The Legend of the Gordian Knot

Uwe Bott
December 30, 2014

At the beginning of this month, Greece's conservative Prime Minister, Antonis Samaras, entered into a high-stakes gamble. He announced that presidential elections, which are held by Greece's parliament, would be advanced from February 2015 to late December. If his coalition's candidate were to win those presidential elections, so he reckoned, this outcome would take a lot of uncertainty off the table.

Less uncertainty would then allow the Greek government to make more painful concessions to the so-called troika (the International Monetary Fund, European Commission and European Central Bank) in their negotiations over an extension of the $290 billion bailout package, which must be concluded by the end of February.

Yesterday, Mr. Samaras lost the first round of this gamble. He failed to muster the necessary majority for his presidential candidate after the three maximum ballots.  As a consequence, he was forced to call for new parliamentary elections to be held on January 25.

Polls show that the left-wing Syriza party under Alexis Tsipras might win. Assuming for a moment that were the case, there is a fairly strong likelihood that Mr. Tsipras would put an end to severe austerity measures. In assessing the potential consequences of such policy shift, the ancient Greek legend of the Gordian Knot comes to mind.

Here is how the supporters of Mr. Tsipras may find some intriguing parallels: Legend has it that, at some point, Phrygians (enter: Greeks) were without a king (enter: Prime Minister). An oracle (enter: The European Commission) decided that the first person driving an ox-cart (enter: Willing to run the economy) into the capital would become king (prime minister). That person was Gordias (enter: Lucas Papademos, who preceded Mr. Samaras).

It is also part of legend that the Gods (enter: The Germans) had blessed his ascendency. In thanking the Gods (Germans), Gordias' son Midas (enter: The Greek elite) tied the ox-cart (the Greek economy) to a post (enter: Stagnation) with an intricate knot (enter: Troika conditionality).

When Alexander the Great (enter: Alexis Tsipras) arrived in the 4thcentury BCE (enter: January 25th, 2015), the once proud country of Phrygia (Greece) had long been diminished to a province of the Persian Empire (enter: Germany).  The ox-cart (the Greek economy) was still tied to the post (stagnation). Alexander the Great (Alexis Tsipras) tried to untie the knot (enter: Renegotiate conditionality) without success. And so, he took his sword (enter: Executive powers) and simply cut the knot (enter: Defaulted). 

Like many fables or legends there is a moral to this story: Was Alexander the Great cheating when he cut the knot with his sword or was his an act of genius? Or to put the analogy in this context: Would a Greek default be cheating or the only plausible solution to an intractable problem?

Of course, the troika would scream: Fraud! After all, most of the irresponsible lending to Greece has long been transferred from the private banking sector to public accounts at the IMF, the EU Commission and the ECB.

Now, many Greeks would call a default ingenious. After all, Greek GDP has plummeted by 25% during the austerity program. Unemployment stands at 25% with youth unemployment double that. Pensions have been cut in half. Poverty is skyrocketing. Suicide rates have doubled and infant mortality is up as the public healthcare system has collapsed.

So, from a Greek perspective what is not to like about a default? Some of the alleged consequences, such as kicking Greece out of the Eurozone, turn out to be paper tigers. There are no means by which Eurozone countries can actually expel a member. In other words, a Greek default within the Eurozone is possible.  

However, defaulting on one's debt is not to be taken lightly. The default would exclude Greece from access to capital markets important to its private sector and banks.

The elimination or drastic reduction of interest payments by the Greek government would materially strengthen the country's fiscal position, but therein also lies some danger. The improved fiscal position might tempt the Tsipras administration to abolish some of the necessary structural reforms instead of just reversing those changes that have undoubtedly impoverished the Greek people.

Finally, a Tsipras administration should carefully consider the systemic consequences of a default. While it is true that a Greek default would no longer directly jeopardize financial stability abroad, it is quite possible that it would deeply unsettle markets.

Financial markets would probably speculate on the next possible Eurozone country to go down. At that point perception can become reality. One of the most worrisome targets of such market reaction would be Italy, because Italy's debt is a multiple of Greece's and it is still widely held.

In other words, a Greek default could trigger a systemic shock 100 times worse than the Lehman default with uncontrollable global consequences. It is very important that a Tsipras administration weigh the unintended consequences of its actions, because these unintended consequences could have implications for Greece that may make its current dismal state look like a "land of milk and honey".

So, what is Alexander the Great to do? It is evident to all but the German government that six years of austerity have destroyed the social fabric of many European countries without much to show for. In fact, everybody is worse not better off than before (including Germans). At the same time, the election of Mr. Tsipras would undoubtedly signal that many Greeks want radical change.

So, to avoid an uncontrolled unraveling of the Eurozone, it is up to Germany to change course. Of all countries in the EU, there are two that should know better than to insist on the impossible: Germany and Poland. Without debt forgiveness in 1953, Germany would never have had its economic miracle. Equally, Poland was drowning in external debt in 1991 and without relief would never have managed its economic transition.

The mounting Greek debt was accrued by an irresponsible political elite. Both mainstream parties and the families that ran them bear equal responsibility. If Poland was forgiven its debt because it was accrued by a Communist dictatorship, Greeks could fairly claim that their elites betrayed them.

By extending its hand rather than pushing the Greek people ever deeper into impoverishment, the EU, under German leadership, could make sure that Mr. Tsipras keeps in place those reforms that have worked and implement others that would.

Germany could disentangle the Gordian Knot without forcing Mr. Tsipras to use his sword. Such German courage would not only save Greece, but the European Project and in the end Germany itself. Enter content here

The Courage of Our Convictions Carries the Day