Greece’s Referendum And The EU Miscalculation

In a result that should surprise no one, the Greeks voted to reject European demands for additional austerity measures as the price for providing funds to allow Greek banks to operate. There are three reasons this should have been no surprise. First, the ruling Coalition of the Radical Left, or Syriza party, is ruling because it has an understanding of the Greek mood. Second, the constant scorn and contempt that the European leadership heaped on the prime minister and finance minister convinced the Greeks not only that the scorn was meant for them as well but also that anyone so despised by the European leadership wasn’t all bad. Finally, and most important, the European leadership put the Greek voters in a position in which they had nothing to lose. The Greeks were left to choose between two forms of devastation — one that was immediate but possible to recover from, and one that was a longer-term strangulation with no exit.

The Europeans’ Mistaken Reasoning

As the International Monetary Fund noted (while maintaining a very hard line on Greece), the Greeks cannot repay their loans or escape from their economic nightmare without a substantial restructuring of the Greek debt, including significant debt forgiveness and a willingness to create a multidecade solution. The IMF also made clear that increased austerity, apart from posing an impossible burden for the Greeks, will actually retard either a Greek recovery or debt repayment.

The Greeks knew this as well. What was obvious is that austerity without radical restructuring would inevitably lead to default, if not now, then somewhere not too far down the line. Focusing on pensions made the Europeans appear tough but was actually quite foolish. All of the austerity measures demanded would not have provided nearly enough money to repay debts without restructuring. In due course, Greece would default, or the debt would be restructured.

Since Europe’s leaders are not stupid, it is important to understand the game they were playing. They knew perfectly well the austerity measures were between irrelevant and damaging to debt repayment. They insisted on this battle at this time because they thought they would win it, and it was important for them to get Greece to capitulate for broader reasons.

No other EU country is in a condition as bad as Greece’s. However, a number of EU countries, particularly in Southern Europe, carry a debt burden they would like to renegotiate. They are doing better than Greece this year, but with persistent high unemployment — for example, 22.5 percent in Spain as of May — two things are not clear: first, what shape these countries will be in next year or the year after that, and second, what governments would come into office, and what the new governments’ positions would be. Greece accounts for less than 2 percent of the European Union’s gross domestic product. Italy and Spain are far more important. The problem of restructuring debt is once it is done for one country, others will want to restructure as well. The European Union did not want to set any precedents for future crises or anti-EU governments.

In Greece, Europe’s leaders had a crisis and a hostile government. It was the perfect place to take a stand, they thought. They became inflexible on debt restructuring, demanding prior increased austerity measures in a country where unemployment exceeded 25 percent and youth unemployment was over 50 percent. The EU strategy in the past had been psychological: spreading fear about what default might mean, spreading fear of the consequences of leaving the eurozone and arguing that it was the European Union that lacked the ability to make concessions. In the past, the EU strategy had been to make agreements that it never thought the Greeks would be able to keep in order to kick the problem down the road. Europe’s leaders demanded austerity measures but tied them to postponing repayments. They expected Greece to continue playing the game. They did not realize, for some reason, that Syriza came to power on a pledge to end the game. They thought that under pressure, the party would fold.

But Syriza couldn’t fold, and not just for political reasons. If Syriza betrayed its election pledge, as the European leadership was sure it would, the party would split and a new anti-European party would form in Greece. But on a deeper level, the Greeks simply could not give any more. With their economy in shambles and Europe insisting that the solution was not stimulus but austerity — an increasingly dubious claim — the Greeks were at the point where default, and the short-term wrenching crisis that would ensue, would be worth the price.

The European leaders miscalculated. They thought Greece could be more flexible, and they wanted to demonstrate to any other country or party that might consider a similar maneuver in the future just what the cost would be. The Europeans feared the moral risk of compromising with the Greeks. They created a more dangerous situation for themselves.

New Threats to the European Union

First, in its treatment of Greece, the European Union has driven home — particularly to rising Euroskeptic parties — that it is merely a treaty organization and in no way a confederation, let alone a federation. Europe was a union so long as a member didn’t get into trouble. As I have said, the Greeks were irresponsible borrowing money. But the rest of Europe was irresponsible in lending it. Indeed, the banks that lent the money knew perfectly well the condition Greece was in. The idea that the Greeks pulled the wool over the bankers’ eyes is nonsense. The bankers wanted to make the loans because they made money off of transactions. Plus, European institutions that bought the loans from them bailed out those that made the loans. The people who made the loans sold them to third parties, and the third parties sold them to EU institutions. As for the Greeks, it was not the current government or the public that borrowed the money. And so the tale will help parties like Podemos in Spain and UKIP in the United Kingdom make the case against the European Union. The European Union appears both protective of banks and predatory to those who didn’t actually borrow.

Second, having played hardball, the Europeans must either continue the game, incurring the criticism discussed above, or offer a compromise they wouldn’t offer prior to the Greek vote. One would lead to a view of the European Union as a potential enemy of nations that fall on hard times, while the latter would cost the bloc credibility in showdowns to come. It is likely that the Europeans will continue discussions with Greece, but they will be playing with a much weaker hand. The Greek voters have, in effect, called their bluff.

It is interesting how the European leaders maneuvered themselves into this position. Part of it was that they could not imagine the Greek government not yielding to the European Union, Germany and the rest. Part of it was that they could not imagine the Greeks not understanding what default would mean to them.

The European leaders did not take the Greeks’ considerations seriously. For the Greeks, there were two issues. The first issue was how they would be more likely to get the deal they needed. It was not by begging but by convincing the Europeans they were ready to walk — a tactic anyone who has bargained in the eastern Mediterranean knows. Second, as any good bargainer knows, it is necessary to be prepared to walk and not simply bluff it. Syriza campaigned on the idea that Greece would not leave the eurozone but that the government would use a “no” vote on the referendum to negotiate a better deal with EU leaders. However, all political campaigns are subject to geopolitical realities, and Syriza needed all options on the table.

The EU leadership was convinced that the Greeks were bluffing, while the Greeks knew that with the stakes this high, they could not afford to bluff. But the Greeks also knew, from watching other countries, that while default would create a massive short-term liquidity crisis in Greece, with currency controls and a new currency under the control of the Greek government, it would be possible to move beyond the crisis before the sense of embattlement dissolves. Many countries do better in short, intense crises than they do in ordinary times. The Greeks repelled an Italian invasion in October 1940, and the Germans didn’t complete their conquest until May 1941. I have no idea what Greece’s short-term ability to rally is today, but Syriza is willing to bet on it.

Greece’s Options in Case of a Grexit

If Greece withdraws from the European Union, its impact on the euro will be trivial. There are those who claim that it would be catastrophic to the euro, but I don’t see why. What might be extremely dangerous is leaving the euro and surviving, if not flourishing. The Greeks are currently fixated on the European Union as a source of