The European Union, European Central Bank and the International Monetary Fund are negotiating hard among themselves about how to structure debt relief for the Greek economy. The latest reports suggest they might have come up with a temporary deal among themselves. But what the EU, ECB and IMF want won't matter unless they get the Greek government to play as well. And that's by no means assured.
For one thing, Greeks are growing fed up with austerity and seem very unwilling to take on the still stricter conditions being demanded of them to win fresh funding and avoid default. The Greek economy has taken a beating during the past couple of years. Non-stop, large-scale political protests, routine general strikes and parliamentary rebellion have brought Athenian streets to a standstill. And Prime Minister George Papandreou's government is teetering.
Greeks are starting to question whether there might not be an easier way out of their crisis. And inevitably, Argentina's experience a decade ago has been attracting plenty of interest.
In the three years leading up to its crisis the Argentine economy struggled, contracting a total of 8.4% by the end of 2001. Strains became so great that the country defaulted on its sovereign debt, causing its economy to slump another 11% in 2002. But the unshackling of its currency from the dollar and subsequent devaluation also reignited growth. Since its 2002 low, Argentine gross domestic product will have expanded by an average annual 7.4% by the end of this year, according to IMF data. Crucially, Argentine output was back above its previous peak within three years of default.
Compare this with Greece's prospects. The IMF forecasts the Greek economy will have contracted 9.3% from its 2008 peak by the end of this year. Although the IMF expects Greece to start growing again next year, that is difficult to believe. The one constant of this crisis has been that all forecasts for Greece have been overly optimistic. Worse still, once Greece starts to grow, it is expected only to do so at an anemic rate of around 2% per year. By the end of 2016, the Greek economy will only just be back to end-2008 levels.
Greeks might well decide an Argentine solution is the only real option. In other words, an exit from the euro, default and devaluation. And maybe that's what the market is already anticipating.
Barry Eichengreen, an economist at the University of California, Berkeley, famously argued that a euro-zone country couldn't leave the single currency because to do so would trigger "the mother of all financial crises." Long before the long political process necessary for any euro-zone country to leave the single currency was concluded, investors would have voted with their wallets. They'd dump the country's sovereign debt and flee its banks.
But this is pretty much what has already happened to Greece. Two-year Greek debt yields 28% while 10-year bonds are trading at less than half of face value. And for months now, depositors have been pulling funds out of Greek banks. Only the lifeline of yet more EU and IMF loans is keeping Greece in the euro. Loans that will have to be paid back.
If Greeks come to think they're already near or have reached the worst-case outcome of a euro exit but are getting none of the upside, they may well start to agitate to leave the single currency.
That would put the EU and the ECB into a very difficult position. A Greek default and departure from the euro would risk a systemic crisis across Europe's financial sector because of the huge exposure of Europe's banks to Greek government debt. The EU doesn't want to give in to Greece because of the costs involved and for fear of feeding moral hazard. But as the financial crisis showed, punctiliousness goes by the wayside when the crunch becomes severe enough.
The Bank of England worried publicly about the consequences of bailing out Northern Rock but then, after the Lehman Brothers collapse, had no compunction about pumping enormous amounts of money into the rest of the U.K.'s banking sector.
German, Dutch and Finnish politicians may be worried about how handing bottomless buckets of money to Greece will play out with their voters, but the alternative looks even uglier.
Ironically, were the Greeks to decide that a euro exit was not only possible, but desirable, the core EU, led by Germany, would almost certainly make huge concessions, including wholesale debt forgiveness.
Of course before they did so, core euro-zone countries would have to weigh up the costs of letting Greece off the hook relative to another rescue of their banking sectors. And not just Greece. Ireland and Portugal and possibly Spain and Italy would demand some sort of easing of their national liabilities if they saw Greece getting too good a deal. This would potentially be catastrophic for the politicians making the concessions. But the more Greeks become convinced they can go it alone the better the deal the EU would have to serve up to prevent them from doing so.
Could core Europe do this without going the way of Ireland, becoming a backstop that itself goes bust under the crushing weight of others' debts? It'll be interesting to see who draws the line where in this Greek standoff.