Innovation/Global Crisis Blog

Three Brief, Simple Comments on the Euro: Europe picks lose-lose

By Shlomo Maital  

 Abe Lincoln


1.  In 1860-4, 151 years ago, America fought a bitter bloody Civil War.  During the war 625,000 persons died – more than all the U.S. deaths in World War I and II combined.  The Civil War was not about abolishing slavery. It was about whether the individual States had the right to do whatever they wished, against the Federal constitution.  The South lost, the North won. America remained one country with a clear set of rules.  Never again was America’s existence questioned.

   Europe is today undergoing the same crisis.  It is not a Civil War but a financial one.  Nobody is dying.  All that is at stake is money.  What Europe does today will determine its future for a century.  The difference is, America had Lincoln, a strong and visionary leader, tough in war and forgiving in peace.  Europe has no Lincoln.    That may be the difference.

2.  Here, in 144 words, is the euro problem.   Greece cannot pay back what it owes. The proof: The ‘insurance’ premium on Greece’s short term debt (known as credit default swaps, CDS) is 98 per cent (you have to pay 98 euros to insure 100 euros of debt!).  So it is clear that soon, Greece will be in default on its debt. It is paying 23 per cent interest to borrow, no country can afford to roll over debt at that rate.  Who will bear the cost of Greece’s default?   Not us, say many Germans.  Not us, say private holders of Greek bonds.  And each day that passes without a solution, the costs to everyone mount.  Europe is incapable of applying the American model (swallow the losses fast, clean up the mess and move on) and instead follows Japan (sweep the losses under the carpet and stagnate for 21 years as a result). 

3.  In the language of game theory, there are only two outcomes of the euro crisis.  Win-win. Or Lose-lose. 

     * Lose-Lose.  Greece is forced out of the euro zone, returns to the drachma, the drachma drops by half, and Greek banks and businesses are all bankrupt, because their old euro debt doubles overnight, in terms of drachma. (How many businesses, or governments, can have their liabilities double overnight and remain solvent?) This is what happened to Argentina in 2001.  Nor will anyone lend to Greece for years – and you cannot do business without credit.   Greek people lose all their savings. Greece’s  GDP falls by 40 per cent.  Greek unemployment soars from 16.6 per cent today to 45 percent.   There is bloody social protest.  Greece is a huge loser. But so is Europe.   Frightened by Greece’s default, lenders bail out of Italy, Spain and Portugal,  pushing those nations toward default as well.  Italy is the 800-pound gorilla – its sovereign debt is massive.     The Greek crisis raises interest rates in Europe, and hurts economies throughout the 27 EU (27 minus Greece) nations.  Everyone loses, including America.  Even China.  Italy thinks China will ride to its rescue.  Does anyone think it is more than ridiculous for an EU nation to ask China to bail it out? 

   *   Win-Win.  Europe wakes up.  On one sheet of paper, Merkel writes down the total financial and economic costs of Greek default and exit from the Euro, for each of the 27 EU nations (including the 10 not in the euro currency zone), and for all taken together.  This is , say,  X trillion euros.  She then writes down, on the same one sheet of paper, the total cost of PREVENTING this massive loss.  This is, say, Y trillion euros.  The exact numbers are imprecise, but it doesn’t matter.  Because X is massively bigger than Y.  The cost of dismantling the euro is massively bigger than the cost of saving it.  Then Merkel, Sarkozy and others take the “Y” number, and split it up reasonably among the stronger European nations; a big European Stabilization Fund is mounted, so big that it might not even be needed, because its very existence shows currency speculators that betting against the Euro might cost them heavily. 

    Merkel then asks the German people:  Do you want to invest  100 billion euros today? Or do you want to lose, say, 200 billion euros, in the coming years, because we failed to invest? 

  The current European rules of the game require unanimity of all 27 nations for a major decision.  This is absurd. Little Slovakia, with 5 million people, can  (and is) sabotaging key EU decisions for the benefit of over 500 million people.  One percent of Europe is calling the shot!  Suspend the rules, and move on!  In 1860, America would have fallen apart if it had allowed Mississippi to veto anti-slavery laws. 

    Lose-lose or win-win.  Which would you choose?  Only in the Mideast do leaders actively and continually pick lose-lose.  Europe seems about to join us.