Published on TheHill.com on November 1, 2011
Like the assassination of the Austrian archduke in Sarajevo that triggered World War I, the decision of Greek Prime Minister George Papandreou to submit his nation’s bailout deal with the European Union to a national referendum could be the spark that brings down the international financial system. The financial interdependence of the world’s banks is so like the interlocking alliances that predated World War I that it is easy to see how an event in a faraway little country could cause a global disaster.
The big powers of Europe have made headlines by agreeing to beef up their bailout fund with extra cash while demanding that the banks that lent Greece money take a 50 percent “haircut” or loss on their bonds and that Athens initiate yet another round of austerity cuts and tax increases. But what made no headlines was what Germany and France refused to do: They would not guarantee Greek bonds by putting their own national credit on the line. On a truly integrated continent, the decision to back up the debt of a member country would be a no-brainer. Recall how George Washington and Alexander Hamilton insisted on federal assumption of colonial Revolutionary War debts at the very outset of our experiment with union.
But the big powers in Europe said no. By increasing the bailout fund but not guaranteeing the debt, they invite speculators to test the fund to figure out if more money will be forthcoming as losses mount. A guarantee would have put a halt to the possible speculation, but the Europeans — perhaps fatally — refused to take that leap.
Now the decision to pose the cuts and taxes to the Greek populace in a referendum imperils the bailout even as it has just begun. Should the Greeks say no — refusing to endure another punishing round of fiscal cuts and new levies — the entire system will be thrown into peril. Greece would have no option but to default, and speculation against the debts of Italy, Spain, Portugal, Ireland and, eventually, France would mount.
Would this new crisis induce Germans and French to step up to guarantee the indebtedness of the remaining countries? Likely a negative vote in Greece would stimulate public opinion in their respective countries to oppose further commitments.
A major international crisis would be at hand. Banks throughout Europe would have to write off their Greek debts, endangering banks in the United States as well. If the collapse of Lehman Brothers caused a wave, the default of a sovereign country would trigger a tsunami. While Lehman’s collapse called into question the viability of other big banks, Greece’s default would lead to great insecurity about national sovereign debt — a panic that, once started, is hard to stop or even to allay.
For their part, the referendum would put Greek voters face to face with a decision, in effect, to pull out of the eurozone and return to their traditional currency, the drachma.
In the near term, Papandreou’s decision to hold a referendum will send Greek politicians scurrying for cover. But, as voters consider their options, a rejectionist faction could gather power.
While dropping the euro is a widely rejected option in Greek public opinion polls, it might be in the best interest of the nation. Any country facing a major depression usually seeks to devalue its currency, stimulating export sales to richer nations and reducing its dependence on foreign imports. But Greece can’t devalue as long as it is tied to the euro. So Athens has indulged in big deficit spending — the only national means to stimulate its economy. Now it would be blocked from deficit spending if it accepted the European deal, leaving it as an economic basket case, unable to take advantage even of its poverty to generate low-cost exports.
A rejection in Greece could be the shot heard ’round the world.