THE ECONOMIST: Breaking Up The Euro Area: How To Resign From The Club. â€œThe idea that the euro itself might also be reversible and that one or more countries might revert to national currencies is no longer unthinkable.â€
It hasn’t been “unthinkable” for quite some time now.
The Prisoner’s Dilemma is probably the most famous game of strategy; each play has a dominant strategy (to Defect), but the equilibrium is worse for all players than when each users her dominated strategy (to Cooperate). The most well known solution to the dilemma is repetition of play. In a finite game of known length, the present value of cooperation is eventually zero and backwards induction yields an equilibrium with no cooperative behaviour (end-game behaviour). With infinite play (or an unknown end date), cooperation can be achieved using an appropriate contingent strategy such as tit-for-tat (TFT) or the grim trigger strategy; in either case, cooperation is possible if the present value of cooperation exceeds the present value of defecting. More generally, the prospect of “no tomorrow” or of short-term relationships leads to increased competition among players.
Experimental evidence suggests that players often cooperate longer than theory might predict.
That bolded note explains why my private prediction of the collapse of the Euro by early fall did not bear fruit. However, the logic of the situation will not permit “cooperation” to prevail much longer. The Game is already in play, and has been since last May:
My dear Nicholas, you can hardly complain. After all, you threatened me with the same thing back in May. You see, when you did that, you made explicit what has been the case for some time now. You have placed us in the Prisonerâ€™s Dilemma. You are familiar with that?
Of course. We French know philosophy. The first prisoner who cooperates, gets the deal. In order to avoid having one prisoner betray the others, they must all have confidence that none will cooperate.
And among the Euroland nations with the ability to have a strong currency, the situation is the same. If any one suspects that another is about to leave, the only thing to do is leave first. When you threatened to leave, we realized that was the position in which we had been put. So we had to make our preparations.
Sarkozy spoke in a calm, level voice.
But I was not serious. It was a bargaining position.
Perhaps. But the Prisonerâ€™s Dilemma requires certainly, not probability.
Exactly. And France made the threat to leave the Euro in May:
In a weekly meeting of European ministers, President Sarkozy threatened the other Euro members to leave the Euro if there was no unified support for a Greek rescue package. The threat, with fists slamming on the table, was clearly directed at Chancellor Angela Merkel of Germany who has been very resistant to approve such a large bail out package.
The reaction of Sarkozy, as confirmed by Prime Minister Zapatero, is more than just an idle threat. It puts Germany in a very precarious position with only two possible options.
Either Germany keeps the Franco-German economic engine running or France will fly solo.
One of the prerequisites of a viable “threat” in terms of game theory is that it must be believable. Sarkozy’s threat is that. And once it was made, it could not be recalled.
However, the threat places Germany in an “intolerable position” only so long as Germany herself chooses to remain in the Euro. And in this game, advantage will accrue to the major player who departs first. It is becoming more and more obvious, as the stresses on the Euro and the Union itself continue to grow, that Germany, who created the Union and the Euro in the first place, will be the nation to destroy both.
The only question at this point is when they will pull the trigger.
My guess is that it will be shortly after the failure of Portugal and Belgium. Certainly they won’t wait for Spain to collapse.
As for the question, What Would a Euro Collapse Mean for the United States? I think the overall answer is, “Good things in general.”