Watching Greece is like watching an amateur tight-rope walker with no net beneath him. He may make it, he may not. His fall would be fatal.
Unless Greece simultaneously negotiates a new austerity package and a "haircut" with private bond holders, it will not receive its second bailout -- worth €130-billion -- from the European Union and the International Monetary Fund. Without the bailout, Greece would default and almost certainly leave the euro zone.
The negotiations on both fronts are not going well. By Monday morning, not nearly enough agreements were in place to assure Greece's second rescue package. Prime Minister Lucas Papademos said that political leaders had agreed on a few "basic issues," among them making spending cuts this year equal to 1.5 percentage points of gross domestic product, worth about €3-billion. But there was little common ground on a series of other austerity measures demanded by the EU and the IMF, ranging from pension and wage cuts to the closure of numerous money-losing state-controlled organizations and enterprises.
Many Greek politicians fear that the deepening austerity measures will do more damage than good. "I will not contribute to the explosion of a revolution due to misery that will burn all of Europe," said George Karatzafaris, the Greek parliamentarian who is leader of the Popular Orthodox Rally party. Later, the prime minister's office said talks between coalition party leaders scheduled for Monday will be pushed back for a day.
Indeed, the more Greece implements austerity programs demanded by its international creditors, the worse its recession becomes. The country has been in recession for four years. Last year, its economy contracted by as much as 6 per cent. Deutsche Bank expects another 3 per cent contraction this year.
As austerity measures have become the central economic features of countries from Britain to Portugal, voters are fighting back. On Monday, Romanian prime minister Emil Bloc, whose government has been the target of mass anti-austerity protests for weeks, announced his resignation "to ease the social situation." He called for a quick election. In 2010, Romania took a €20-billion lifeline from the EU, the IMF and the World Bank.
Greece, meanwhile, is bracing for another round of mass union strikes starting tomorrow.
Greece has all of the euro zone on tenterhooks because of the high potential for a disorderly default unless Athens agrees to the twin conditions -- more austerity and the bond deal -- required to secure the bailout package. Without the bailout, Greece would be unable to redeem €14.5-billion of sovereign bonds that come due on March 20.
"If we determine that it's all going wrong in Greece, then there won't be a new program, and that means in March you'll have a declaration of bankruptcy," Luxembourg's prime minister, Jean-Claude Juncker, who chairs the meetings of the euro zone finance ministers, told Germany's Der Spiegel magazine in an article published Sunday.
Over the weekend, Deutsche Bank CEO Josef Ackerman, who is chairman of the group negotiating the private Greek bond restructuring, called for a "make or break" moment.
The bond restructuring's goal is to reduce Greece's national debt load by about €100-billion. Bond holders would see the face value of their investment fall by 50 per cent. But even if the effort works, Greece's debt-to-GDP ratio would fall only to about 120 per cent of GDP by 2020. It is currently almost 160 per cent. Many economists consider the lower debt level unsustainable unless Greece miraculously achieves strong growth.
Complicating the bond negotiations is the European Central Bank. The Greek government and the IMF want the ECB to take a haircut on its Greek bond holdings along with private investors. Barclays and UBS estimate that the ECB owns between €36-billion and €55-billion of Greek sovereign debt. Since it's not know what price it paid for the bonds, the central bank's precise losses are not known.
Setting a precedent is the problem. If the ECB is forced to write down the value of its Greek bonds, it naturally would be less willing to buy the distressed bonds of other euro zone countries, for fear of having to take more losses.
A bond deal must be done by Feb. 13 if all the paperwork is to be completed before the March 20 bonds comes due.