Greece: The Morning After

"Greece faces the same problems and the same bad choices: staying within the Eurozone and agreeing to make additional sacrifices that produce even greater economic pain, or reverting to the drachma."

Greek voters, facing a choice between voting yea or nay in a referendum on whether to accept the additional spending cuts mandated by the European Union (EU) and International Monetary Fund (IMF) in exchange for a further infusions of funds, roundly rejected additional belt tightening. Whether they did so based on a reasoned, Keynesian-inspired economic basis that more budget slashing would not have produced the economic growth that alone can help Greece extricate itself from the economic quagmire it’s in, or out of we’re-not-going-to-be pushed-around-anymore national pride, remains unclear.

But, in the end, it doesn’t matter whether logic or passion produced the outcome: the vote hasn’t changed the fundamentals of Greece’s predicament.

If the Eurogroup and the European Central Bank (ECB) now decide to make an example out of defiant Greece (but for whose benefit and to what end?) by refusing to lift the cap on the ECB funds that have provided a lifeline to the country’s depleted banks, Prime Minister Alexis Tsipras will have no choice but to continue, and perhaps tighten, the restrictions imposed on the sums that Greek depositors can withdraw from their accounts.

Absent that draconian step and continued capital controls, Greeks will stampede to rescue what savings they have left, leaving the already cash-strapped Greek banking system in ruins. Salaries will then have to be paid by some alternative form of paper, in effect putting Greece on a path back to the drachma.

That, as economists such as Paul Krugman have pointed out, will at least give Athens control over its monetary policy, allowing it to devalue its currency in hopes that exports and domestic demand will perk up, stimulate the economy and produce growth and revenue. But even a quick look at Greece’s principal exports raises an obvious question: Given competing sources of supply for the products it sells, what if devaluation doesn’t do the trick?

If it doesn’t, Greece will be saddled with the same staggering debt (over $352.7 billion: 175 percent of its GDP) but without the hoped-for boost in growth. It can then either declare a debt moratorium or bargain with its creditors for a write down of what it owes—a “haircut.” But Greece will have even less leverage than it has had thus far. It faces an economic collapse and will be negotiating with an IMF, ECB and Eurogroup that, following the result of the referendum, won't be in a charitable mood.

Perhaps Athens’s creditors will be forced to reckon with the reality that, as the IMF has already conceded, Greece simply cannot repay its total debt, and that the prudent decision for lenders is it settle for less in repayment than, possibly, getting back nothing at all, or very little.

That scenario—a compromise between Greece and the EU—will become more likely if, in the coming days, a split emerges in the Eurogroup and some of members, led by France, call for keeping Greece in the Eurozone by continuing to provide it the funds it needs to stay solvent while easing up on the demands Athens has faced to make additional budget cuts.

This can happen only if the resistance of Germany and other like-minded countries that believe that providing additional assistance to Greece and relaxing austerity demands will only produce a moral hazard can be overcome. Persuading them to ease up won’t be easy because, rightly or wrongly, in most of northern Europe, the sentiment that Greece’s fellow Eurozone members are being asked to pay for its profligacy—reckless borrowing enabled by lenders’ confidence that the Eurozone offered debtors a solid safety net, excess spending on social programs, and rampant tax evasion—remains strong. And that perception reduces leaders’ room to cut Greece more slack.

For now, Greeks voters have called the Eurogroup’s bluff and left it with the choice between bad (cutting a new deal with Athens) and worse (expelling Greece from the Eurozone and forgetting about the money lent it).

The result of the Greek referendum will likely create divisions among the Eurozone’s big players. In the coming days, a dissonance between Germany and France could emerge on what to do about the Greek problem. How that discord plays out depends on whether the majority of Eurozone states conclude that forcing Greece out of the monetary union amounts to a risk worth taking.

Even if some sort of compromise emerges, Greece will still face shipwreck; the satisfaction of having thumbed its nose at the EU will prove short-lived.

Staying in the Eurozone, even with an easing of demands by the EU, will leave Greece with an unsustainable debt burden. While its creditors may ease their demands to enable a compromise, Tsipras will still have push more budget cuts through his parliament, ones that extend to third-rail items such as pensions.