THE European Union seems to have adopted a new rule: if a plan is not working, stick to it. Despite the thousands protesting in Athens, despite the judders in the markets, Europe’s leaders have a neat timetable to solve the euro zone’s problems. Next week Greece is likely to pass a new austerity package. It will then get the next €12 billion ($17 billion) of its first €110 billion bail-out, which it needs by mid-July. Assuming the Europeans agree on a face-saving “voluntary” participation by private creditors to please the Germans, a second bail-out of some €100 billion will follow. This will keep the country afloat through 2013, when a permanent euro-zone bail-out fund, the European Stability Mechanism (ESM), will take effect. The euro will be saved and the world will applaud.
Time to stop kicking the can
That is the hope that the EU’s leaders, gathering in Brussels as The Economist went to press, want to cling to. But their strategy of denial—refusing to accept that Greece cannot pay its debts—has become untenable, for three reasons.

First, the politics blocking a resolution of the euro crisis is becoming ever more toxic (see article). Greeks see no relief at the end of their agonies. People are protesting daily in Syntagma Square against austerity. The government scraped through a vote of confidence this week; the main opposition party has committed itself to voting against the austerity plan next week and a few members of the ruling Socialist party are also doubtful about it. Meanwhile, German voters are aghast at the prospect of a second Greek bail-out, which they think would merely tip more money down the plughole of a country that is incapable either of repaying its debts or of reforming itself. As the climate gets more poisonous and elections approach in France, Germany and Greece itself, the risk of a disastrous accident—anything from a disorderly default to a currency break-up—is growing.
Second, the markets are convinced that muddling through cannot work. Spreads on Greek bonds over German bunds are eight points wider than a year ago. Traders know that Greece, whose debts are equivalent to around 160% of its GDP, is insolvent. Private investors are shying away from a place where default and devaluation seem imminent, giving the economy little chance of growing. The longer restructuring is put off, the more Greek debt will be owed to official lenders, whether other EU governments or the IMF—so the more taxpayers will eventually suffer.
The third objection to denial is that fears of contagion are growing, not receding. Early hopes that Greece alone might need a bail-out were dashed when Ireland and Portugal also sought help. The euro zone has tried to draw a line around these three relatively small economies. But the jitters of recent weeks have pushed Spain and even Italy back into the markets’ sights again. The belief that big euro-zone countries could be protected from attack has been disproved. Indeed, far from fears of contagion ebbing, the talk is of a Greek default as a “Lehman moment”: like the investment bank’s bankruptcy in September 2008, it might unexpectedly bring down many others and devastate the world economy.

While the EU’s leaders are trying to deny the need for default, a rising chorus is taking the opposite line. Greece should embrace default, walk away from its debts, abandon the euro and bring back the drachma (in a similar way to Britain leaving the gold standard in 1931 or Argentina dumping its currency board in 2001).
That option would be ruinous, both for Greece and for the EU. Even if capital controls were brought in, some Greek banks would go bust. The new drachma would plummet, making Greece’s debt burden even more onerous. Inflation would take off as import prices shot up and Greece had to print money to finance its deficit. The benefit from a weaker currency would be small: Greece’s exports make up a small slice of GDP. The country would still need external finance, but who would lend to it? And the contagion risk would be bigger than from restructuring alone: if Greece left, why not Portugal or even Spain and Italy? If the euro zone were to break up it would put huge pressure on the single market.
The third way
There is an alternative, for which this newspaper has long argued: an orderly restructuring of Greece’s debts, halving their value to around 80% of GDP. It would hardly be a shock to the markets, which have long expected a default (an important difference from Lehman). The banks that still hold a big chunk of the bonds are in better shape to absorb losses today than they were last year. Even if Greece’s debts were cut in half, the net loss would still represent an absorbable proportion of most European banks’ capital.
An orderly restructuring would be risky. Doing it now would crystallise losses for banks and taxpayers across Europe. Nor would it, by itself, right Greece. The country’s economy is in deep recession and it is running a primary budget deficit (ie, before interest payments). Even if Greece restructures its debt and embraces the reforms demanded by the EU and IMF, it will need outside support for some years. That is bound to bring more fiscal-policy control from Brussels, turning the euro zone into a more politically integrated club. Even if that need not mean a superstate with its own finance ministry, the EU’s leaders have not started to explain the likely ramifications of all this to voters. But at least Greece and the markets would have a plan with a chance of working.
No matter what fictions they concoct this week, the euro zone’s leaders will sooner or later face a choice between three options: massive transfers to Greece that would infuriate other Europeans; a disorderly default that destabilises markets and threatens the European project; or an orderly debt restructuring. This last option would entail a long period of external support for Greece, greater political union and a debate about the institutions Europe would then need. But it is the best way out for Greece and the euro. That option will not be available for much longer. Europe’s leaders must grab it while they can.