A Greek default must go the whole way and leave the euro

An end to the Greek crisis has been a long time coming. So much so, that it is now easy to believe that it will never come. The Greeks and their creditors may simply continue to “kick the can down the road”.

But the can appears to have been kicked into a cul-de-sac. Greece had evidently hoped that it could persuade the IMF to allow it to defer payment of the €1bn due in two amounts on May 1 and May 12. The IMF has said no. No developed country has ever defaulted to it, or even been granted a postponement of payment. (Mind you, if things carry on much longer as they are, perhaps Greece will cease to be classified as a developed country, thereby allowing a default to the IMF to seem less earth-shattering.)

Greece had also hoped that this Friday’s meeting of eurozone finance ministers in Latvia would bring, not only acceptance of the Greek government’s latest draft, (the fourth, by the way), of its plans for reform, but also the immediate release of funds. Yet the European Commission’s vice-president has made it clear that funds will only be released once Greece has demonstrably started to implement reforms.

Admittedly, we have seemingly been here before, only for the prisoner to wriggle free. Some observers suggest that the German finance minister, Mr Schaeuble and his boss, Mrs Merkel, are deliberately playing a game of bad cop/good cop. But Mr Schaeuble doesn’t look like the sort of chap who would be a good actor.

Although Mrs Merkel’s instinct always seems to be towards compromise, her room for manoeuvre has been reduced by the rise of the eurosceptic party AfD, increasing opposition within her own ruling coalition, and clear evidence of a majority in favour of Grexit among the German electorate. Greek politicians’ aggressive language and hectoring over war reparations have made her position even more difficult.

Moreover, Mr Tsipras’s attempt to put pressure on Germany by playing the Russian card, and his finance minister, Mr Varoufakis, trying to enlist support from Barack Obama, may have served to strengthen, rather than moderate, German intransigence.

Why has the deferral of the apparently inevitable been so protracted? First, each side has thought that the saga could have a happy ending because it has underestimated the determination of the other side to stick with its pre-existing position.

Second, even those members of both sides’ negotiating teams who thought that this whole sorry episode must end in Grexit didn’t want to be the ones to pull the trigger – or at least not to be seen to be doing so. In the Greek case, this was because Syriza has no mandate for leaving the euro. Moreover, opinion polls in Greece have consistently suggested that there is no majority for Grexit.

This has meant that, in order to protect its own domestic political position, the Syriza government has had to avoid the accusation that it has willingly, or still worse, capriciously, left the euro.

For those members of the Syriza movement who have wanted a Greek exit, their objective must have been to get Greece pushed out, against all its best efforts to stay in.

Meanwhile, those in Germany who have come to the conclusion that Greece must leave, apparently including Mr Schaeuble, do not want to be seen to be pushing Greece out. With memories of the war evidently still uncomfortably alive across much of Europe, not least in Greece, Germany wants to avoid coming across as an overbearing bully.

But not at any price. Syriza has underestimated the degree to which Greece’s continued maladministration of its public finances has drained any sympathy in Germany.

It has also miscalculated the extent to which Greece could rely on support from other members of the eurozone. It enjoys some sympathy and support from France, but the real let-down has been the fact that the other peripheral countries, which have similar problems with heavy indebtedness and a lack of competitiveness, namely Spain and Portugal, have not been accommodating. Their worry has been that if Greece were seen to win further concessions then their own pursuit of austerity would become indefensible to their electorates.

This whole affair is so messy that, if it comes to it, even a euro exit will probably not be straightforward. It is possible that Greece will default to the IMF and be in no position to honour all its other obligations, yet still try to remain in the eurozone. It has been suggested that if the government finds itself unable to pay pensions and public sector salaries, it would issue IOUs instead. It has even been mooted that these could circulate as a form of pseudo-currency.

However, this “solution” would not be sustainable for long. For a start, the outflow of money from Greek banks would become a flood. The government would surely have to impose capital controls, even including a freeze on bank deposits. This could be extremely damaging.

Without euro exit, just defaulting and refusing further austerity would not do much good.

Greece needs to become much more competitive. This is only possible if it leaves the euro and allows its new currency to depreciate sharply on the exchanges. To forgo this opportunity while nevertheless defaulting and becoming a pariah among fellow EU members would be to condemn the country to a prolonged near-death experience.

The Greek government surely understands this. If it is pushed into defaulting, it must go the whole hog and pull out of the euro as well. Of course umpteen officials, bankers and commentators around the world have suggested that if this were to happen then Greece would suffer an economic calamity. In such circumstances, they always do. And they are usually wrong.

History is full of examples of countries that have gained economic respite through a weaker currency. It is not that this is a panacea, nor that it is bound to work if other policies run completely counter to it. But, if properly handled, in the right circumstances it can work wonders, as examples from countries as diverse as the UK, Iceland and Korea attest.

Ironically, currency devaluation has always played a central role in the IMF’s classic treatment for countries in difficulties. And, let’s face it, for Greece there isn’t much alternative.