The future of Europe could be decided in the next 12 hours. Or it could be put off for another summit on another day. There are always more summits. But at some point, Europe's wealthy powers will either have to grant Greece a new lifeline in exchange for new budget-cutting and tax-hiking measures, or Greece will face a sudden banking collapse that would likely force it out of the euro zone.
If Greece does leave the 15-year-old currency pact, it would not only be an economy-crushing event, but it would also be the first time that Europe has moved further apart after 60 years of moving closer together. So in the end, after five years of bailouts, budget battles and a battered economy, Europe has to decide whether it wants to keep moving toward what it hopes will one day be a United States of Europe or not. That is the central question.
As we enter these final hours, with European finance ministers and heads of government meeting to decide whether to accept, amend or reject the latest Greek bailout proposal, here are the basics of what's happening, how we got here, and what it means for Greece, Europe and the rest of the global economy.
1. What's the situation right now?
Europe's leaders are deciding whether they're willing to trust Greece as little as they did two weeks ago, a little less than that, or not at all.
Two weeks ago, Greek Prime Minister Alexis Tsipras, leader of the anti-austerity party Syriza, refused to accept a European offer of fresh financial assistance in exchange for tough new austerity measures, and called a referendum on it instead. Europe's leaders weren't exactly pleased, and they insisted that voting against the bailout would mean voting to leave the euro zone. Despite this, Tsipras campaigned against the deal because he said rejecting it would give him the chance to get better terms — and he unexpectedly won in a landslide.
It was an empty victory. Tsipras had just as much leverage after the referendum as he had before it: none. Athens had already had to close Greece's banks when the European Central Bank refused to provide more of the emergency loans that they rely on to stay afloat, and now the economy was shutting down. When the creditors didn't ease their terms, Tsipras had no choice but to comply with them if he wanted to keep Greece in the euro — which he, and the Greek people, did. That's why Athens capitulated a few days later and proposed almost the same bailout that it and the voters had just turned down. The Greek parliament quickly ratified this surrender.
But even though Greece is now willing to meet Europe's old terms, it doesn't seem as if that will be good enough anymore. Now before this latest round of wrangling, the sticking points had been how fast Athens would phase in pension cuts for poor Greeks and how high the sales tax would be at the country's island hotels. Greece had conceded most of these points in its latest offer, so we don't know exactly what the terms of the new negotiations are. A big part of it seems to be that Europe doesn't trust Syriza and doesn't want to deal with them. But short of telling Greece there won't be a new agreement unless there's a new government, Europe seems to be pushing them to make reforms first — like, within a few days — as a show of good faith. Greece, for its part, wants debt relief first and foremost. Europe insists, though, that it won't write down the face value of any debt, and may only, in October, lower the interest rates further and give Greece even more time to pay.
Meanwhile, Europe may need even more austerity than it demanded just two weeks ago. The reason this has become more difficult is not just the utter loss of trust between Europe and Syriza. It's that Greece's economy is in much worse shape now than it was even a few weeks ago. So now the previously contemplated tax hikes and spending cuts, which would have produced a budget surplus before, won't anymore.
Sunday in Brussels, where European finance ministers were meeting, it still wasn't clear if there would be a new agreement. Germany had circulated to other countries a plan to force Greece to take a five-year “time-out” from the euro, Finland had said they couldn't sign off on a deal or their anti-bailout government would collapse, and the French continued to insist that some common ground could be found, on either the old terms or stiffer ones. In any case, Greece will have to move fast if it does get a new bailout as a token of good faith for the ECB, who still have to decide whether or not to save Greece's banks from imminent collapse.
2. What's really at stake?
The numbers aren't key here. Greece is never going to pay back all its debt, and the International Monetary Fund has said just that. Really, Greece's debt is mostly meaningless at this point. Greece's interest rates are so low and it has so long to pay back what it owes that even though its debt is 175 percent of gross domestic, its debt payments are a much more manageable 2.6 percent of gross domestic product. That's less that the U.S. government's debt payments. If Europe worried about getting paid back, it would have continued its bailout. The past two weeks alone have increased the cost of getting Greek banks running again by 25 billion euros.
Nor is Greece much of a threat to Europe's economy. Greece's economy is only about 2 percent of the euro zone's total. The ECB has erected a firewall and would do all it can to make sure any financial explosion is contained. Investors in Europe and around the world have had five years to detach from Greece.
So what's behind this? The best way to think about why something so small still matters so much is to think about how we got here in the first place. Whenever a country borrows too much, the IMF usually recommends that it write down its debts, balance its budget and devalue its currency. The idea is that it's pointless to try to pay back more than you can — it can actually be self-defeating — but you also need to become fiscally self-reliant so you don't have to go back for one bailout after another.
The tricky thing, though, is that at the same time you're raising taxes and cutting spending, which hurts the economy, you need to get it growing again. That's why the IMF prescribes a big dose of monetary stimulus — that is, a cheaper currency — to offset the economic pain from fiscal austerity.
But this isn't what happened in Greece. Well, aside from the austerity. It did get a lot of that. What it didn't get, though, was a cheaper currency or enough debt relief. See, back in 2010, policymakers were petrified that the euro zone was like a line of dominoes just waiting to get knocked over by the weakest link. If Greece defaulted on its debt, the French and German banks that had lent it money might go bust, and the banks that had lent them money might, too. Not only that, but default also might force Greece out of the euro, at which point markets would begin to bet against whatever they thought was the next weakest link. That would push up borrowing costs for, say, Portugal and make it more likely that it would, in fact, default, which would then push up borrowing costs for Spain. In other words, Greece wasn't allowed to default, even though it needed to, because doing so threatened to set off a series of self-fulfilling prophecies that could have ripped the common currency apart.
So Greece got bailed out to the extent that it was given money to then give to the people to whom it owed money. That was good news for French and German banks that got their money back, but it wasn't for Greece. It still had as much debt as before, only now it owed official creditors such as the IMF instead of private ones like the banks. Since 2008, Greece's debt burden has shot up mostly because of its economy was getting smaller rather than its debts getting bigger.
Now, the Europeans face a choice, but the problem is they don't how what they decide will turn out. It's possible that ejecting Greece from the euro could actually make it easier for the rest of the euro zone to come even closer together. Greece really was unique in that its government's irresponsibility was what got it into trouble. Or it could be the beginning of the end of the dream of a United States of Europe. But in either case, the continent's political future is at stake.
The mistake most people made was thinking that Syriza was just an anti-austerity party. It swiftly capitulated when it realized Europe wasn't going to really negotiate, and all along was proposing tough austerity. It was really a pro-sovereignty one. And that's why Europeans are so alarmed. Syriza didn't want Europe to tell Greece what to do anymore. It wanted to make its own decisions.
But this is why the Europeans are so distrustful. It's not just that Europe doubts Greece would follow through on its fiscal promises if it didn't have the constant threat of default hanging over its head. It's more that Europe is worried that if it rewards Greece for acting out against austerity, Spain, Italy and Portugal will start to act out, too — and then things will get really expensive for Germany.
3. What's next?
There are two potential outcomes to the talks.
Deal: If there is a deal, things would go back to normal, or what we refer to normal when a formerly rich country is suffering a Great Depression with 25 percent unemployment. Syriza would implement the tough austerity it's promised, unless something else goes wrong, which it might, and Greece's economy would suffer. Meanwhile, though, the ECB would approve new funding for the nation's banks, and they could open for business. It would be more of the same until the next crisis hits.
No deal: Without new loans from the ECB, Greece's bankrupt banks, which have now been closed for two weeks, would collapse, causing utter ruin and dysfunction in the country. To avoid that, at least in principle, Athens would either need bailed in those banks by taking money from depositors or bail them out by leaving the euro and firing up the printing presses at the Bank of Greece.
If they left the euro, it might take time for the bank to actually print enough drachma, Greece's old currency, to circulate and replace the euro. There would be massive confusion — and massive inflation — as the drachma plummets in value relative to the euro. To address the simple fact that it could take a while to circulate drachma, Greek banks could offer a type of IOU known as a scrip.
The government could start paying its employees with this scrip, and telling people that they could pay their taxes with it. That would be enough for banks and businesses to accept it — at a discount to the euro, of course — and the economy to start functioning with at least a facsimile of normalcy. Companies might also start their own IOUs.
The beauty of an IOU is it exists in the legal gray area between money and debt. If Greece somehow manages to stay in the euro, it could always say that it hadn't printed any new money, since IOUs were just new debts. But if it does ditch the common currency, then the IOUs would be a bridge between the euro and the drachma while Athens goes about the more-difficult-than-it-sounds business of getting the printing presses going.
Meanwhile, the euro zone project, which was really in the end trying to create a United States of Europe, would be dealt a bitter setback.
4. What would the two different outcomes mean for Greece, Europe and the global economy?
Deal: If there is a deal, it would be more of the same for Greece, for the foreseeable future. Its economy wouldn't grow, its unemployment rate would stay elevated, the brain drain of the country's best and brightest would continue. Financial markets would likely celebrate the news, as they did Friday when there were optimistic signs about the outcome of the crisis. When would things get better for Greece? Nobody knows.
As this tweet from RBS Economics shows, Greece has suffered one of the worst economic declines in modern history, especially considering that it is not at war.
Europe and the global economy would go back to worrying about more worrisome things, like the state of China's economy and whether and by how much the U.S. Federal Reserve hikes rates later this year.
No deal: It's hard to say what would happen in the worst case of Greece leaving the euro zone, but it's probably something like this:
- Greece. The new drachma would plummet, inflation would soar into the double digits, imports such as food and oil might need to be rationed, companies that borrowed in euros might go bankrupt, and the government would have to balance its budget overnight. In other words, things would get a good deal worse than they already are, which is saying something when you're talking about a country with 25 percent unemployment. But it's possible after a year or two, this pain would pass, and Greece would be left with a cheaper currency that would make its exports more competitive and its tourism more attractive.
- Europe. First, they would lose real money here, as in the hundreds of billions. Greece's government hasn't just gotten 240 billion euros, but its banks also have received 89 billion euros in loans from the ECB that might be defaulted on in the case of euro exit. Second, there would be some contagion. Borrowing costs could creep up for Italy, Spain and Portugal, but the fact that the ECB is already buying their bonds and has promised to buy as many as it takes to keep their interest rates low means they shouldn't rise that much. Third, all this uncertainty should make the euro fall more, boosting their exports in the process. And finally, though this might sound cruel, the worst thing that could happen to Europe is if Greece does well after it leaves. That would embolden anti-austerity parties in the rest of the continent by showing that they have nothing to lose but their fiscal chains by challenging the continent's budget-cutting orthodoxy.
- The United States and everybody else. Our banks should be fine. Some hedge funds might fail. And the stronger dollar (the flip side of the weaker euro) should make our exports a little less competitive overseas. And that's it. There really shouldn't be too much damage from the failure of a country whose GDP is the size of Connecticut's. The fact that there ever would have been — and there would have — tells you how fragile the euro zone is.
5. What led to this point?
It's a long story that has its roots in the creation of the euro, five years of unsuccessful efforts to stem the burgeoning crisis and the diverging experiences of Greece and Germany, Europe's economic behemoth and decision maker. These two charts make those differences stark:
The first, uncollected tax receipts, shows that Germany has had almost no problem when it comes to taxpayers paying their bills due to the government, while Greece has had an unparalleled challenge. Germany has fewer outstanding tax debts than any other country in Europe, while Greece has more than any other. That difference not only helps Germany enjoy a far more fiscally sound position than Greece, but it offers a stark contrast between a disciplined government and one that historically has been hardly disciplined.
The second, unemployment, shows why Greece wants to take control of its own future. It is suffering the worst unemployment on the continent — worse than unemployment in the United States during the Great Depression — and even worse unemployment among its young workers. When they see that one in two young Greeks is unemployed — a problem that will cast a shadow on the Greek economy for generations — Greece's leaders want a different course.
More immediately, Tsipras called for the referendum last weekend after negotiations with Europe broke down in Brussels. The European Commission, the European Central Bank and the International Monetary Fund — “the troika” — were giving Greece the money it needed to function and to, well, pay the troika back. The IMF, in particular, insisted that Greece cut its pensions by 1 percent of gross domestic product, and Greece responded that it was willing to cut them only half as much and make up the difference with higher taxes on businesses. When they couldn't come to an agreement, Tsipras called for the vote.
That led to not only a political escalation of the crisis — but to an economic one. There has been a slow-motion bank run the past few months — a bank jog, really — that has picked up pace as it has appeared as if there wouldn't be a deal. That's because people were worried that Greece would be forced out of the common currency without one, and their old euros would get turned into new Greek drachmas, which wouldn't be worth anywhere near as much.
So when there wasn't a deal, Greece was forced to close its banks, limit ATM withdrawals to 60 euros a day and prevent people from moving their money abroad in a capitulation to this panic. Then Greece defaulted on a 1.5 billion euro payment to the IMF. That wasn't surprising. Greece doesn't have 1.5 billion euros. It doesn't have anything. It's broke.
For a moment it seemed talks might resume last week. Greece's government was making a last-minute request for a new bailout, and Europe was offering at least minor concessions. But then Germany's Chancellor Angela Merkel and other creditors made it clear that they want to await the terms of the referendum, and the rhetoric coming from Syriza only heated up, making the referendum all but a certainty.
6. Would leaving the euro be an absolute disaster?
It is hard to know what the future brings beyond a greater Depression. But there's a case to be made that leaving the euro could be a good thing for Greece. If not that, there's an even stronger case to be made that joining the euro was a bad thing.
As the culmination of Europe's 60-year project toward greater and greater integration, the euro was a political masterstroke. It was also an economic albatross. And it's one that wasn't hard to see coming. Plenty of economists, including Nobel Prize-winner Milton Friedman, warned that it wouldn't work for countries with different economic needs to share a single monetary policy but not a fiscal policy. At any given time, money would be either be too tight or too loose for some members, and there wouldn't be anything — like unemployment insurance — to balance it out. The euro, in other words, is a paper monument to peace and prosperity that has made the latter impossible for some countries.
None more so than Greece. Its big bubble in the early 2000s was the result of interest rates that were too low for it, and its big bust since is, in large part, the result of a currency that has been too strong. You can see that in the chart below comparing bond yields between Germany and Greece. With a stronger economy and much less debt, Germany should have always paid less to borrow. But investors treated more risky Greece and Germany the same for years, because they were both part of the euro.
When the debt crisis started, though, investors abandoned Greece and rushed for safe havens such as Germany (and U.S. Treasury bonds).
Now, instead of being able to devalue its way back to competitiveness, Greece has been forced to deflate its economy. That is, it has had to cut wages — which makes unemployment worse — rather than cut its currency. It's the same problem that the gold standard created during the 1930s. The difference, though, is that Europeans are even more attached to the euro than they were to the gold standard, which is saying something, since, at the time, they equated it with Western civilization itself. That's because the euro is the gold standard with moral authority.
Nobody wants to get rid of the real problem, and so the other ones continue.