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The increasingly bizarre standoff between Greece and the Eurozone, explained

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  1. Greece and the Eurozone appeared to reach a deal early on Thursday morning, US east coast time, and then it fell apart.
  2. Financial markets jacknifed, with a whole range of indicators — interest rates on Greek bonds, the euro:dollar exchange rate, etc. — shooting one way then the other way then back again in a very brief span of time.
  3. The key is that Greece's new government made an offer everyone thought European officials would agree to, and then the German finance ministry turned it down.
  4. This could be a sign of ever-narrowing disagreements and a prelude to an 11th-hour deal, or a weird moment after which everything spins out of control.

Greece's new government has big promises and little leverage

The backdrop is that on January 25th, a far-left party called Syriza won an election in Greece. Syriza has never served as a member of a coalition before, but suddenly it was running the show. Syriza's platform called for an end to the austerity budgets forced on Greece years ago, called for the re-hiring of many laid off civil servants, called for the cancellation of privatizations that were promised by earlier Greek governments, and called for a doubling of the minimum wage. But Syriza's platform also called for Greece to stay inside the Eurozone.

Syriza's problem is that it has very little leverage with which to make all of those things happen.

As a result, after weeks of huffing and puffing, it appeared early this morning that Greece was prepared to kick the can down the road and accept a deal with the Eurozone in which there would be no big changes for at least six more months. Then Germany rather unexpectedly rejected that proposal. Two consecutive tweets from Die Zeit's economics editor tell the story:

But no!

What the fight is really about

The conflict between Greece on the one hand and Germany and other Eurozone states on the other can get somewhat confusing because a lot of the attention is ostensibly on the question of whether or not Greece will request or accept a new extension of the bailout program that's been in place for years. A bailout extension means that Greece gets new loans that let it roll over old loans.

Economically speaking, though, this is a red herring. Greece currently runs what's called a primary surplus, meaning that tax revenue covers current spending. New borrowing is only needed to pay off interest on old borrowing. This superficially appears to give the Greek government a lot of leverage. The only thing they need new money from creditors for is to pay off old debts to creditors, so in theory they can just walk away, default, and wipe their hands of the whole thing.

The real issue is Greek banks.

Greek banks are regulated by the European Central Bank. Greek banks also depend on the ECB for liquidity — for the short-term loans banks need to stay in operation. If the ECB decides it's lost faith in the Greek government, it can use either the liquidity lever or the regulatory lever to squeeze the Greek banking system. If the Greek banking system is squeezed hard enough, Greece could be forced to leave the Eurozone. If Greece doesn't want to leave the Eurozone, Greece needs to stay on the ECB's good side. And the ECB has made it clear that staying on the ECB's good side means reaching a deal with the other Eurozone countries over the bailout.

So the bailout is crucial, but not because of the money involved. It's simply the issue on which the ECB has chosen to make its stand.

What Greece proposed

After weeks of acrimony, name-calling, and occasional bouts of confusion the Greek government made a proposal on Thursday that seemed like a huge climbdown. They had previously said they wanted to tear up the old deals, and now said they wanted a six months extension. The letter from the Greek finance ministry seemed to simply ask that the status quo endure for six more months, while asking the rest of the Eurogroup to simply acknowledge Greece's desire for more lenient terms.

This seemed to most like Germany essentially getting what it wanted, so the rejection by German Finance Minister Wolfgang Schäuble came as a big surprise.

The larger political context

Most of the best coverage of the situation is found in business sections or business-oriented publications. But an important subtext to the negotiations concerns partisan politics. Syriza is the only far-left party to participate in a governing coalition in Europe. Europe's other governments are either run by center-right parties who wouldn't mind seeing a far-left government humiliated for ideological reasons, or else by center-left parties who wouldn't want to see a far-left party victorious lest it induce their own base to defect to the local far-left.

In particular, European leaders don't want to do anything that will further encourage the rise of the new, leftist Spanish party Podemos, a factor that is probably leaving the Greeks with less flexibility than they might enjoy in a vacuum.

What happens next?

The German Finance Ministry has not really clarified the nature of its opposition. Nor have we heard from the finance ministers of other Eurozone countries. It is certainly conceivable that Germany's objections will turn out to be small, especially after consultations with other countries. On the other hand, it is also possible that the Germans will genuinely hold to a hard line and insist that Syriza utterly and completely surrender.

As is often the case in Eurozone matters, the need to coordinate over a dozen different national governments — many of which are themselves multi-party coalitions — plus several distinct European-level institutions tends to create a fair amount of confusion. At the moment, everyone seems to be playing things relatively quietly, which could be a sign of an imminent deal or an imminent blowup.