resign following a “yes” vote, the path would open to some form of national unity government, either political or technocratic. This government would immediately restart negotiations with the creditors in the hope of closing a deal before Greece’s 3.5 billion euro ($3.92 billion) repayment to the ECB comes due on July 20, and it would probably succeed.

But if Tsipras chose not to resign, which looks equally likely, the path to a deal with creditors would be much more challenging. With Syriza on its heels, Tsipras could opt to walk back Syriza’s previous demands by pointing to the referendum mandate to reach an agreement with creditors. Should that scenario come to pass, Tsipras would restore his reputation for craftiness, call new elections, and likely remain the dominant political force in Greece.

Ultimately, hard negotiating lines on both sides will lead to a long and drawn-out economic conflict, sustained by religious-like certainty, in which European integration will be the biggest loser.

By far the most welcome outcome for the rest of the eurozone would be for Tsipras to form a new coalition with pro-European parties, such as Potami, but it is unclear that Syriza has the will, or the ability, to follow through on a deal with Europe by getting serious about structural reform.

AVOIDING “NO”

At the end of the day, it is in Europe’s best interest not to push Greece out the eurozone door. Should Greece vote “no,” Europe’s negotiators could double down on the regime change strategy in the hope that a deepening financial crisis will shift the Greek political dynamics. This strategy could very well succeed, especially given that any pseudo-currency would likely rapidly depreciate against the euro and erode the Syriza government’s credibility. But should Syriza not fall even then, Europe would be faced with the worst-case scenario of a weak and alienated Greece becoming a “free radical” in Europe’s least stable region. So, just as a “yes” vote would focus pressure on Tsipras, a “no” vote could become Merkel’s most serious challenge yet.

Ultimately, hard negotiating lines on both sides will lead to a long and drawn-out economic conflict, sustained by religious-like certainty, in which European integration will be the biggest loser. The only way out is what the IMF, the United States, and many Europeans have long known—debt relief for Greece in exchange for unprecedented and far-reaching structural reform. This appears unlikely, though, as long as the theocratic Tsipras and Schäuble remain in place.