Greek drama

Greece is struggling to raise money by raiding local municipalities' and pension funds' reserves to meet the due payments to the IMF and the ECB. Some 40 billion euros ($43 billion) have been withdrawn in the past three months from the Greek banking system which has seen shares collapse. As Greek sovereign bonds are no longer accepted as collateral due to their junk bond status (and they have been downgraded again in the past couple of weeks) the banks are entirely dependent on emergency liquidity assistance currently running at over 70 billion euros. In an extraordinary move toward a euro member state, the Greek banks have also been urged by the ECB not to invest in treasury bills issued by the government.

Indeed to many Greeks it looks like this continuous squeeze on the country, seemingly inspired by the Germans and reinforced by the IMF and more recently the ECB, is aimed to bring the country to its knees and engineer a political crisis that might result in either a referendum or new elections to solidify the position of Syriza , the radical left wing party currently leading a coalition with the right wing Independent Greeks.

Syriza, the argument goes, would then jettison the extreme communist and ex-communist factions and end up being more like a center-left government of the type Europe knows and understands, closer in spirit and ideology to the old Pasok. Or even form a government of national unity in which the New Democracy which was ousted in late January could be a part. It would effectively mean acceptance by the population of the continued austerity conditions demanded by the creditors in return for staying in the euro and return to some normality. The eurozone will have shown its mettle and won.

Playing with fire

But this is playing with fire.The current Syriza coalition has already made numerous 'somersaults' or 'kolotoumbes' as the Greeks refer to U-turns. That is fine as it goes as much of the population had voted for Syriza in protest and frankly would be happy if even two out of 10 pre-election pledges were met. But there are clear divisions appearing and demonstrations in the street. And even though Prime Minister Tsipras remains popular the clouds are gathering.

Talk of default and departure from the euro has certainly risen considerably over the past few weeks. But if bank liquidity by the ECB can be maintained even in the case of default then Grexit does not necessarily have to follow default. Capital controls may be necessary or Greece may instead substitute the (lack of) euros domestically with an alternative currency to cover internal payments needed to sustain the public sector.

But what if Greece was forced to leave the euro? It would make little sense then for it to honour any of its debt as the cost in drachmas which would replace the euro and which would immediately devalue would be enormous. Default would therefore be inevitable. The banking system would be bankrupt and Greece would have to support it by issuing money. Worries of hyperinflation would materialize. The value of money held in accounts by the Greeks would decline hugely. Capital controls and restricted access to bank accounts would be inevitable. Any obligations in euros by companies would become astronomical and therefore would not be honoured either. And there could be political chaos ahead that is particularly worrying given the current geopolitical tensions in the region.

Things could normalize at some point, especially if the debt burden was removed. The IMF would probably have to move in to assist and it may in fact cost it much more than its lending to Greece at present to prop up a collapsing country. And if it remained a member of the EU, Greece would get emergency funding and a bigger allocation of structural funds. But it would find it hard to borrow again from capital markets and its finances and therefore its economy would struggle for a long time to come.

'Grexit' is no solution

Greece is not a major commodity producer like Argentina and therefore would not benefit to any considerable extent from any devaluation. As it is, its huge internal devaluation through cutting salaries by over 35 percent as a result of the IMF-inspired austerity has hardly improved competitiveness. What will be obvious is that the austerity measures, though bringing down the deficit, have done very little to change the structure of the economy and move the Greek administration and governance system to the 21st century. The greek population, which accepted this austerity if it promised real change, feels totally let down.

'Grexit' would make little sense for the eurozone as a whole. For a start creditors would not get the 240 billion euros owed by the Greek back. Germany would lose at least 50 billion euros in terms of direct lending to Greece. The ECB would take a hit too.

And the world would realize that the eurozone is reversible and if Greece can leave, so can others. The Quantative Easing (QE) firewall can only do so much to stabilize markets and the European Stability Mechanism resources are not deemed to be sufficient to deal with a crisis in a larger country. There are high debt to GDP ratios, not that dissimilar from Greece's, in places like Ireland, Portugal and Italy for example; an unemployment rate stubbornly stuck above 11 percent; deflation; still serious structural problems in many countries which have in fact done very little reform; imbalances still remaining both in fiscal budgets and in the current account with surplus countries refusing to stimulate domestic demand - Germany being the main culprit. Investment and lending and growth remain subdued.

No progress this weekend and a 'Grexit' by accident or design could well lead to the beginning of the end of the euro project as we have come to know it.

Vicky Pryce is Chief Economic Adviser at the Center for Economics and Business Research and author of 'Greekonomics.'