Ring-fenced Greece: The evolution of a false promise first to an incredible threat and, then, to a dangerous delusion

19/05/2011 by

It all started with a false promise: The Greek ‘bailout’ (i.e. a combination of a gargantuan, expensive loan and severe austerity) would contain the Greek debt mountain and would, in association with the establishment of the EFSF a few days later, ring-fence Greece thus preventing the crisis from spreading to Ireland and the Iberian peninsula.

When this false promise was shattered by the reality of a deepening Greek recession (and an impressive contagion spree across the European continent), the same falsity metamorphosised into an incredible threat: Greece would be allowed to hang if it did not do as it was told. No fifth installment of the bailout money and no new funding for 2012 and beyond.

The problem with incredible threats, just like false promises, is that it is as if they have never been issued. And what makes a threat credible? The simple answer is: a discernible reason of why the threat’s issuer will, if some pre-specified condition is not met, be worse off ex post if she does not carry out the issued threat. For if it is common knowledge that she will suffer an inter-temporal penalty from carrying the threat out (as compared to her situation if she desists and allows the threat to be quietly forgotten), then the threat is hollow. (To give a silly example, my students stubbornly, and rationally, refuse pay notice to my threat that unless they study hard I shall hold my breath till I die.)

But, am I right in saying that the threat to let Greece hand is incredible? Is it true that Germany, the Netherlands, Finland, Austria, even France, would be no worse off if they let Greece default (if Greece does not do as it is being told)? Note that the Northerners do not have to demonstrate that there will have no price to pay for letting Greece fall. All they need, to make their threat credible, is a demonstration that, if Greece does not do as it is told, a Greek default, however painful, is less costly to them than a sequence of fresh loans.

The Northerners understand this well. They know that, unless the world believes that they will be at least as well off hanging Greece out to dry as they would be if they continued to finance its expanding debt, no one will take seriously their efforts to convince their electorates (and the markets) that they are on top of the situation; that they are dealing harshly with a ‘recalcitrant’ Greece; that they have more ammunition in their warehouses with which to threaten George Papandreou, the Greek PM, to ‘get on with it’.

The problem here is that the Northerners have no such ammunition left. In its May report on Europe, the IMF hinted at two issues that Europe steadfastly refuses to engage with, at its peril: The danger that comes from its banks and the systemic risks of continued austerity policies in the periphery. Regarding the banks, the IMF warns that “the European Commission and other regulatory agencies should continue to insist on bold restructuring and balance sheet repair in instances in which state aid has been provided…” As for the dangers of austerity, the IMF has this to say: “To overcome the crisis decisively, adjusting imbalances is not enough: the most critical factor in the longer term is restoring GDP growth in the crisis-affected countries to secure lasting prosperity.”

The Northerners, thus, have no excuse. Even the IMF, not an organisation renowned for its empathy with the fiscally distressed and economically weak, has warned them: It is the (German) banks, stupid. They cannot take the new crisis that will inevitably erupt if the present impasse continues or if Europe tries to resolve it by exacting more pounds of flesh from Greece (before it does the same in Ireland, Portugal, Spain etc.)

The Northerners, of course, understand perfectly well all this. But they refuse to countenance the only alternative that they have: a serious redesign of the eurosystem. Caught up in their own delusional game playing, they are holding on tenaciously to the game plan; the one that depends on showing that a Greek default will not be catastrophic for the rest of the eurozone; that the Crisis has been contained; that all the fuss is about Greece and Greece alone.

Thus, what began life as a false promise ended up as a delusion. For this is what the present claims regarding the Greek crisis constitute; a final retreat from reality, a grand delusion to end all grand delusions; a sloppy threat based on the erroneous judgment that Greece is different and, thus, treatable as ripe for an inconsequential fall.

Returning to reality, to close this piece, the Greek crisis cannot be quarantined. This is the beauty and the horror of a common currency: Without the shock absorbers of some modicum of common debt and surplus recycling, the tragedies of the weak become the calamities of the powerful. Just like the recession in tiny Nevada could not be kept separate from that of the richer and larger states, and would have brought the USA down with it if an attempt was made to subject it to a Greek bailout-like ordeal, so Greece’s debt crisis cannot be decoupled from the unfolding eurozone crisis (which it ignited in the first place). A Greek default will start a mighty bushfire that will rage through the eurozone’s heartland. It will begin with the Greek banking sector, leap over all defences and rekindle the ongoing smokeless flames in the German banking sector, undermine confidence in France, finish Ireland off, start a sequence of events that will lead to a Spanish earthquake and a predictable German exit.

Europe is, to conclude, caught in a typical Buridan Ass dilemma, behaving just like the famous philosophical ass (i.e. choosing paralysis over action) while the rest of the world is watching in disbelief, making polite noises to steer us, to no avail, in the right direction.

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