“The crisis takes a much longer time coming than you think and then it happens much faster than you would have thought.” – Rudiger Dornbusch.

Greece is at the moment of truth.

  • There is no longer a functioning government.
  • The ability to continue austerity is in doubt, and with it the ability to meet the conditions which the EU has set in exchange for funding the balance of payments.
  • Numerous commentators have openly questioned whether Greece can stay in the euro.


Once there is substantial doubt about remaining in the euro, it’s game over very quickly. Every spare euro gets moved from Greek banks to German banks, as depositors fear waking up to find their money forcibly converted to drachma at an unfavorable rate. The Greek banks then have to rely on the Greek central bank for emergency funding. The Greek central bank can only provide it to them by getting credit from the ECB system. (Although I’ve wondered what controls are in place to prevent the Greeks from printing up a few extra notes at their national printer.)

The ECB will never get the money back in the event of a Greek default and euro exit. So the question becomes, are the ECB and EU willing to fully backstop the Greek banks and make them a ward of the state?

Either the ECB is effectively willing to write a blank check loan to the Greek financial system, or the Greek banks fail, the financial system collapses, and Greece defaults and departs the euro.

Then the question is whether similar bank runs begin in the rest of the PIIGS.

The only surprise is that it’s taken this long. The mystery is why anyone would have any euros at all in a Greek bank.

The guy to read is Krugman, whatever you think of him. He gets it and doesn’t pull punches too much. Unlike the bankers and politicians, he doesn’t have skin in the game, and unlike the journalists, he doesn’t have to lend false credence to an absurd government party line in exchange for access.

It appears to me that the ECB’s choice is to either write the blank check, or trigger Greece’s default and euro exit, and then backstop Italy, Spain, Portugal etc. with a blank check.

On the one hand, having a bad situation in Greece would be a strong incentive for the remaining countries to do whatever Germany and the ECB require to remain in the euro. And Greece probably should not remain in the euro long-term, it can’t recover without a devaluation, and there is insufficient economic convergence for ECB monetary policy to be appropriate for Greece.

On the other hand, the geopolitical consequences are hard to predict, such as an extremist government in Greece, Russian and other interests getting a foothold. The EU doesn’t want it, and the Greek oligarchs don’t want it. (The oligarchs want to avoid taxes and tax evasion charges, and hopefully the chance to buy state assets on the cheap with the euros they stashed abroad.)

If I had to guess, the ECB will write the blank check to Greece. If two trucks are playing a game of chicken, driving at each other on a one-lane highway to see who swerves first, the one who acts craziest and throws the steering wheel out the window usually wins.

But worth remembering that with 29 sufficiently large dominos, you could topple the Empire State Building.