To stay or not to stay: Both from Greece's perspective as well as the rest of the Euro Zone, it is far from clear which is the better option.

On board The Firefly, a gold-coloured A319 that delivered a British delegation to Athens this week, was London's mayor, Mr Boris Johnson, in whose city a considerable chunk of the wealth of Greece's elites has been parked in recent months.

Yet it was not for anything crisis-related that Mr Johnson, alongside a host of British dignitaries, entered the historic city, but for the ceremony that passed London the Olympic torch.

It was one of those surreal moments in a whole week of surreal moments — capped, of course, by the lightning strike that slightly delayed the crucial first meeting where France's pro-growth President, Mr Francois Hollande, had sought to chart a road ahead for Europe with austerity's leading champion, the German Chancellor, Ms Angela Merkel.

Over the two years or so since Greece first requested a bailout we've seen many a warning that the country's position in the Euro Zone wasn't likely to be an enduring one, but never has a “Grexit” (now a popular Twitter hashtag, alongside “Drachmail”) seemed more likely than it does at present.

Citigroup has put the odds of a Grexit at between 50 and 75 per cent. Signs range from the more subtle — the description of a Grexit as an “amicable divorce” by one policymaker and confident talk by Germany's Finance Minister of inbuilt “protective mechanisms”— to the more dramatic — a step-up in the pace of withdrawals from Greek banks.

It's also notable that for all his talk of Europe's need for growth, there is one point on which that the French President seems to be on the same page as Ms Merkel: the need for Greece to stand by its austerity commitments.

Games of chicken

“Reading between the lines of comments made by various European officials over the past few days, we think that Greece will be given the possibility to stay in the euro area only if it adheres to the Troika's programme,” say Barclays' economists.

For all the chaos and the billions of euros that would be needed to be pumped into other peripheral Euro Zone countries to stave off contagion, the issue that seems to trouble leaders the most is the signal that easing Greece's bailout terms would send to other nations undergoing painful structural reforms.

Which raises the question of what next month's Greek election re-run will bring: a coalition with Mr Alexis Tsipras, the charismatic leader of the first round's surprise success story, Syriza, at the helm, adamantly opposed to the “hell” of austerity? Or the return of old guards PASOK and New Democracy?

It's very hard to read at the moment: despite the very clear anger directed at EU institutions and austerity, nearly 80 per cent of Greeks say they want to remain within the Euro Zone. Even Mr Tsipras is a committed Euro Zoner. All in all, there seem to be many games of chicken afoot, with each side waiting for the first swerve.

Triple whammy

The trouble is that both from Greece's perspective as well as the rest of the Euro Zone, it is far from clear which is the better option.

There's been much criticism levelled at comparisons between Greece and other nations that have risen up from the ashes of default, such as Russia and Argentina.

Aside from not having to contend with the same currency issues, both had strong natural resource bases to work from, which helped convince investors back.

Greece, on the other hand, must not only contend with a smaller tool bag — being a land of tourism, agriculture and shipping — but will also face the triple whammy of default, a new currency and a devaluation of between 50 and 80 per cent, according to current estimates.

Moreover, observers argue that a return to the drachma won't resolve the nation's fundamental issues.

“If we leave the euro, we will still remain a badly administrated, badly run economy…we are not going to solve our problems,” says Ms Evi Papa, professor of macroeconomics at the European University Institute.

At the same time, it's hard to see how things could get much worse in an uncompetitive nation, where the recession is deepening, public sector debts remain unrelentingly high, youth unemployment is an astonishing 53.8 per cent, and in whose capital city one in 11 residents visits a soup kitchen daily, according to a recent Guardian report.

Flight of capital

“Greece has to leave the euro to restore its competiveness…it has a choice to restore control or carry on with what the troika says with miserable conditions in a hope that this slow miserable decline resolves itself into a foreign investment boom,” says Mr James Meadway, a senior economist at the New Economics Foundation.

Likewise for the rest of the Euro Zone: plans may be in place to limit the contagion of a Grexit, but is the firepower of the European Stability Mechanism and its predecessor, the EFSF, really enough to contend with the potential conclusions the markets could draw: that the Euro Zone isn't as un-exitable as its leaders suggest, triggering a flight of capital from Spain and Italy?

The direct costs will be high, too: European nations have so far lent a total of 53 billion euros to Greece in the first bailout, and a further 35 billion euros in the second, while the ECB has spent around 20 billion euros on the Greek bonds it holds, according to Berenberg Bank estimates.

But how much better is the current scenario where, over the week, Spanish bond yields rose to well over 6 per cent, its Prime Minister warned that it soon might not be able to borrow any more, investors dumped their shares in its third largest bank on rumours of a deposit run, and Moody's downgraded 16 lenders?

stronger economies

Caught between so many unknowns and moving parts it is impossible to know how things will play out. Still, there are reasons to believe that the doomsdayers are overstating their case.

For one thing, European leaders and institutions may be moving at what appears to be a snail-like pace and have shown a very high pain threshold, but when push comes to shove they have displayed an ability to adapt and do things that aren't in the rule book.

The ECB has shown itself to be a far more activist central bank than was ever originally intended. Also, the firewall capacity is substantial: the European Stability Mechanism which comes into effect in July has 500 billion euros available, enough to support the recapitalisation of Spain's banks, and the nation's refinancing needs for the next couple of years, says Berenberg's senior economist, Mr Christian Schulz, though he adds a caveat. “The question is whether it hits Italy…it would be possible to finance Italy for two years but not Spain and Italy together.”

Key to solving this will be a commitment from Europe's stronger economies that they would be willing, through the ESM, to do whatever it takes to support the peripheral nations, and for commitments to do the necessary from the European Central Bank.

Of course, given that these could ease pressure on Greece as it prepares for elections, such commitments aren't likely to be forthcoming at the moment, bringing us back to the unpredictable games of chicken.

(This article was published on May 20, 2012)
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