In yesterday’s post, I argued that the chain reaction that started with Greece, moved to Dublin and now is proceeding to the Iberian peninsula, is increasing in magnitude inexorably because of the CDO-like structure of the EFSF/EFSB ‘bail outs’ of heavily indebted eurozone members. So far, we have all been thinking of this process in terms of falling dominos. But then it hit me that we need to abandon the domino metaphor. The reason? Dominos tumble at a relative constant speed. They do not accelerate. Nor do they capture the essence of the vicious dynamic that is now gathering pace around the eurozone.
The main criticism about the EFSF/EFSB is that with every country that switches from being a lender with market access to being a borrower that is cut off from the markets, the costs of borrowing by the ‘marginal’ lender country rise, thus pushing it over to the other side. With every such ‘transition’, the cost of ‘bailing out’ the next country both rises and is born by a smaller pool of countries. It is a dynamic far more calamitous than the domino allegory can capture.
So, is there a better metaphor? Yes, I think there is. It is that of a group of disparate mountaineers, perched on some steep cliff-face, tied to one another by a single rope. Some are more agile, others less fit, all bound together in a forced state of solidarity. Suddenly an earthquake hits (the Crash of 2008) and one of them (of a certain Hellenic… disposition) is dislodged, her fall arrested only by the common rope. Under the strain of the stricken member’s weight, dangling in mid-air, and with some extra loose rocks falling from above, the next weakest (or ‘marginal’) mountaineer struggles to hang on but, eventually, has to let go too. The strain on the remaining mountaineers greatly increases, and the new ‘marginal’ member is now teetering on the verge of another mini free-fall that will cause another hideous tug on the remaining circle of ‘saviours’.
Will the stronger members hold on? Will they manage to reach the peak, carrying the hangers-on with them, before the ruthless dynamic plunges the whole group into the underlying ravine? Or will the strongest members cut themselves loose with their sharp knives (and revert to something akin to the Deutsch Mark)?
It is an appealing allegory for the euro crisis that is currently unfolding. With each country that leaves the bond markets, and seeks shelter in the EFSF/EFSB, the next ‘marginal’ country faces higher interest rates while the average country’s burden also rises. This is a dynamic from hell. It is like watching a tragic accident happen in slow motion. Only the reality of the euro crisis is, in fact, much worse. For there is another aspect of it that the mountaineering example does not capture: The banking crisis which is intensifying with each ‘transition’ of a country into the ‘receiving’ end of the EFSF/EFSB.
Indeed, as the tragedy on the cliff-face deepens, the drama in the banking arena intensifies too, the budget deficits grow (as states pump more money into the banks and the austerity measures reduce economic activity and, in turn, the governments’ tax take) and, in a never-ending circle, that parallel drama dislodges the next ‘marginal’ country from the cliff-face.
In conclusion, the euro crisis is too fierce to be related by the imagery of falling dominos. The mountaineering metaphor does a better job, even though it also fails to capture the true dimensions of the drama. On the one hand, it can only relate one of the crisis’ two aspects (that of the sovereign debt conundrum and the inadequacy of the EFSF/EFSB), ignoring the second, equally crucial, aspect (the banking sector debacle). On the other hand, it also fails to convey the very real option which Europe has, but which our mountaineers lack: That of escaping the whole thing as if by summoning a nearby helicopter that can safely carry the whole group to safety. What helicopter? Read the Modest Proposal for a quick guide to how such a rescue can be effected.
For now the question is begged: If I am right that a helicopter ride is available (in the form of the Modest Proposal), why is it not summoned? Why are the stronger members vetoing its use? It turns out that they are not really sure on how keen they are to see the weaker members escape cleanly from the cliff-face. A truly sad conclusion, I dare add.