G8 summit: A clash that could make or break the eurozone

THE soup kitchens are twice as busy as they were a year ago. Those who don’t get a meal scour through rubbish bins in search of scrap they can sell. Figures show that 23,800 Greeks emigrated to Germany alone last year, 90 per cent up on the previous 12 months. Those staying behind are, it is reported, queuing up to get into German classes in the hope of finding work north. And yet, Greece’s political establishment warns, this is just a taster for what would happen if this crippled nation of 11 million people leaves the Eurozone in the next few weeks.

Even back using drachmas, the country (where archaic labour laws still allow many to retire in their 50s) would still be in the red, unable to afford all the food, oil, gas and medicine it needs, most of which it imports from abroad. Businesses would go to the wall. A wave of emigration would ensue. The government would be forced to print money in order to pay wages, the people who stayed would end up returning to barter. Black humour has kicked in: a local TV station last year ran a skit about how the drachma, kicked into outer space in 2001, crashes back to earth as a meteor and destroys everything. The title? “Drachmageddon.”

Bad and badder. The choices for Greece, saddled with its ¤250 billion of debt, and a zombie economy, are only awful. On the one hand there lies years of EU-imposed austerity as the country is ordered into cold turkey to wean itself off its spendthrift ways in return for a quarterly fix of euros. On the other, lies the option of isolation, stagflation, anarchy and a return to virtual third-world status: Europe’s very own Zimbabwe.

Like the Olympic flame which began its journey from Athens to Cornwall on Friday, so the fear across the continent is that the burn-up in Greece will spread to inflame other countries too. An inconclusive election two weeks ago now sees the country return to the polls on 17 June, with the Greeks aware that it is not just their own fate which it will decide in that vote, but possibly the fate of the rest of the continent too. Left-wing politicians now appear ready to take on the role of suicide bombers for the euro project. So how is this high-stakes political battle likely to play out? And how, here in Scotland, might ordinary families be affected?

American economist and Nobel laureate Paul Krugman has called it “Eurodämmerung”.

“We have moved quite rapidly to a point where it is easy to see how the whole thing could fall apart in a matter of months. I hate to sound apocalyptic but it really is quite shocking.” Under Krugman’s helpful step-by-step guide, the collapse of the Eurozone goes as follows: in Greece, a new anti-austerity government refuses to accept the eye-watering terms of its euro bail-out. It refuses the cash, runs out of money, and is forced to quit the euro in order to print its own drachmas. In Spain, Italy and Portugal, where attention quickly turns, people rush to withdraw all their precious euros from local banks and move them to Germany, the only safe haven left. The banks run out of money, the countries go bust, and follow Greece out of the door. “End of the euro,” says Krugman.

Such a scenario is welcomed by Eurosceptics who argue that, free from the straitjacket of the single currency, indebted nations like Greece and Spain would be able to devalue their currencies, knock out cheap exports, and pay their way out of trouble. In practice, both politicians and economists are warning that the consequences will ensure a re-run of the credit crunch of 2008.

Professor Brian Ashcroft, of the Fraser of Allander Institute at Strathclyde University, notes: “A ‘Grexit’ is the situation where we have the most to lose because the impact will be felt right through the banking system.” While British banks would lose comparatively small sums if Greece defaulted on its debts, they would be massively more exposed to countries next in line, such as Spain.

If such a large country defaulted, Professor Ashcroft notes, “it then becomes a credit crunch problem where our banks (which have lost the debts owed) have to restore their own balance sheets. That means they lend even less.” The consequence of that would be, as in 2008 and 2009, once again to starve firms of much needed credit, as they seek to run their businesses, and to block off loans for households hoping for a better mortgage.

Robert Chote, the head of Britain’s Office of Budget Responsibility, which has already slashed its growth forecast in the UK to a limp 0.8 per cent, said he was particularly concerned about the possibility that a second deep recession would leave permanent scars. He said: “That means not just that the economy weakens and then strengthens again – it goes into a hole and comes out – but that you go down and you never quite get back up to where you started.”

He added: “The concern is that you end up with an outcome in the Eurozone that creates the same sort of structural difficulties in the financial system and in the economy that we saw in the past recession, and that has consequences both for hitting economic activity in the economy, but also its underlying potential.”

The parallels with 2008, when the collapse of Lehman Brothers sparked a domino effect across other banks and insurance firms, are exact – except this time with nations. That experience could effect this crisis both ways, analysts say. On the one hand, the experience has taught policymakers and banks about how to prepare. British banks now have far more cash in their vaults, leaving them better prepared. Thus it is argued that a Grexit would, for the UK, be less of a bump in the road than the turmoil which followed in 2008, when RBS was two hours away from shutting its cash machines.

But there is also concern that memories of that period are making the likelihood of a second crash most likely, as edgy depositers, remembering the crisis, flee for the exits. And, while British banks may be healthier, those on the continent, particularly in Spain, remain scarily short of cash to withstand any sudden shocks. It is this lack of confidence which, last week, saw shares in the part-nationalised Spanish bank Bankia fall by 30 per cent at one point after reports customers had withdrawn more than ¤1bn in a week. In Spain, the weakness of the banks is only heightened by the billions of pounds of bad loans behind the construction of thousands of now-empty properties during its housing bubble.

The contagion effect of this uncertainty is already impacting on UK families. The estimated £165bn wiped off the value of the London stock market over the last month, caused by the euro crisis, has ensured that insurance policies, pension funds, unit trusts and ISAs have all fallen in value once again. Furthermore, with the fear of default once again stalking the banks, so the price of loans between banks and financial institutions has risen. The banks are now passing this increased cost on to households and businesses through higher mortgage rates and interest rates.

Back in Greece, there will be at least one boom industry over the coming weeks, say analysts: polling. The outcome of the election on 17 June could decide where the entire continent goes next. A win for the pro-bail-out mainstream parties would see the muddling going on. But, now rising fast, is the option offered by the head of the left-wing Syriza party, Alexis Tsipras, who appears ready to press the nuclear button. “If they [Europe] proceed with unilateral action on their side, in other words they cut off our funding, then we will be forced to stop paying our creditors, to go to a suspension in payments to our creditors,” he said on Friday.

Aware that such a move would trigger Krugman’s Europe-wide death spiral, Tsipras appears ready to gamble that Europe’s central bankers and Germany’s Angela Merkel will be forced to dump their current starvation strategy, to avoid the euro’s collapse. For economists such as Ashcroft, the ultimatum is worth it. “The Greek people are saying we are not going to put up with this any more. We are going to vote in somebody who is going to change this. This is what is needed otherwise it will go on and on and gradually the Eurozone will crumble away.” Only such an ultimatum, so the theory goes, would finally force Germany to accept the logic of the currency union it dominates – where Germany and the European Central Bank stand behind Europe’s crippled economies, and ensure that its dodgy banks are properly repaired.

The other side of the bargain would then be for the Eurozone to form the close-knit fiscal union which gives the centre control over the spending habits of individual nations. “The Eurozone has to accept the consequences of a single currency,” notes Labour’s former chancellor Alistair Darling. “It means increasing economic and political union. It also means the richer parts helping the poorer areas. That is what happens in the United States.”

That is also the message that David Cameron, Barack Obama and French president François Hollande were giving to Merkel at the G8 yesterday. Labour leader Ed Miliband also threw in his own, more barbed, call, demanding an end to what he called the “Camer-kozy” economics of austerity. Like the last great female European leader however, Chancellor Merkel, is not one for turning. A cosier deal for Greece would, she believes, only prompt other bailed-out nations such as Ireland and Portugal to demand the same. Moreover, her right-wing CDU-CSU coalition government could fracture entirely if she were seen to be putting the priorities of the German taxpayer behind the reckless Greeks. Merkel and Tsipras are set to meet later this week. The staring match has begun. Who will blink first?