Greece’s game of high-stakes chicken

published 9 January 2015

In 2009, the eurozone crisis was triggered by turmoil in Greece. Five years on, not much has changed. Ructions in one of the eurozone's smallest economies have rattled markets, fuelling fears of a potential rupture of the single currency.

Late last month, the Greek parliament failed to elect a president, triggering a snap election for 25 January. The polls suggest that Syriza, a far-left populist party, will win.

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Syriza wants to reverse public spending cuts, end austerity and negotiate a big reduction in Greece's debt load, having at first said it would repudiate some of the debt. "Such a programme," says The Economist, "seems, to put it mildly, to sit uncomfortably with Greece's continuing membership of the single currency."

The populists have struck a chord. Even though the economy has returned to growth, the crisis has left deep scars. GDP has shrunk by around a quarter since 2008 and youth unemployment is at 50%.

Syriza's ragbag policy mix, centred on more borrowing, more public-sector workers on higher salaries, and lower taxes (no, we don't see how that works either) would merely perpetuate the disastrous policies that got Greece into trouble in the first place, as Hans Rauscher points out in Austria's Der Standard.

So Greece's growth prospects would be badly damaged by a Syriza victory, making it even less likely that it could ever begin to make a dent in its huge debt pile.

A stand-off with Germany

This could set off a chain reaction, with markets ditching bonds of other heavily indebted states (in the expectation that they might be repaid in a new, devalued currency). That would force up their long-term interest rates, making them all the more likely to default and leave the euro.

Germany, for its part, has signalled that it won't give in to what it sees as blackmail, not least because this could encourage other indebted states to ease up on reforms. And it has let it be known that it is willing to run the risk of Greece leaving.

That's because "the eurozone is in a stronger position than it was three years ago", when Greeks almost elected Syriza, as Richard Barley notes in The Wall Street Journal.

A Greek default wouldn't threaten Europe's banking system, as most of the debt is now owed to eurozone governments and the IMF. Confidence in the banks is also higher as recent stress tests have been deemed more credible than in the past.

Europe has set up a bail-out fund, and much of the periphery is growing again, allaying fears of permanent decline within the euro. Populists in other countries don't yet look strong enough to cause a Greek-style stand-off.

Finally, the European Central Bank has set up a bond-buying programme that should keep peripheral yields down if markets panic amid a Grexit in which case it should also bring forward quantitative easing (money printing), which would likewise involve government bond purchases. All of this explains why other peripheral bond yields have stayed low.

Exactly how this game of chicken will play out is anybody's guess, but somesort of fudge seems much more likely than a Grexit, given how turbulent the transition to a new currency would be. But either way, the case for sticking with European equities rests on QE, which looks like it should soon be with us whether Greece stays or goes.