The news has just broken that the European Central Bank will agree later today to end emergency assistance to Greek banks. This, together with yesterday’s news that the EU will not extend the bailout until Greece can hold a referendum on further austerity, means that it looks very likely that Greece is about to crash out of the Euro. Let’s quickly catch up on how the negotiations fell apart, before looking at what the events of today mean, and what could follow.
The situation is still changing fast, and on the evening of the 28th of June the ECB had indeed decided to end additional assistance to Greek banks, and capital controls have been imposed. The description below of what could happen is still relevant., but actual actions taken by the ECB and government may change.
Negotations fall apart
As I mentioned last week, the Greek government and their creditors (the EU, ECB and the IMF) were negotiating on a deal to provide Greece with further funds to make Tuesday’s upcoming payment to the IMF. With deadlock over the nature of measures the government was going to have to take, Prime Minister Tsipras left the talks, and announced that there would be a referendum on July 5 to decide whether Greece would accept more austerity in exchange for funds. Tsipras then asked for bailout funds to allow Greece to make it to the referendum without defaulting on their debt. Yesterday the EU refused this, leaving Greece almost certain to default on Tuesday.
ECB cuts support
Today though, something more vital has happened, as sources say the ECB will decide today to stop propping up Greek banks. These banks were totally reliant on cash given to them by the ECB through the Bank of Greece under the Emergency Liquidity Assistance (ELA). However, with default imminent, the ECB can’t justify supporting the banks anymore. They would be pouring money into a system that has none left, and into banks that are therefore lost causes. This may seem like a foolish step to take in the midst of crisis, but the ECB is already stretching their rules, and this would break them.
So what happens now? The immediate problem is that without ECB help, Greek banks have very little cash, the government has none to give them – and there are already queues at ATM’s. Greeks have been taking money out of the banks for months now, storing up nice and safe Euro banknotes. This news will only increase the run on banks with no money left. What is likely to happen is that the Greek government will impose capital controls, meaning people can only withdraw very small amounts from their account, and transfer no money abroad. You can imagine the panic and disruption this will cause to a modern economy.
Next to this crisis, on Tuesday the government will almost certainly fail to pay the IMF. This basically makes what has been true for months official – the Greek government has no money. Without access to a bailout, with the impossibility of borrowing more money, and with taxes not covering expenses, the Greek state will be in deep trouble. Without further help from the EU, the only option left would be for Greece to return to the drachma.
With a new currency the government could print its own money, but the new drachma would immediately drop significantly in value, as it would be backed by a bankrupt government. This would lead to serious inflation. And remember the people who can’t get money out of their accounts? Their euro accounts would be converted to drachma, which would then drop in value, meaning people’s savings will be wiped out. When a similar devaluation happened in Argentina in 2001, people who had saved enough for a house could barely buy a car when they regained access to their accounts.
This return to the drachma will obviously be extremely complex and difficult. Firstly the Greek government has to find funds to pay for the printing costs of all those drachma. More importantly though, the devalued drachma would make business extremely hard for Greek companies, and the benefit it would bring to exports is offset by the fact that Greece doesn’t export all that much. This scenario leads to years of economic crisis far worse than what we’ve seen so far. It could also lead to an exit from the EU as well as the Euro, but as this as never happened, no one is exactly sure whether a total Grexit would be necessary.
The only hope for Greece now is that Tsipras comes back to the negotiating table, and that both sides agree an emergency deal that allows for both immediate support and long term growth. The experience of the last few weeks makes this seem unlikely. In the EU and ECB there is very little trust left in Greece. Over the last few years the austerity program has been implemented in fits and starts. The easiest measures, like cutting pensions, were also the most painful. More serious structural reform has been avoided, put off, or carried out in a half-hearted manner. The manner in which Tsipras called the referendum was also a blow to trust in the government, with some EU finance ministers apparently finding out on Twitter.
The game of chicken between Greece and the EU seems to have ended with a crash. The question now is whether the passengers in the Greek car can be saved.