Interesting days lie ahead for the euro zone.
On Thursday, the European Central Bank (ECB) will meet and either announce a quantitative easing-style monetary policy action, as most expect, or issue yet another statement suggesting the need to wait for more data.
Three days later, elections in Greece will decide whether the first political party with strong views against austerity and with an explicit proposal for a serious haircut on its government debt, reaches power in the euro-zone area.
There is no doubt the outcome of these two developments will determine the fate of the euro-zone economy over the coming years. But it is also possible it will determine the fate of the euro zone.
Rumours have started reaching the press that the Germans will not negotiate with Syriza and are ready to let Greece leave the euro zone. We have seen this before.
Back in 2011 and 2012 when the fear of Greece leaving the euro was at its peak the contagion to other countries, in particular Italy and Spain, forced the Germans (and the ECB) to come to the rescue. A reduction of Greek debt plus the “whatever it takes” statement from the ECB president, Mario Draghi, saved the day and ensured that no country left the currency bloc.
Today the situation is very different. So far, contagion has not spread to other euro-zone countries, possibly because of their stronger fundamentals. However, the real effect may have less to do with economics than politics. Other countries in the bloc have political parties with platforms very similar to that of Syriza in Greece, and they will be looking very carefully at what happens next.
If Syriza wins the election on Sunday and their negotiating strategy is successful, it is likely we will see similar political changes across the region and a revolt against the current euro economic policy. This is the last thing that Germany wants.
How does Germany avoid this outcome? Let me be cynical and argue that they only have one potential strategy, a very risky one: be nice to the ECB on Thursday and let it go ahead with a full-blown QE policy involving government bonds; and then let the Greeks decide on Sunday if they want to be part of the euro zone.
If the Greeks vote for Syriza then the Germans will not negotiate, leaving Greece with one alternative, to ditch the currency.
If that happens, the financial system in Greece will face enormous pressure with a high chance of bank runs.
While the risk may spread to other countries, the ECB could be very aggressive to avoid contagion. If a bank run happens in Greece and the ECB refuses to provide liquidity, Greece will default and be out of the euro zone. This will lead, at least in the short run, to a deeper crisis in Greece with strong disturbances to the banking sector and businesses.
This is exactly the scenario that the Germans need to scare the other countries in the euro zone into line. The costs are the potential losses on Greek debt, but at this point very few people believe that Greece will be able to pay its dues.
This is a serious gamble. It requires three things: that German voters accept the new ECB aggressive policies; that the potential losses associated with a Greek default and exit from the euro zone are contained; and that other countries in the bloc play along with this strategy. Very risky.
Maybe the Europeans will, once again, find a way to kick the can down the road without a proper solution or a final crisis, but I feel this time it is different. The possibility of a serious political challenge to the status quo is too high to ignore the prospect of a very volatile period ahead.
Antonio Fatas is a professor of economics at Insead international business school.
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