Eurozone’s weakest link is the voters

Eurozone’s weakest link is the voters

Gideon Rachman

The rise of anti-system parties threatens a currency that depends on consensus

http://www.ft.com/intl/cms/s/0/6201efaa-86f4-11e4-982e-00144feabdc0.html?siteedition=intl#axzz3NJTufFiB

The euro crisis is back. An election in Greece next month and the probable victory of Syriza, a far-left party, will frighten politicians and investors. Once again they will be engaged in a grim discussion of a connected series of possible horrors: debt-default, bank runs, bailouts, social unrest and the possible ejection of Greece from the eurozone.

It is somehow fitting that this crisis should break out at the very end of a year in which markets were lulled into believing that the euro crisis was essentially over. The cost of borrowing of debtor nations in Europe had fallen sharply, reflecting the widespread belief that the European Central Bank’s famous pledge to do “whatever it takes” to save the single currency has removed the risk of euro collapse.

That idea was always naive, as events in Greece are now illustrating. The weak link in the theory was European politics – and, specifically, the risk that voters would revolt against economic austerity and cast their ballots for “anti-system” parties that reject the European consensus on how to keep the single currency together.

If that consensus is broken the whole delicate house of cards of debt, bailouts and austerity begins to wobble. And that is what we are seeing in Greece now.

The development of the euro crisis has always involved the interaction of three elements: politics, markets and economics. When things are improving, the three elements can create a virtuous circle: voters elect mainstream politicians, the markets relax and interest-rates fall, and so the real economy improves, strengthening the position of the political centre. Alternatively, a vicious circle can set in. Economic distress leads to political radicalisation which frightens markets, which leads to higher interest rates, a heavier debt burden and more austerity – which in turns leads to further political radicalisation.

Those who hoped for a virtuous circle in Greece pointed out that the economy has finally returned to growth in 2014. The trouble is that the growth has been too slow and too weak to counter popular anguish at the state of the nation. The Greek economy has shrunk by more than 25 per cent since the onset of the crisis, youth unemployment is above 50 per cent and the state’s debt-to-gross domestic product ratio is considerably higher than when the crisis began. Under the circumstances, the rise of anti-system political parties is not hard to understand.

As ever, Greece is an extreme but not an isolated case in the eurozone. Austerity has also led to the rise of radical parties in other key economies. In Spain Podemos – a leftist party with a similar ideology to Syriza – is currently top of the polls. In France, the far-right National Front won most votes in the elections to the European Parliament last May. In Italy, extremists from both the right and the left are waiting in the wings, readying themselves for the failure of the reformist government, led by Matteo Renzi.

The rise of anti-system parties threatens the survival of the euro because the single currency depends on the maintenance of a pro-euro consensus among the 18 countries that have adopted the currency. As long as the leaders gathered around the table at yet another “emergency summit” in Brussels are all basically committed to the project, experience suggests that they will find a way to keep it together.

In theory, Syriza would not break that consensus. The Greek radicals say that they intend to keep their country inside the eurozone. The trouble is that they also want to write off about half of Greece’s foreign debt – a demand that is likely to prove unacceptable to the other eurozone members, above all, Germany.

Syriza may be right that Greece’s debts are essentially unpayable. But the policy of “extend and pretend” (extending the payback period, but pretending that all debts will eventually be paid) was essential to allow Angela Merkel, the German chancellor, to persuade her voters to agree to successive bailouts. If German voters are now told that all those loans to Greece will not, in fact, be repaid, they may also drift to the extremes. The rising force in German politics is on the right, not the left, in the form of the anti-euro Alternative for Germany (AfD) party. There are also external reasons for Germany to be very wary of giving ground to Syriza. A debt write-off for Greece may be affordable – but it would clearly open the door for similar demands from Italy, Portugal, Ireland, Spain and even France.

It is very easy to see how a train-wreck could happen in the eurozone. But how might it be avoided? There are two main ways. First, Greek voters may take fright. Syriza’s lead over the mainstream parties has narrowed in recent days and may fall further between now and election day on January 25. That could allow centrist parties to group together to keep out the anti-system parties – a pattern that is becoming fairly common in Europe. Second, even if Syriza takes power, it is possible that the party will moderate its demands once it looks into the abyss of debt default. There is nothing like empty Treasury coffers to concentrate the mind. The Germans, too, may make further compromises when they consider the potential anarchy unleashed by a Greek exit from the euro.

A messy compromise seems to be the outcome that the markets are betting on. That is what recent history suggests will happen. But the story of the euro is still unfolding. And a happy ending is far from guaranteed.

gideon.rachman@ft.com