An unmanaged Greek default gets closer

Strauss-Kahn right.jpgThe Dominique Strauss-Kahn affair may come to be seen as a critical turning point, when the story of the Greek default is written.

The then IMF head was en route to meet German Chancellor Merkel, when arrested in New York last month.

He had been at the forefront of the campaign to pretend that Greece has only a liquidity problem, and is not bankrupt.

Had he arrived, he would probably have persuaded her that the Greeks just needed a little more money. He would probably also have persuaded the Greeks that a little more austerity was worth the pain.

But he never made the trip. A month later, his deal is now getting harder to complete, as the 2 key questions remain unanswered:

• Will Europe end up offering Greece the money it needs?
• Will Greece accept the austerity package on offer?

Both sides have since hardened their positions. And the undecideds, who might have followed Merkel and Papandreou last month, are now doubtful.

Papandreou won the confidence vote on Tuesday, but no democracy will accept a decade of forced austerity to pay off foreign bankers.

As the blog argued last December, the Eurozone is approaching a critical crossroads. Strauss-Kahn’s absence makes it much harder for policymakers to maintain his pretence that Greece will repay its debt.

But the options for solving the problem have narrowed over the past year. They are also equally unattractive:

• Will Greece default and devalue, which means leaving the Eurozone?
• Or will Europe move towards fiscal union and pay off Greece’s bills?

And when the head of the European Central Bank says “risk signals for financial stability in the Eurozone are flashing red“, we know that the odds on a happy outcome are reducing.

UPDATE: On Friday, the Governor of the Bank of England joined the blog in recognising that the Greek problem is one of solvency, not liquidity:

“Right through this crisis from the very beginning … an awful lot of people wanted to believe that it was a crisis of liquidity. It wasn’t, it isn’t. And until we accept that, we will never find an answer to it. It was a crisis based on solvency … initially financial institutions and now sovereigns.”

UPDATE July 11: Bloomberg today confirms the blog’s view that DSK’s arrest was a turning point in the crisis:

Strauss-Kahn’s May 14 arrest on charges of sexual assault left a void atop the International Monetary Fund, busting the one thing that had gone consistently right in the handling of the euro-area debt crisis: cooperation between European leaders and the Washington-based IMF.”

About Paul Hodges

Paul Hodges is Chairman of International eChem, trusted commercial advisers to the global chemical industry. He also serves as a Global Expert for the World Economic Forum. The aim of this blog is to share ideas about the influences that may shape the chemical industry and the global economy over the next 12 – 18 months. It looks behind today’s headlines, to understand what may happen next in critical areas such as oil prices, China and Emerging Markets, currencies, autos, housing, economic growth and the environment. Please do join me and share your thoughts. Between us, we will hopefully develop useful insights into the key factors that will drive the industry's future performance.

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