Hugo Dixon: Greece has no good Plan Bs

March 9, 2015

By Hugo Dixon

The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

Greece has no good Plan Bs. Its only rational course of action is to work with its euro zone creditors to reform its economy.

Alexis Tsipras, the prime minister, is in a bind. He agreed a short-term deal with other euro zone governments two weeks ago. But he has found it difficult to sell this to hardliners in his radical left Syriza party back home, who accuse him of a U-turn.

Some of the subsequent rhetoric from Tsipras’ ministerial colleagues, such as promises to cancel privatisations, has been troubling. So have decisions such as raising the salaries of electricity workers.

Meanwhile, Yanis Varoufakis, the finance minister, has sent a rather thin list of proposed reforms to his euro zone counterparts in advance of a meeting on March 9. He has also raised the possibility of holding a second election or a referendum if Greece met with intransigence from its creditors, although it is unclear whether such a possible appeal to the voters would be the precursor to further U-turns by the government or an exit from the euro or might have some other purpose. Varoufakis will have much explaining to do.

If Greece is to secure a long-term pact with its creditors by end-June, Tsipras will have to abandon most of his election promises. Given the difficulties he is having delivering on even the short-term pact, there is a temptation to cast around for alternatives.

Some members of Syriza want Greece to regain its financial independence by defaulting on its debts and cutting loose from the euro. Meanwhile, pundits such as Wolfgang Munchau of the Financial Times want Greece to threaten to default while staying within the single currency – and to use that as a tactic to secure a better deal from its creditors.

Tsipras should resist these siren voices. Their advice will lead to disaster, as Odysseus, the ancient Greek mythological hero, knew well when he had himself tied to his ship’s mast so he could listen to the sirens but not do their bidding.

Look first at the option of default combined with exiting the euro. This is superficially attractive because Greece’s debt would be cut to more manageable levels, while bringing back the drachma would allow the country to devalue its currency and boost its competitiveness.

The snag is that the transition would be nightmarish. It could be managed only by imposing severe capital controls until the new currency was introduced – a process that would take several months given the need to jump through political, legal and logistical hoops. Otherwise, the Greek people would merely take their money out of the banks knowing that their euros would be replaced with devalued drachmas.

Capital controls were introduced in Cyprus two years ago when its banks were restructured and are only due to be lifted this month. But if controls were imposed in Greece to coincide with a default, the Cypriot ones would look like a walk in the park.

After all, Nicosia didn’t default on its debt and was working with its creditors towards a mutually acceptable solution. As a result, the European Central Bank flew in piles of cash, people were allowed to take 300 euros a day out of their accounts and companies were able to pay for imports.

By contrast, Athens would have stopped paying its creditors, including not just other euro zone governments but also the ECB. It’s pie in the sky to suppose that, in such circumstances, Europe’s central bank would feed the cash machines or supply liquidity so businesses could bring in vital commodities such as oil and medicines. This would worsen the humanitarian crisis and possibly trigger a new depression.

It’s not just that the transition to the drachma would be terrible. The aftermath would also be appalling, as taxes would have plummeted and the newly bust government would not be able to borrow abroad.

In such circumstances, a responsible government would tighten its belt, cut spending and run a balanced budget. But what chance is there of Syriza, which was voted in on a promise to increase spending, doing that? Instead, it might take the irresponsible option: printing drachmas to fill the hole in its finances and so fuelling inflation and, ultimately, hyperinflation.

What, then, about the other supposed Plan B: defaulting while staying in the euro? This would be miserable too.

Such a move would bankrupt the Greek banking system as it is exposed to the state. Since Athens would no longer be able to get funds from its euro zone partners to recapitalise the banks, the only option would be to “bail in” depositors – converting a portion of the money in their accounts into shares in the banks, on the lines of what was done in Cyprus. For the duration of such an operation, capital controls would have to be introduced.

The newly bust government, meanwhile, would have to balance its budget. This would be hard given that the depositor bail-in plus capital controls would deaden economic activity.

The state might, therefore, be tempted to pay salaries, pensions and the like with IOUs. This would be extremely unpopular, as the recipients would view them as worth a fraction of real euros. The IOUs would start to circulate as a parallel currency, trading at a discount to euros and seen as the probable precursor to the reintroduction of drachmas.

Given that none of the supposed Plan Bs is any good, Tsipras’ best bet is to persuade his creditors of his good faith and push ahead with vigorous reforms in the hope that they will cut him some slack. If that means breaking with his far-left faction and calling a new election or a referendum to validate a U-turn in his promises, so be it. His duty is to the Greek people as a whole.

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