Eurodoom update

I've said this before, but things look to be coming to a head in Greece. Felix Salmon explains:

This isn’t good; the Greece talks have now moved past their clear deadline and have reached the finger-pointing stage. The broad outline of the dynamics here is now very clear: you need three different parties to agree on a deal for the whole thing to have a chance of success. Private-sector bondholders need to agree to a very deep cut in the value of their bonds; the Greek government needs to agree to enormous spending cuts over and above the 1.5% of GDP that they’ve already offered; and the Troika of the EU, ECB, and IMF needs to agree to pony up extra bailout money to cover the larger-than-expected deficits that Greece is running.

His conclusion:

If the Troika fails to save Greece, the past 66 years of ever-increasing European unity will come to a sudden and drastic halt, and all eyes will turn to Portugal, asking if it will be next. (The Europeans will say no, and indeed already the ECB seems to be pre-emptively shoring up Portuguese bond prices; the bond markets will say yes.) There will also be a second sovereign default, sooner rather than later, in Cyprus, and at that point the European and international communities will have essentially no credibility in terms of its ability to prevent dominoes from falling.

But I’ve never seen less appetite, at the European level, for a policy of continuing to kick the can down the road. Which means that there’s a very good chance that the long-awaited and long-feared crunch might soon be upon us. Greece and the Troika might not be able to agree on whether the latest deadline has been missed, but there’s one deadline no one can move: March 20, when Greece’s big €14 billion bond issue comes due. Either there’s an exchange offer in place by that point — or else the European project will have failed.

Paul Krugman brings the pessimism:

And here’s the thing: when this started, Greece was running a large primary deficit — which meant that even if it repudiated all its debt, it would still have been forced to make a major fiscal contraction. This is no longer true. So we’re now looking at a scenario in which Greece is forced into killing levels of austerity to pay its foreign creditors, with no real light at the end of the tunnel.

This is just not going to work.

Matt Yglesias explains the political calculus underlying the insanity:

Bild, the super-high-selling right-of-center German tabloid is out with a new poll which shows that fifty-three percent of Germans want Greece out of the euro, and just 34 percent want it to stay in.

On the merits, I think a "Greece out, everyone else stays in" solution was perfectly possible 24 or 18 or 12 months ago. Today, however, it's not going to work. The exit of Greece from the system would likely lead to a run on Portugal. And while "Greece out, everyone else in" in a psychologically and politically plausible stopping point "Greece and Portugal out, everyone else stays in" isn't. If Portugal is out then Spain is out and if Spain is out then Italy's out, and if Italy's out then France is out, and if France is out there's no point. So you're left with either a big bailout of Greece or a big bailout of Portugal, and the basic technical logic of just doing it for Greece rather than mucking around is very sound. The political case is much weaker, however, as the poll illustrates. So what's happening right now is that European officials are trying to get Greek politicians to agree to vicious austerity measures not so much because the austerity per se will actually solve anything, but because the politics of Northern Europe demands that Greece pay a pound of flesh in exchange for its bailout.

Ezra Klein, meanwhile, is still convinced that this will determine the 2012 election:

So the question as we look towards Greece's troubles today and the Eurozone over the next year is whether the rules governing the macro question -- whether the Eurozone will survive -- trump the rules governing the everyday panics and political decisions that imperil its survival. Or perhaps there's some theory that can bring them both together. The answer to this question, perhaps more than any other, will decide whether Obama's momentum continues, or fizzles out amidst a new economic crisis.

Krugman parries, noting European exports only account for 2% of GDP, while Yglesias adds that the slow grind of crisis has given US elites a long time to prepare themselves:

What's interesting is that a few months ago I was incredibly alarmed about Europe dealing a hammer-blow to the American financial system. We turned out to be much more intertwined with the European banking system than one would have thought. But these various deals that European leaders have worked out over the past several months have been a boon to the United States from this perspective. For one thing, they've bought time. European banks haven't collapsed, and American officials, American banks, and American non-financial firms have all had time to start thinking through the implications and insulating themselves. That's been an extra source of problems for Europe but it's good for us. The other factor is that while Europe's leaders haven't hit upon a way to forestall a years-long span of catastrophically high unemployment and falling living standards, they do appear to be really really really really committed to saving banks. This kind of "bankers and and rich people first" approach to coping with an emergency is terrible for the average European, but it does take care of our main concern from Europe which was that we might get hit with a sudden credit crunch.

I sure hope he's right about that, but I'm still skeptical.