High Stakes Game of Euro Chicken

05/02/2015 15:15 GMT | Updated 07/04/2015 10:59 BST

Grexit on the table again

Left-wing Syriza lead by Alexis Tsipras has not wasted time after winning the Greek elections: he formed a coalition with the right-wing anti-bailout Independent Greeks and the new government is now involved in a very high-stakes game of chicken with the Troika (the European Commission, the ECB and the IMF).

Many fear that a Syriza win could eventually spell the end of Greece's Eurozone participation. Earlier, Syriza's leader did indeed hint at this but lately his tone has become more moderate. Syriza's bark will turn out to be worse than its bite, partly because to the surprise of many, in recent years the Greeks have become more enamoured of the euro - almost three-quarters want Greece to stay in the Eurozone.

Tough talks

In Germany, some voices have said that Greece should quit the euro if it is so keen to thwart reforms and forgo spending cuts. This is probably a ploy used by Merkel to gain an advantage ahead of the negotiations about a (potential) new aid package. The trade-off could be debt repayment extensions - 'extent and pretend' - in exchange for job market and pension reforms, less bureaucracy, etcetera.

In other words, events could take a turn for the better. After all, both Germany and Greece will benefit more from a compromise than from a collapse of the Eurozone (70-80% of the Greek national debt, which runs to over €300bn, is owned by the Troika, in which the Germans have the largest share).

The Greeks will now have to haggle with the EU, ECB and IMF in order to receive the remainder of the promised aid package. Simultaneously, Greek banks will be hoping for more cash injections by the ECB. If no agreement is reached on 28 February (a deadline that has already been extended by two months), Greece will not be entitled the outstanding tranche worth seven billion euro. The ECB has already tightened the screws by will constricting the requirements regarding Greek collateral.

German-Greek clash

So we can expect a game of chicken: the Greeks and the Troika will drive straight towards each other, but both will - probably at the last moment - alter their course. At the same time, we cannot rule out an unwished-for frontal collision. If so, inflated egos on both sides of the table may well play a part.

On the one hand because the German economy is doing quite well, with very low unemployment rates. In addition countries such as Spain, Ireland, and Portugal are in a much better state than a few years ago, the financial sector has become healthier, and the Eurozone's foundations have been reinforced. That is to say Germany and others could convince themselves that it will be possible to absorb the fallout of a Grexit. Based on this, a rigid approach is conceivable.

This could stir up ill will among the Greeks, who may believe that their negotiating hand is stronger than in 2010 and 2012. Greece now has a primary surplus, a small current account surplus, and a modicum of economic growth. National pride could also rear its head. Numerous economic studies show that it makes more sense for Greece to stay in the Eurozone, but rationality is not a given. In the past, emotions and nationalism did sometimes win the day in comparable situations.

Markets complacent

But as I said, a Grexit is the alternative scenario. Quite likely, Greece will come to an agreement with its reform-loving creditors (although this could initially result in a lot of political turmoil under a fragile government). The markets are of the same opinion. Whereas the Greek 10-year yield is around 9-10%, in March 2012 it almost hit 50%. Plus, long-term interest rates in other vulnerable countries have not risen concomitantly. Stock markets are also not really panicking. Investors are not worried that a Greek crisis would be contagious and the QE announcement of the ECB seems to overshadow what worries the markets could have had following this outcome of the Greek vote.

Eurozone still in trouble

Even if Europe and Greece come to an agreement, this does not mean to say that the euro bloc is out of the woods. The Greek woes are similar to problems in many other member states while the overall outlook is sombre. The main economic issues are:

• High unemployment

• Deflation (fears)

• Stagnation

• High debt

• The ticking demographic time bomb (by 2030, 25% of Europeans will be over 65).

In addition, two political developments are very worrying:

• General voter dissatisfaction

• The rise of movements and parties that are both populist and extremist

The foundations for a strong economic revival in Europe are inadequate. Whatever else happens in 2015, monetary and fiscal impulses in themselves will not be enough to get the economy back on its feet. What Europe needs is an open society, which is amenable to immigration, with flexible job markets and substantially higher labour participation rates. The Greek and over a handful of coming European elections will not made things any easier, that's for sure.