Greece and Europe: This way to the exit?

Prime Minister Alexis Tsipras has proven again that he is a master of Greek domestic politics, winning a lopsided victory in Greece’s referendum on the negotiations with its creditors. Now he must show that he is good at European politics, where he and his government have a record that is mixed at best and arguably poor. He needs the European Central Bank to provide more money to keep his banks open beyond about Tuesday, even with the strict withdrawal limits currently in place. He needs the key national governments in Europe, especially Germany and France, to agree to substantially sweeten Europe’s last offer to Greece. To gain such a deal, he will need the support of the European Commission and probably also the International Monetary Fund. And he needs at least the outline of an accord to be accepted within days so that his banks can re-open and the economy start up again.

The odds of an agreement have fallen sharply since Tsipras called the referendum and are now 50/50 at best, with a failure likely to lead eventually to Greece’s exit from the Euro. The biggest factor is that the prime minister cannot now accept a deal close to what was on offer. He needs to show a big improvement to the Greeks, since he campaigned strongly for a “no” to the last offer and the public supported him clearly. There is a good chance that this makes the gap between the two sides too wide to bridge. Thus, he has raised both the chance of a significantly improved deal for Greece as well as the potential for a total failure of negotiations.

Second, the procedural hurdles are higher since the existing program expired at the end of June. In some cases, national parliaments, including Germany’s, will need to vote to start negotiations for a new deal, as well as voting again to approve the ultimate outcome. In the meantime, it is harder for the ECB to agree to supply more euros for the Greek banks in the absence of a formal program or the high probability of a new one being agreed to shortly. It is also harder to bring the IMF into a new deal, since the Greeks recently defaulted on payments to the IMF. The procedural issues are not determinative, as Europe is clever at finding solutions to these problems, but they do make it trickier and more time-consuming and the parties really do not have much time if this is to work.

Third, Tsipras has raised the political stakes very high for the other governments of Europe. It will be difficult now to reach a deal that does not look like a surrender to Greece by the rest of Europe, which would invigorate other radical parties with approaches similar to Tsipras’ Syriza party — especially Podemos in Spain. As a matter of pure politics, it would be preferable for many European governments to have Greece fall out of the Euro and endure the massive pain of that transition than to have voters in Spain, Portugal, Italy, and possibly even France, conclude that the best approach is to just say “no” to the economic policies required by European authorities and potentially even to refuse to pay back all of their national debts.

Fourth, the already weakened bonds of trust between Greece and the rest of Europe have been damaged even further by both the unexpected calling of the referendum and the rhetoric employed in the campaign. Members of the Greek government referred to the creditors as “terrorists” and as engaged in a “soft coup d’etat” to overthrow the Syriza government, among other things. It also does not please the French Socialist government to have Syriza ministers refer to the Greeks as the only “leftist” government in power in Europe. For their part, some in governments and institutions in the rest of Europe clearly implied that the Syriza government would have to fall for there to be any hope of a deal and the rhetoric of non-government commentators was harsher still.

So, as of early Monday morning, European time, the process looks very tricky going forward. I have always said that there was an appreciable risk of Greece leaving the Euro, but have felt until recently that it was no more than a one in five chance and certainly not the base case. The last few weeks have raised the probability substantially and it is at least as likely as not that Greece exits. Many in the financial markets now believe it to be a two-in-three chance or higher. As I have written multiple times, this would be a shame, since an exit would do major short-term harm to Greece and inflict moderate pain on the rest of Europe and some damage outside that continent. There is a chance that it would be for the best in the long run, but my own belief is that everyone would be worse off in the end.