The euro zone is not yet ready for a game of chicken with Athens. Angela Merkel and Nicolas Sarkozy have threatened to cut Greece loose if it doesn’t back the latest bailout plan. But, Europe isn’t prepared to handle the backlash. With barely a month to get its act together and a history of dysfunctional decision-making, there’s a huge risk of a mega crash.
The Greek government may be on the point of collapse, with even the deputy prime minister speaking out against George Papandreou’s plans for a referendum on staying in the euro. If so, that could be good. Most probably, new elections would then be called and plans for a referendum shelved. There is a reasonable chance that whatever government emerges, it would back some version of the austerity-cum-debt restructuring plan.
But, such a relatively rosy scenario can’t be guaranteed. Without a cash injection, Greece will probably default and may even leave the euro as soon as the year-end. The rest of Europe isn’t well placed to handle the contagion. Its banks are inadequately capitalised. Silvio Berlusconi’s government is incapable of tackling Italy’s debt load. And, the euro zone’s bailout fund, the European Financial Stability Facility (EFSF), is in no shape to provide a safety net.
Merkel and Sarkozy talk about accelerating the plan agreed at last week’s euro summit. But, this would be woefully inadequate if Greece went bust. The bank recapitalisation plan needs to be doubled to ¤200 billion and implemented now, rather than by next June. New contingency plans need to be put in place to provide longer-term loans to banks and leverage up the EFSF. The current plans based on elaborate financial engineering won’t pass muster. The only practical way of beefing these defences would be to unleash the European Central Bank’s power to print euros.
There would also be a strong case for restructuring Portugal’s and, possibly, Ireland’s debts. If Greece left the euro, the spotlight would inevitably move to Lisbon and Dublin. If their debts were cut to more manageable levels, the idea that they would stay in the single currency would be more credible.
There is no evidence that Europe is prepared to embrace such radical contingency plans. The hardest part would be to convince Germany and the ECB that the central bank should act as a more generous lender of last resort. That would involve both of them swallowing long-cherished principles.
But, even if such a plan could be put together, the Italian question would remain unanswered. The rest of Europe would not want to write a blank cheque unless the Berlusconi government starts delivering on its reform promises; but, equally, the possibility of Italy going bust is horrendous. Even if Europe could get ready to play chicken with Athens, doing the same with Rome would require a whole different order of preparation.