LONDON – Once again, Greece seems to have slipped the financial noose. By drawing on its holdings in an International Monetary Fund reserve account, it was able to repay €750 million ($851 million) – ironically to the IMF itself – just as the payment was falling due.
This brinkmanship is no accident. Since coming to power in January, the Greek government, led by Prime Minister Alexis Tsipras’s Syriza party, has believed that the threat of default – and thus of a financial crisis that might break up the euro – provides negotiating leverage to offset Greece’s lack of economic and political power. Months later, Tsipras and his finance minister, Yanis Varoufakis, an academic expert in game theory, still seem committed to this view, despite the lack of any evidence to support it.
But their calculation is based on a false premise. Tsipras and Varoufakis assume that a default would force Europe to choose between just two alternatives: expel Greece from the eurozone or offer it unconditional debt relief. But the European authorities have a third option in the event of a Greek default. Instead of forcing a “Grexit,” the EU could trap Greece inside the eurozone and starve it of money, then simply sit back and watch the Tsipras government’s domestic political support collapse.
Such a siege strategy – waiting for Greece to run out of the money it needs to maintain the normal functions of government – now looks like the EU’s most promising technique to break Greek resistance. It is likely to work because the Greek government finds it increasingly difficult to scrape together enough money to pay wages and pensions at the end of each month.
To do so, Varoufakis has been resorting to increasingly desperate measures, such as seizing the cash in municipal and hospital bank accounts. The implication is that tax collections have been so badly hit by the economic chaos since January’s election that government revenues are no longer sufficient to cover day-to-day costs. If this is true – nobody can say for sure because of the unreliability of Greek financial statistics (another of the EU authorities’ complaints) – the Greek government’s negotiating strategy is doomed.
The Tsipras-Varoufakis strategy assumed that Greece could credibly threaten to default, because the government, if forced to follow through, would still have more than enough money to pay for wages, pensions, and public services. That was a reasonable assumption back in January. The government had budgeted for a large primary surplus (which excludes interest payments), which was projected at 4% of GDP.
If Greece had defaulted in January, this primary surplus could (in theory) have been redirected from interest payments to finance the higher wages, pensions, and public spending that Syriza had promised in its election campaign. Given this possibility, Varoufakis may have believed that he was making other EU finance ministers a generous offer by proposing to cut the primary surplus from 4% to 1% of GDP, rather than all the way to zero. If the EU refused, his implied threat was simply to stop paying interest and make the entire primary surplus available for extra public spending.
But what if the primary surplus – the Greek government’s trump card in its confrontational negotiating strategy – has now disappeared? In that case, the threat of default is no longer credible. With the primary surplus gone, a default would no longer permit Tsipras to fulfill Syriza’s campaign promises; on the contrary, it would imply even bigger cutbacks in wages, pensions, and public spending than the “troika” – the European Commission, the European Central Bank, and the IMF – is now demanding.
For the EU authorities, by contrast, a Greek default would now be much less problematic than previously assumed. They no longer need to deter a default by threatening Greece with expulsion from the euro. Instead, the EU can now rely on the Greek government itself to punish its people by failing to pay wages and pensions and honor bank guarantees.
Tsipras and Varoufakis should have seen this coming, because the same thing happened two years ago, when Cyprus, in the throes of a banking crisis, attempted to defy the EU. The Cyprus experience suggests that, with the credibility of the government’s default threat in tatters, the EU is likely to force Greece to stay in the euro and put it through an American-style municipal bankruptcy, like that of Detroit.
The legal and political mechanisms for treating Greece like a municipal bankruptcy are clear.
The European treaties state unequivocally that euro membership is irreversible unless a country decides to exit not just from the single currency but from the entire EU. That is also the political message that EU governments want to instill in their own citizens and financial investors.
If Greece defaults, the EU will be legally justified and politically motivated to insist that the euro remains its only legal tender. Even if the Greek government decides to pay wages and pensions by printing its own IOUs or “new drachmas,” the European Court of Justice will rule that all domestic debts and bank deposits must be repaid in euros. That, in turn, will force a default against Greek citizens, as well as foreign creditors, because the government will be unable to honor the euro value of insured deposits in Greek banks.
So a Greek default within the euro, far from allowing Syriza to honor its election promises, would inflict even greater austerity on Greek voters than they endured under the troika program. At that point, the government’s collapse would become inevitable. Instead of Greece exiting the eurozone, Syriza would exit the Greek government. As soon as Tsipras realizes that the rules of the game between Greece and Europe have changed, his capitulation will be just a matter of time.
The writer is Chief Economist and Co-Chairman of Gavekal Dragonomics and Chairman of the Institute for New Economic Thinking.
© Project Syndicate