Greece vs. Germany: A Game of Chicken Or Cat and Mouse?

Paul Krugman in the New York Times has called the rapidly unfolding Euro crisis a "game of chicken" (here). I think it's more like a  cat-and-mouse game played by Germany against Greece, in which Germany is a Big Fat Cat trying to immobilize a darting Greek mouse.

As I explained in my previous blog post, the Greek Prime Minister Alexis Tsipras and his Finance Minister, Varoufakis, started by refusing to talk to the "troika" (European Central Bank, International Monetary Fund and European Commission) and traveling all over Europe to raise support for a renegotiation of the bailout that has caused so much suffering in Greece - from unbearably high unemployment (over 40%) to a collapse of the national health system and a 25% shrinking of the economy.

Yes, a darting mouse.

Next, last Wednesday (4 February) , the European Central Bank (ECB) made the first move,  announcing that it would no longer accept Greek government debt as collateral for loans. And the announcement came just before Varoufakis, the Greek Finance Minister, was to visit the ECB President, Mario Draghi.

Mr. Krugman did not see this as a serious move. Yet, it means further pains to the Greek banking system that is already suffering from a run that began last week with Syriza's victory. No surprise there: wealthy Greeks are all taking their deposits out and with the click of a button sending them to Frankfurt or London.

When that happens, it is in principle the role of the ECB to provide liquidity to the affected banking system and this is normally done by accepting national bonds as collateral,  at a very low cost. Mr. Krugman sees the ECB decision as merely one step in the on-going negotiations - a warning signal that doesn't substantially change Greece's situation since it can still have recourse to an ECB special loan program designed to support banks, called Emergency Liquidity Assistance (ELA). That's true but the trouble is that it's much more expensive, about three times as much.

Then, the next bomb exploded: on 6 February, one of the world's three major rating agencies, Standard & Poor's, downgraded Greece's rating from B to B-, practically junk.

The upshot? To raise funds, Greece will now face higher costs on international capital markets.

The reasons given for the downgrade - liquidity constraints on the banking system and prolongation of talks with official creditors for a revised bailout deal -  come as no surprise.  As Standard & Poor's put it:

In our view, a prolongation of talks with official creditors could also lead to further pressure on financial stability in the form of deposit withdrawals and, in a worst-case scenario, the imposition of capital controls and a loss of access to lender-of-last-resort financing, potentially resulting in Greece's exclusion from the Economic and Monetary Union.

Needless to say, the Tsipras-Varoufakis travels did not yield the expected returns. Even Italy's Prime Minister, Matteo Renzi, abandoned the Greek cause, siding with Merkel - alleging the Italian banking system held €40 billion in Greek debt.

The Greeks are taking it well (so far) saying they've got sufficient sources of financing.Varoufakis, upon his return, exhibited his usual self-assurance, saying that he had "logic" on his side.

Logic? Yes, if Europe, with its continued demands for austerity, pushes Greece too far against the wall, there won't be any reason for it to stay in the Euro. In particular, if the ECB doesn't act as a lender of last resort to Greek banks, why should Greece continue with the Euro? A collapse of the banking system has always been identified as the first thing that would happen to any Euro-zone member leaving the Euro. But if it is already collapsing, why stay in?

I know, for years, I have blogged about the Euro crisis, taking the position that a Grexit (exit of Greece from the Euro) was impossible. Now, I believe it's entirely possible. The main reason for believing that a Grexit would never happen used to be the so-called "domino effect": if Greece left, the next in line would be all the Southern European States suffering from the same debt overload and faced with the same urgent need to reform, i.e. Spain, Portugal, Ireland and Italy. This was such a huge chunk of the Eurozone that it would have caused an avalanche, burying the Euro.

But now something is changed: starting in March, the ECB will be able to engage in Quantitative Easing (QE), on the model of the Federal Reserve - something it has never done before because the Germans, fearful as always of any growth in sovereign debt, had prevented it. But now, the German red light has turned yellow, and QE is no longer out - indeed, it is in.

This means that if Greece exits the Eurozone, the ECB has the power to stabilize the currency through QE. And Greece is a small part of the game: its GNP is about 2.5% of the total Euro-zone. The ECB surely has now the firepower to handle a Grexit.

So, the outcome could really be a Grexit...Your opinion? Do we want Greece out of Europe? If it goes back to the Drachma, it will find new friends to help its finances: Russia and China - perhaps even Turkey (in spite of historic dislikes...) How will Europeans feel when Greek ports on the Mediterranean are run by the Chinese? When Greek banks recycle Russian money? Where is European solidarity and the dream of a United Europe?

Ask the Germans...