We heard that Greece’s new finance minister, Yanis Varoufakis, is an expert on game theory, and we thought it would be fun to analyze the Greek debt crisis from that perspective. Patrick Young says the EU is in a lose-lose predicament, and that certainly sounds like applied game theory.
On one horn of the dilemma (a Greek invention) the EU may accede to Varoufakis’ demands for restructuring. Some of these demands are quite extreme, like growth linked bonds, perpetuities, a bridge loan, and more haircuts. If the EU blinks or, more accurately, if the troika blinks – then the other bailout countries will want the same concessions. Also, as Patrick Young says, it would be unfair to countries like Ireland, which took the medicine.
Germans at all walks of life are sick and tired of seeing their own municipal facilities closed down … bailing out the Greek economy to the tune of €700 per family. That’s a transfer payment the Germans didn’t sign up for.
Morally, this is where Jeremiah stands. Estonia lived through an internal devaluation and emerged stronger for it. Someday, some Greek government will have to make reforms – to cronyism, tax evasion, and unsustainable social spending. Germany seems to be the only fiscally responsible country over there – and they’re pilloried for it. Jeremiah’s moralizing is not the topic, however. We’re talking about game theory.
On the other horn, if the troika plays hardball – halting the ECB collateral waiver, suspending the next tranche of bailout cash – then Greece will be “forced” to exit the Eurozone, and maybe the Union. We put “forced” in quotes because, at this move in the game, Varoufakis would not accept the troika’s terms. Greece would exit, and play the victim. Of course, as Thomas Schelling will tell you, the key is to make sure the troika knows you’re not bluffing.
This is where the IMF comes in. Exiting the euro has always been the right answer for Greece (see this comparison with Argentina). They’re in primary balance, and they could easily implement the three D’s – drachma, default, and devaluation. There would be some pain, but Greece has already endured some seven years of pain. If they had exited right away, they’d be back in the bond market by now. However, like Argentina, they would need help from that lender of last resort, the IMF.
The government quickly collapsed and was replaced by one that devalued the currency and defaulted on the country’s debts … growth resumed a few months later
The IMF is blocking the exit, by cooperating with the EU and ECB. This is because a successful exit, like a successful renegotiation, would also set an undesirable precedent. Spain would be next, the Eurozone would dissolve, and the IMF would have to fund more emergencies than it can handle. It would be the capital equivalent of a refugee crisis. If Greece were to exit, the troika would prefer them to crash and burn, pour encourager les autres.
So, when Varoufakis threatens to borrow from China or Russia, this is not as petulant as it sounds. Whether a practical matter or a bluff, he needs a source of funding other than the IMF – and the IMF has done a lousy job of including emerging economies. Small wonder that China is willing to lend contrary to Western preferences. We wonder, by the way, if the IMF will be so hardnosed when the time comes for France.
So, while there is no guessing how Chancellor Merkel will play the troika’s hand, the likeliest outcome seems to be a continuing fudge while the EU grinds steadily toward mutualization. They should arrive at that goal just in time for the whole Union to go bankrupt together. Pyrrhus, another Greek.