Greece is insolvent, and almost illiquid as well. Over €25-billion ($34-billion) in deposits have fled its banks since early December, and €450-million is due to the International Monetary Fund by April 9. Its government's main source of short-term funding, €2.4-billion in Treasury bills, mature in mid-May and new bills will have to be sold to its hapless banks. No external bailout money can come before June, at the earliest.
The country's immediate fate now hinges dangerously upon a colourful but corrosive personality struggle. Prime Minister Alexis Tsipras's charm has worn thin, and so has Finance Minister Yanis Varoufakis's charisma. Mr. Varoufakis is visibly despised by his German counterpart, Wolfgang Schaeuble, though the latter is no match for him in wit and lucidity.
Mr. Schaeuble is more or less in tune with his boss, Chancellor Angela Merkel, but both are at loggerheads with Jean-Claude Juncker, the new President of the European Commission in Brussels. Mario Draghi, president of the European Central Bank, is in conflict with Jens Weidmann, president of the German Bundesbank. The Prime Minister of Spain, fearful of a challenge from his leftist opposition, is openly derisive of the new Greek government, and even the socialist leaders of Italy and France are keeping their distance.
The root cause of this personality struggle is the merit of so called "austerity" as a remedy for indebtedness. Under German leadership, the European Union has imposed spending cutbacks on Greece that are the most severe in postwar history: the outcome has been the most prolonged economic contraction and highest unemployment in Europe's postwar history.
Mr. Schaeuble embodies German advocacy of austerity: the misguided notion that the solution to rising burdens of sovereign debt relative to income in Greece and the other so-called PIGS (Portugal, Italy, Greece and Spain) during the Great Recession that began in 2008 was to cut back on spending so as to reduce debt, rather than increase spending to increase income. Underlying this is a classical view of the world, versus a Keynesian view. The Keynesian view is much more embedded in Anglo-American countries, partly because Keynes was English and his followers North American, but also partly because Germans are paranoid about inflation, after experiencing devastating hyperinflation after the first World War and, much more briefly, after the Second World War.
Mr. Schaeuble also embodies a German penchant for Ordnung: he is prone to repeat that all countries receiving "bailout" lending must stick to the same rules that were agreed to in 2011. Of course he also worries about "moral hazard": the danger that other, larger PIGS, like Spain or Italy, or even France, would demand similar concessions if Greece is given a break.
Mr. Varoufakis, by contrast, embodies a left-Keynesian set of priorities, where averting unemployment supersedes worries of inflation and indebtedness.
The striking contrast in their personalities – Mr. Schaeuble, well-shaven in his dark suit and tie, and Mr. Varoufakis, 20 years younger, with a hint of stubble and decked out in his leather motorcycle jacket – serves only to reinforce their philosophical differences.
Mr. Juncker and Ms. Merkel are at odds over a slightly different issue: keeping Greece in the euro zone. Mr. Juncker has repeatedly vowed he will do all that is necessary to keep Greece in. Ms. Merkel is visibly irritated, viewing this a blanket commitment that undermines her bargaining power on bailouts. In fact many around her are muttering that they'd be happy to see Greece go, and much of the German press, notably Bild, the lurid but popular tabloid, is virtually shouting the message from its headlines.
Mr. Draghi in turn is as always under pressure from Mr. Weidmann, who views the ECB's commitment to buy troubled sovereign debt as not only a blank cheque from the German taxpayer to Greece, but a source of moral hazard for other PIGS as well. In fact, since January, Greece has drawn billions in implicit credit from the German central bank by selling its own treasury bills to Greek banks. Yet without that implicit line of credit, the continuing flight of deposits would accelerate to an unstoppable "run" and Greek banks would collapse.
In 2013, Cyprus managed to avoid an exit from the euro but the more likely outcome for Greece would be similar to Argentina's in early 2002, when it abandoned its hard fix to the U.S. dollar: deposits would be frozen and then converted to a "new drachma," whose value against the euro would plummet. Greek savers would suffer severe losses. And Greeks who had borrowed in euros would be liable for much more in terms of drachmas. Most private borrowers would likely default, as would the Greek government. Greeks would find themselves cut off from future credit, not just from the EU but from most of the financial world.
In short, Greece's Syriza government finds itself in a severe bind. Greece is already insolvent: not even under the rosiest of outcomes can it ever repay its €350-billion debt burden. Worse, it is very close to illiquidity: its immediate bills for salaries, pensions and so on may be unfundable within a few weeks. Nevertheless, Syriza passed a bill two weeks ago that provides food and free electricity to the poor – a bill that Bild called "a declaration of war."
At Ms. Merkel's invitation, Mr. Tsipras met with her in Berlin on March 23. There was a superficial sense of warming as he turned on his charm. By contrast, Mr. Varoufakis has been told to stay at home and work on emergency reform. Indeed, he has mellowed: on March 30 he actually called for "an end to the toxic blame game." And one small sign of progress was a new list of putative reforms submitted last Friday, which included the promise of an extra €3-billion in tax and other revenues.
It is imperative that the Greeks stop grandstanding and nail down their crumbling country with brass tacks. Recent threats to release refugees into the rest of Europe, to confiscate German property, and so on were ill-timed at best. They need to be replaced by a bargain to swap debt writeoffs for sales of Greek assets and real estate to its creditors, or, indeed, to any high-bidding foreign investor. This would be a bitter pill for Syriza to swallow. But in return, Brussels and Berlin must abandon their micro-management of Athens' budget, because unless Syriza can provide salve to the wounds that austerity has cut into its unemployed and vulnerable, there will be blood in the streets.
James W Dean is Professor Emeritus, Economics, Simon Fraser University. He has written extensively on resolution of troubled sovereign debt.