Salvatore Cantale
November 7, 2011The euro zone has won the battle with Greece, but economic war still looms.
The euro zone may have stood up against Greece, but its fragility is now fully illuminated. The picture is grim and becomes even grimmer looking ahead. Consider the reasons that pushed George Papandreou's decision to call the Greeks to the polls and then consider whether the very same behaviour may happen again in the future, but with much bigger players and much bigger stakes.
Critics say Papandreou's decision to call the Greeks to a referendum to be held at the beginning of December was foolish. I beg to differ. The Greek Prime Minister used some of his political acumen to gain room for negotiation - for himself and for his country. In the past few months, the country has been at the centre of many talks in the finance community. The looming question: will small Greece bring down mighty Germany and the euro?
Europe was in check, or so he must have thought. As the old motto goes: ''If you owe one million to a bank, the bank owns you. But if you owe one billion to a bank, then you own that bank!'' Greece owes some €340 billion ($452 billion) to many banks in Europe and to the European Central Bank. Papandreou must have believed that he owned a couple of banks.
Papandreou also knew that, to some extent, the pressure was more on Europe than on Greece. That is, Europe had more to lose from a paralysis than Greece.
In periods of great uncertainty, investment dries up. When the fate of millions is left in the hands of a few statesmen with a less than transparent agenda, the real economy waits for the new rules to be defined and clearly communicated and entrepreneurs and investors may move on to new investment opportunities.
Papandreou must have thought that the more Greece could make the process drag on, the more it would bring Europe to the brink of default, and the more Greece would remain a high priority on the agenda. All of which meant more room for negotiating a neat package for the Greek people.
However, the risks were high, and I am sure Papandreou knew it. As is often the case in finance, the higher the returns one wants to achieve, the higher the risks one needs to take. The art of decision-making lies in balancing the trade-off between risk and return. The Greek Prime Minister played a balancing game, miscalculated and ended up failing.
Papandreou likely overestimated the economic damage that a Greek default and exit could cause to other members of the euro zone. Or he underestimated the damage that the paralysis could have caused for other members of the euro zone, namely Italy. The investment slowdown and volatility that might have followed could have impaired the ability of Italy to survive in the euro zone. And the euro zone could not afford that. At least, not now.
The crystal-clear clarity of the German Chancellor, Angela Merkel, and French President, Nicolas Sarkozy, was enough to help lessen the impact and bring Greece to reason. But will it be enough if something similar is done by other more important players in the future? A Greek exit from the euro zone can inflict a lot of pain both in and out of Europe, but the world can handle it. However, what if Italy (or Spain) resorts to this kind of behaviour? The stakes would be much higher and it is not clear what Merkel and Sarkozy would or could reply.
A battle has been won and the horizon is clear for now. But this is no time for celebrations. A much bigger war may be coming, and it is not clear that Europe has the right weapons to fight it.
Salvatore Cantale is Professor of Finance at IMD in Switzerland
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