How The Greek Debt Crisis Could Wreck Europe

"Alexis Tsipras Syriza" by FrangiscoDer - Own work. Licensed under CC BY-SA 3.0 via Wikimedia Commons.

Unless you’ve been under a rock for the last five years, you’ve probably heard something about the Greek debt crisis. It’s preoccupied European policymakers for a while now and could end up complicating a host of other geopolitical situations, from Russia’s aggression in Ukraine to the migrant crisis in the Mediterranean.

Things have gotten progressively worse, to the point where this week could mark a significant, potentially transformational, shift in European politics. Will the European Union, led by Germany’s Angela Merkel in this case, impose prohibitive costs on Greece and force Grexit (“Greek exit” from the E.U.) or will it allow for another “one last chance”?

So, what is this about?

The Great Recession likely served as the immediate cause of the Greek economy’s collapse in 2009, but the government in Athens had racked up substantial debt over the years and created an untenable system. Like many others, the Greek economy fell into recession between 2007 and 2010, but that debt load spooked investors and caused private financial support to dry up.

That led to successive bailouts by the European Commission, International Monetary Fund, and European Central Bank (these three became known, collectively, as “the troika”). Greece wasn’t the only Eurozone country in this situation, either. Portugal, Ireland, and Cyprus all suffered a similar sovereign debt crisis and required Troika bailouts. Other countries, like Spain and Italy, saw their economies suffer sharp downturns but did not dip as far as Greece.

The Greek situation started to look better in 2014. Economic indicators began tilting upward, and private capital once again became available. But then in January, the leftist Syriza party took power in a snap election thanks to voter frustrations with the severe austerity measures imposed by the E.U. as part of the bailout terms. Germany, in particular, has been a leader of those pushing for greater austerity in getting Greece’s house in order. Because of that, there is little love lost among Greeks when it comes to Germany.

Current Prime Minister Alexis Tsipras has been aggressively anti-austerity. On election day, he said that the choice Greeks faced is “whether the troika will return to Greece…or whether, through tough negotiation, the country will claim its return to dignity.”

That has made the last five months…tense, to say the least.

Okay. How are things looking right now?

Not good.

E.U. officials are set to meet in Brussels Monday to decide the way forward. The European Central Bank announced Friday that it would help prop up Greek banks for at least a few more days until a final decision can be made on the broader support package. That decision, by the way, came after depositors pulled a staggering €1 billion from Greek banks on Friday.

But frustration with Tsipras’ government has led its eurozone creditors to threaten pulling additional funds of the table. With that likely in mind, Greek State Minister Alekos Flabouraris said that “[w]e are not going with the old proposal,” signaling a new approach coming from Syriza on Monday.

But time is quickly running out. According to The Guardian, Greece needs another loan so it can pay €1.6 billion to the IMF by June 30 or it will default – and likely be kicked out of the eurozone.

“We are close to the point where the Greek government will have to choose between accepting what I believe is a good offer of continued support or to head towards default,” said European Council President Donald Tusk on Friday.

And Jean-Claude Juncker, President of the European Commission (the E.U.’s executive branch and one of the bodies making up the troika), told Germany’s Der Spiegel that “I don’t understand Tsipras, adding that “the trust I placed in him has not always been reciprocated in kind.”

If Tsipras’ government accepts the troika’s conditions or comes up with an alternative plan amenable to its creditors, then it seems likely to result in an extension of the bailout. But it’s important to keep in mind that Syriza came to power largely because Greeks were fed up with the previous conditions of austerity levied by the troika. That fact – and the potential for political crisis in Athens – looms large over the negotiations.

Yikes. So what happens if a deal isn’t reached?

Yikes indeed. No deal makes a default almost impossible to avoid. And it also increases the chances of a Grexit – or Greece exiting the common European currency.

The Economist argues that Grexit would be a disaster, even if it has some short-term benefits for Greece:

Ejected from the euro, and possibly the EU, a country with a history of coups would risk becoming violent and even more corrupt.

That is one reason for the euro zone to think twice before ditching Greece. A failing state on the Aegean would be the EU’s problem regardless of whether its politicians accepted bribes in euros or drachmas—indeed, it would be a greater and less tractable problem than Greece is today. In addition, monetary union was supposed to be irrevocable. If, in fact, its members risk ejection, then contagion will be more likely to spread to other vulnerable economies, such as Portugal and Cyprus—if not in this crisis, then in the next.

A Greece without eurozone financial backing and possibly separated from the E.U. altogether would also find it harder to deal with the migrant crisis hitting Mediterranean countries particularly hard. The New Yorker recently reported that “the number of people arriving in Greece this year rivals the number of those coming to Italy: The I.O.M. says that at least 30,400 migrants have arrived in Greece as of May 12th, compared with thirty-four thousand in all of 2014. At least 35,100 have arrived this year in Italy.”

Writing in the Washington Post Sunday, former U.S. Treasury Secretary Lawrence Summers compared the current diplomatic failures to those that resulted in World War I a century ago. Summers warns of potentially devastating consequences should negotiations fail:

Make no mistake about the consequences of a breakdown. With an end to European support and consequent bank closures and credit problems, austerity will get far worse in Greece than it is today, and Greece will likely become a failed state to the great detriment of all its people and their leadership. Once Greece fails as a state, Europe will collect far less debt repayment than it would have with an orderly restructuring. And a massive northern emigration of Greeks will strain national budgets throughout Europe, not to mention the challenges that will come as Russia achieves a presence in Greece. The IMF is looking at by far the largest nonpayment by a borrower in its history.

A default could thus mean that a broke Greece would have to deal with stabilizing its domestic politics while also dealing with an unprecedented influx of migrants fleeing places like Syria, Libya, and elsewhere in the Middle East.

What if talks end up successful?

“Success” appears to be reaching agreement on austerity measures that convince the troika to extend bailout assistance for another six months or so, possibly to the tune of €10 billion.

But an extension won’t solve the systemic problems in Greece. Strong resistance to austerity there will make the possibility of a political challenge to Tsipras’ government more likely, which could cast doubt on any future assistance since E.U. leaders are increasingly wary of dealing with Athens.

Essentially, reaching a deal now amounts to kicking the can down the road.

This doesn’t sound good. I heard Vladimir Putin got involved – what’s he have to do with this?

Putin has been busily positioning himself as de facto leader of an anti-American coalition that also likes to thumb its nose at Western European elitism. Unfortunately for Athens, Russia isn’t in position to offer financial aid (thanks in large part to American sanctions related to Russia’s invasion of Ukraine). But Putin stood literally and symbolically with Tsipras last week in denouncing the European Union and Germany in particular, pushing his usual line that countries should be in control of their own internal affairs.

Of course, Greece’s place as part of the E.U. means that its economic affairs are also Europe’s. A Greek default would impact the rest of the E.U., and probably the rest of the world economy by extension.

But Syriza rode a wave of self-determination into power last January. On top of that, Athens is keenly aware that its fate is tied to Europe’s, and vice versa. Tsipras, speaking shortly after Putin at the St. Petersburg Economic Forum, said

The problem we are facing is deeply rooted in the process I have described. The EU should pursue its own path. The EU should go back to its initial principals of solidarity and social justice. Ensuring strict economic measures will lead us nowhere. The so-called problem of Greece is the problem of the whole European Union.

Tsipras has criticized the E.U. sanctions on Russia, calling them “economic war” back in April, and taken steps to cozy up to Moscow as relations with Europe have chilled. Last week, Tsipras and Putin announced a deal that would extend the Turkish Steam gas pipeline across Greece and provide Athens with €2 billion in needed funds.

“The E.U. should be applauding us,” Putin said. “What’s bad about creating new jobs in Greece?”

It remains to be seen whether this “grand pageant of solidarity, friendship and supposed economic cooperation,” as The New York Times called it, causes even more heartburn for Europe (and the U.S.) or proves to be just a lot of hot air from Athens and Moscow.

Written by Gene Giannotta

Gene Giannotta is a writer based in Washington, D.C. He reports on economic policy, finance and business news.