Greek Drama Reaches Climax

SMITH BRAIN TRUST — Greece appears to be entering the end game of its long-running financial drama. As the Mediterranean nation missed a $1.7 billion payment to the International Monetary Fund, and Greeks rushed to withdraw money from their banks, the European Central Bank signaled that it would not increase emergency liquidity to a level that would permit banks to meet withdrawals. Greece has now closed those banks for six days — Greeks can withdraw $66 in cash daily — and the government of Prime Minister Alexis Tsipras has called for a July 5 referendum on whether Greece should accept the terms imposed by its creditors, which include limits on state spending and on tax increases.

Since he was elected specifically to oppose that kind of "austerity," a "yes" vote to accede to creditor demands could lead Tsipras to resign. A "no" vote, on the other hand — which Tsipras has urged — could precipitate Greece's exit from the Eurozone, with unpredictable effects. On Tuesday, Tsipras signaled a new willingness to move toward the creditors' position, but the creditors say the concessions are too little, too late and that no further discussions will be held until after the referendum.

William Longbrake, executive-in-residence at the Robert H. Smith School of Business, at the University of Maryland, and a member of its finance department, summarizes the standoff tersely: "For political reasons Germany cannot give debt relief. To prevent a total collapse of its economy the Greeks need debt relief."

The austerity plans imposed by creditors are not working, and indeed have plunged Greece into a deep depression: Greek unemployment stands at 25 percent and the economy has shrunk by over 25 percent since 2010. Yet Angela Merkel, the German Chancellor, and others have staked their credibility on making the Greeks pay their debts. The German public views the Greeks as spendthrifts who need to be disciplined.

"There are times when, even though there might be a logical solution from an economic and financial point of view, you can't get there because of political constraints," Longbrake says. 

No outcome to the crisis is likely to be good. If Greece should give up the Euro, Longbrake says some kind of parallel currency would have to be issued, "call it drachma or whatever you like," to pay bills. "It would decline in value, there would be financial and economic chaos for a period of time, and the economy would get even worse for a while. But most economists argue that after six months or so things would get a lot better because the Greek government would now be in charge of its own economy, rather than having the terms be dictated by outsiders."

The medium-term effects would include these: First, the weight of debt would be lifted, since Greece would be walking away from it. Greece could devalue its currency, stimulating the demand for Greek goods abroad. On the other hand, Greeks who owe debts in euros would take a beating.

But that path also contains much uncertainty, and no one can rule out the possibility of a worst-case scenario, near-total economic implosion. Fear of such a dire outcome may lead voters to vote to accept the creditors' terms, despite the wishes of Tsipras.

Some news articles are focusing on the plight of tourists — some stores and hotels are demanding cash — but that's not a topic of interest only to self-interested vacationers. About 18 percent of Greece's economy, and a quarter of its workers, are tourism-related. Greece is trying to alleviate these concerns by permitting foreigners to make unlimited cash withdrawals from ATMs.

Globally, the question is whether Greece bears any resemblance to the Lehman Brothers bankruptcy of 2008: Is it an integral part of the financial world, whose effective bankruptcy would bring down other institutions in domino fashion? This seems unlikely.  "The spillover effects in the short run are expected to be pretty negligible," Longbrake says. Greece's debt is held by institutions like the IMF — not private creditors — and so losses could absorbed without too much pain by member states.

Over the long term, the consequences of the so-called Grexit are likely to be more political than economic, Longbrake thinks: "The political situation throughout the European Union and particularly in the so-called peripheral countries has been fragmenting over a number of years. The strong center-right and center-left parties that are in support of the European project or the European Union are being hollowed out, and the fringe parties on both the left and the right have been gaining in stature." A Greek exit, he says, "would increase the centrifugal forces that are slowly tearing the European Union apart."

"If one member of the Union is forced out," Longbrake says, "it really undercuts the rationale for the Union and increases the likelihood that other members, such as Spain and Portugal, will find it in their best interests to depart."

Related: "The Sooner Greece Defaults and Dumps the Euro the Better," by the Smith School professor Peter Morici.

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