For Want of a Nail, the Kingdom was Lost

Greece needs about 10 bln euros by the end of the month.  The negotiations are fierce.  Although the ECB and Germany are clashed over the conduct of monetary policy, they seem to be in agreement, not to concede to Greek requests for debt forgiveness or a debt swap.  At least until the end of the month, German media is unlikely to repeat the slur, referring to the ECB as the Banca d'Italia's Frankfurt branch. 

In his critique of the Versailles Treaty that ended WWI, Keynes cautioned that the bleeding of Germany can only lead to ruin.  He urged the creditors of the day not to be shackled by paper--contracts.  The current generation of European creditors appear so antithetical to what has become Keynesian economics that they are willing to ignore the important insight that there is a limit to people's willingness to turn their output to service foreign debt. 

Ironically, it appears that others have understood Keynes' insight.  Egypt has roughly the same rating as Greece.  Fitch and Moody's rate them identical (B and Caa1 respectively).  S&P rates Egypt B- and Greece B.  Saudi Arabia, Kuwait, and UAE have given Egypt more than $12 bln in aid, deposits for the central bank and petrol since 2013. News reports indicate that they will deposit another $10 bln in Egypt ahead of the large investment conference next month. 

Egypt, like Greece, is trying to repair its economy with structural reforms, and appealing to foreign investors.  It faces domestic strife between President Abdel-Fattah al-Sisi and former Islamist President Mursi and the outlawed Muslim Brotherhood.  The new government in Greece faces powerful resistance by its official creditors and the domestic oligarchs and chronic tax evasion. 

Saudi Arabia, Kuwait and UAE see a slippery slope.  The current Egyptian government is an important bulwark against a threat that could jeopardize the political stability of their regimes. As ironic as it may seem, Greece's official creditors are less enlightened.  Even at this late date, they pretend that Greece has to decide whether it wants to remain in the monetary union or not.    To remain in the money union, they insist Greece needs to respect current agreements, even though they have clearly failed.  

The IMF itself has admitted it under-estimated the fiscal multiplier and over-estimated Greek growth.  It resists a mid-course correction.  The ECB and Germany seem particular sensitive to its slippery slope: whatever concessions are made to Greece will likely be demand by others.  Both Portugal and Spain hold elections later this year.   Spain's Podemos is polling strongly and share Syriza's predilections, even though Spain is among the fastest growing in the euro area. 

Below the surface, there is a sense in official circles that Greece can leave and not pose systemic risk to EMU.  This a grave risk.  Officials have repeatedly been surprised by the market's reaction.  Remember Lehman?  The Swiss abandonment of its franc cap? 

A Greek exit would demonstrate once and for all that EMU is reversible.  If Greece leaves and has a deep recession, high inflation and an intense banking crisis, as would be expected, it would be a severe cost to its creditors.  If it finds that its only friends are adversaries of Europe, like Russia, which has already offered assistance, would EMU members really be better off?  Negotiating with Greece, devising a new and sustainable course will ultimately be cheaper than sticking to the old course has failed.