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The global crisis, Chapter Three

Published:Monday | May 21, 2012 | 12:00 AM

By John Rapley

For all we know, the presses at De La Rue
, the company outside London which produces the currencies of more than 150 countries (Jamaica included), are working full speed right now, secretly making a new Greek drachma. With recent Greek elections having failed to produce a government, the country will head back to the polls next month.

Current indications suggest that anti-austerity parties will further strengthen their hand next month. Meanwhile, Greece's European partners show little sign of relenting on their demands. An impasse may already have been reached.

Assuming a new Greek government emerges next month, and that it rejects the European Union demands, Europe will likely cut off the flow of further bailout funds. As the supply of money runs out, ordinary Greeks will rush to withdraw their deposits and stash banknotes under their mattresses. Even before then, once Greeks judge that a bank run is inevitable, they will start withdrawing funds and force the issue.

They would do well to do so. A new Greek currency will probably trade at less than half the value of the euro, wiping out savings. Greece might then be forced to close the banks, seal the borders, and introduce a new currency. There's a good chance the caretaker government is preparing for this possibility, and has already placed its order in Basingstoke.

Anti-austerity pushback

Greece's short-term future looks grim. But if the crisis is bottled up within its borders, a less pessimistic scenario becomes possible for the rest of us. The recent election of François Hollande to the French presidency has tipped European leaders towards a necessary rebalancing away from austerity alone, and towards long-term austerity with short-term stimulus. Shorn of its weakest partner, Europe might finally face up to its crisis.

But that is optimistic, indeed. In reality, the collapse in Greek asset values would hurt foreign banks with Greek assets, particularly in Europe. Given the continued fragility of the financial system, this might cause banks to retreat from lending and build up cash reserves, tipping Europe back into recession.

And that's just to start. Foreign investors in other southern European economies, like Italy, Spain and Portugal, might regard the evaporation of Greek assets with alarm. Seeking to retreat to safe ground, they could begin liquidating their holdings in those countries, instigating runs on banks there. Should such a contagion spread, a European recession would turn grave. And it would likely bring the rest of the world down with it.

Calamity inevitable

In short, we would return to crisis conditions. If the first chapter of the global crisis was the 2008 global crash, and the second was last year's sovereign-debt crisis, this would be the third. And it would reveal the underlying problem: governments, especially in Europe, managed the previous chapters of the crisis in such a way as to buy time, without fixing the problem. But the problem keeps returning. It will continue doing so.

This is a particularly vulnerable moment in the global economy. In 2008, China and much of the developing world was booming. Those economies provided the continued demand which helped stave off a global collapse.

But now, Chinese growth is slowing. And with the tensions in both the Chinese economy and society ever near the surface, and moreover with the Chinese leadership patching up a serious internal division, it is not out of the question that another global crisis might spread even to that country.

Greeks might yet elect a government which finds a compromise with the country's European partners. They might, but they probably won't. The greater hope is that European leadership rises to the momentous challenge it now faces.

So far, Europe's leaders have shown little sign that they either appreciate, or are prepared to deal with, the gravity of the situation. Until they can restore confidence that they are up to the task, we will all do best to start preparing shelter for the next storm.

John Rapley is a research associate at the International Growth Centre, London School of Economics and Political Science. Email feedback to and