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Greek Prime Minister Papandreou takes a high-stakes gamble

By calling a referendum, Greek Prime Minister George Papandreou risks being told to turn his back on the European bailout he welcomed a few days ago.


Call it a Hail Mary pass, a reckless bluff or a bold ploy to blunt political opposition.

Greek Prime Minister George Papandreou's sudden decision to hold a parliamentary confidence vote and then a national referendum on the bailout package for his beleaguered country has sparked questions about his end game and the consequences attached to it.

The latest twist in the long-running Greek soap opera came less than a week after Mr. Papandreou had welcomed a broad European bailout plan, including a 50-per-cent writedown of Greek sovereign debt held by banks. Now that debt relief – and the rest of the rescue package – will be held captive to a proposed referendum, the government may well lose.

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The latest polls show that more than 60 per cent of Greeks oppose the conditions attached to the rescue plan, which require deeper public cuts and close supervision of government ministries. And that opposition could intensify as the economy continues to unravel.

"Our sense is that economic life in Greece will be more difficult in the coming weeks [and]months, so by the time the referendum comes around people will be more miserable and angry," said David Ader, head of government bond strategy at CRT Capital Group in Stamford, Conn.

Some economy watchers argue that the Greeks would be better off if they turned thumbs down on the bailout. "Greece is stuck in a vicious cycle of insolvency, low competitiveness and ever-deepening depression," bearish economist Nouriel Roubini said recently. His solution: an orderly default on its debt, exit from the euro zone and a return to the drachma.

But other analysts say the dire consequences of abandoning the euro far outweigh any perceived advantages of an independent monetary policy.

The stakes are equally high for the rest of the world.

"If the Greek government were to announce tomorrow that it had decided to reintroduce the drachma, it would precipitate the mother of all financial crises," monetary expert Barry Eichengreen, an economics professor at the University of California, has warned. The result "would be the biggest bank run and financial crisis the world has ever seen."

In Greece, merely signalling a public referendum on the subject threatens a run on battered banks, as customers rush to pull out their euros. And a "No" vote would make conditions considerably tougher for businesses and the public alike.

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"The gain from having their own currency is overestimated," said Carsten Brzeski, a senior economist with ING Group in Brussels. "It could even backfire. Then, on top of that, you would have defaults all over the place. And not just on sovereign debt. Companies will need to default on loans they have in euros with other euro-zone companies. So there would be enormous pressure on business."

Nor would a default or devaluation do anything to narrow the fiscal deficit, a product of public expenses far outstripping tax revenues. Greece would have no access to financing in the capital markets. That's the case today, but there would be no helping hand from other euro-zone countries to cover the gap. So the government, whether led by Mr. Papandreou's socialists or the opposition, would still have to impose tough austerity cuts and raise taxes.

Having its own devalued currency would not even make Greece more competitive, said Mr. Brzeski, punching holes in a favourite argument of return-to-the-drachma advocates. What a weak domestic currency would do is drive up the costs of imports, translating into higher energy and food prices.

"For a worst-case situation, look at what happened in the Middle East and North Africa this year," when prices of staples shot up, he said. "I wouldn't exclude that in the Greek case, because this is a country with enormous social unrest."

The government may not survive long enough to hold a referendum. Widening divisions within Mr. Papandreou's ruling socialist party, and his slim parliamentary majority put the outcome of Friday's scheduled confidence vote in doubt.

Political analysts say Mr. Papandreou is likely to prevail, because his opponents will not want to be seen opposing the public say on the austerity cuts.

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Then it will come down to a challenge to the Greek people: Give up the notion of staying in the euro without facing further austerity, or take the far more dangerous road back to an independent monetary policy.

Mr. Papandreou's democracy gambit could work, once Greeks understand the full consequences of what amounts to a rejection of the euro and their country's possible departure from the European Union itself.

"I have no idea about the outcome," said Nicolas Véron, a senior fellow at Bruegel, a think tank in Brussels. "It would be foolish to predict. It's a very open situation."

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About the Author
Senior Economics Writer and Global Markets Columnist

Brian Milner is a senior economics writer and global markets columnist. In a long career at The Globe and Mail, he has covered diverse business beats, including international trade, the automotive industry, media, debt markets, banking and the business side of sports. More

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