There can be no winners in Europe's game of 'chicken'

It is a dangerous game of “chicken”, so named because the first person to jump out of his car to avoid going over the cliff will forever carry the stigma of chickening out. But the bigger risk is that if one of them – or both – is too late to quit the game; he – or they – will then be sleeping with the fishes in the ocean below.

As the race is about to start, Jim asks: “Why do we do this?”

“You got to do something now, don’t you?” Buzz replies.

A few seconds later, both cars go over the cliff. Jim has bailed out in the nick of time. Buzz is not so lucky – a strap on the arm of his leather jacket gets looped around the handle of his car door.

From a cinematic perspective, Buzz’s demise was the optimal solution. Mathematically speaking, it was one of the two possible “equilibrium” outcomes out of four possible scenarios; Jim going over the cliff and Buzz jumping out would have been as elegant, though that would have doomed the prospects of the movie.

But what is gripping in a movie plot or elegant on the blackboard does not always work in real life. More often than not, variants of the game of “chicken” played by politicians, diplomats and business executives – such as Qantas chief executive Alan Joyce, who in late October grounded his entire fleet to break incessant labour protests – do not have clear-cut, winning outcomes.

Take all the talk currently going on about a potential break-up of the eurozone, which will mean the demise of the euro as a shared currency of 17 countries.

How did this speculation gather so much momentum that investors are increasingly jittery even about financing the budget of AAA-rated Germany?

For an answer, look no further than the dare that former Greek prime minister George Papandreou threw at German Chancellor Angela Merkel and French President Nicolas Sarkozy when, early last month, he unexpectedly announced a proposed national referendum on the terms of a second bail-out for his country.

Athens University law professor Aristides Hatzis called Mr Papandreou’s manoeuvre a “ghastly game of chicken”.

Dr Merkel and Mr Sarkozy were giving Greece a breather by asking private creditors to accept a 50 per cent loss. Mr Papandreou thought he could get a sweeter deal by raising the spectre of a referendum, where a “no” vote would have implied a chaotic Greek exit from the eurozone.

The resultant threat to the single currency would force Germany and France into settling for a compromise. Or so Mr Papandreou might have thought.

But Dr Merkel and Mr Sarkozy refused to swerve. Not only did they vow not to give Mr Papandreou “one more cent” (Mr Sarkozy’s words) in aid until he won [or scrapped the idea of] the referendum, they also began publicly talking about Greece leaving the euro area – something they had never done in the past. “If the Greeks say they do not want to stay in the euro, we will accept it,” Dr Merkel said matter-of-factly.

Mr Papandreou lost the dare, and soon he lost his tenuous grip on power as well.

But the winners have also paid a price.

Now that politicians have mentioned the unmentionable, there are big question marks over the future of the euro.

“Although the Greek referendum was eventually aborted, references to a break-up have led to an escalation of market tensions, as the whole structure of the European monetary union was formed on the basis that adoption of the euro represented an irrevocable commitment,” noted Goldman Sachs economists Francesco Garzarelli and Huw Pill.

Europe is now busy playing another “chicken” game. As Citigroup chief economist Willem Buiter and his colleagues noted this week, it is a three-cornered one involving the European Central Bank (ECB), a growing list of countries facing financial stress (Italy, Spain, France, Belgium and Austria) and a shrinking core of what the bond market perceives to be fiscally sound economies (Germany, Luxembourg, Finland and the Netherlands).

There is much the ECB can do to end the crisis. It can open its mouth and say it will print as much money as it needs to buy as many bonds of distressed countries as it takes. That promise alone will bring down yields on Italian and Spanish debt to levels they can afford to pay without becoming insolvent.

The ECB is not allowed to lend directly to countries. But it can always write a cheque to the International Monetary Fund, which can pass on the money to Rome and Madrid.

But if the central bank was seen to be “chickening out” before troubled countries made enforceable promises to act more responsibly in future, Germany, along with a few other nations, would accuse the ECB of jeopardising the prosperity of their citizens by debasing the shared currency. They could even walk away to set up a smaller single-currency area of AAA-rated countries.

The countries on a relatively sound footing can also save the euro by blinking first. All they have to do is to agree to the idea of euro bonds that are backed jointly by everyone. Their own borrowing costs will go up a little, but those of distressed economies will fall much more. But before giving any such guarantee, Dr Merkel wants countries to first agree to constitutional ceilings on future deficits so they do not rack up fresh debts once borrowing costs come down. She also wants European treaties changed first, so stricter limits are placed on each member’s fiscal sovereignty.

Dr Merkel’s demands are not unreasonable. But time, a crucial ingredient for bringing about changes to institutional designs, is not on Europe’s side. The edge of the cliff is near, and Buzz cannot bail even if he wanted to: Italy and Spain will together need to borrow 10 billion euros (US$13 billion) every week next year and in 2013. Markets will baulk at that amount.

We have seen the consequences of Mr Papandreou’s game of chicken. If the ECB and Dr Merkel do not relent now, it may very soon be too late to save the euro.