3 Nov 2011

Papandreou faces axe after bluff called by Merkozy

Athens, outside finance ministry 12.45

As we stand here there is a Cabinet meeting happening inside the Greek Parliament. Papandreou looks unlikely to survive it. Finance minister Evangelos Venizelos was meeting with the rural minister. As he left I shouted at him a question: “is Greece going to return to the drachma?” No answer, but Venizelos gave a nervous smile getting into the car. It appears that the meeting was to shore up Cabinet support against Papandreou’s referendum.

Venizelos has form for challenging Papandreou. In 2007 he got 38% of the vote for the Pasok leadership then in opposition. He is also a constitutional lawyer, keenly aware of the legal subtleties around his boss’s shock call for a referendum.

At 4.45am this morning Venizelos returned from Cannes and issued an astonishing statement. It firmly disputed Papandreou’s plan to effectively put Greece’s euro membership to a vote. “This acquis by the Greek people cannot depend on a referendum”. The third paragraph is vital. “Greek banks are totally secure, as an integral part of the European banking system.”

As I wrote yesterday, if there is a credible sense of the drachma returning there would be a sensible and rational increase in capital flight now, ahead of the reintroduction of capital controls, shrinking of redenominated savings etc. in fact this has been occurring in slow motion over the past 18 months, down something like €60 bn.

A quick caveat here: Greece’s banking system was in comparatively strong health, there was no private sector bubble here. Their problem is their huge holdings of soon to be written down Greek debt, the now larger tail risk that Greece will return to the drachma, and the subsequent exit of euros from Greece’s banking system.

The way Venizelos has written his statement suggests that the “total security” of the Greek banking system is contingent on being an integral part of the European banking system. This is a not very subtle reference to the massive role of the European Central Bank in using its funding facilities to replace the Greek banking system’s lost deposits. It was this ultimate power that the ECB’S used to force Ireland and Portugal to ask for a bailout last year.

This is the nexus that the US and the UK is most fearful about, what US Treasury Secretary Tim Geithner called: “a cascading default, bank runs and catastrophic risk”.

It is why Papandreou’s gambit fell on deaf ears, and he was humiliated by Merkel and Sarkozy in Cannes last night. They called his bluff. The EC is now preparing the modalities of Greek euro exit in order to ensure that if the referendum happens, that whatever the question, it is seen as a straightforward choice for Greece of euro or no euro.

That is why Venizelos stepped up today. And it is why Papandreou is far more likely to fall before we get anywhere near a referendum. But is the prospect of an election any more stabilising than the referendum? Polls indicate a messy coalition government here. As one observer here told me, “even in Athens, democracy isn’t always civilised”. I will try to update during a dramatic day.

Waiting for Venizelos: hear Faisal’s audioboo here

Follow Faisal Islam on twitter: @faisalislam