The Next Financial Crisis: the European Chapter?

European leaders have had it relatively easy in the recent crisis. The events that sparked the crisis occurred in America, and many of the effects of the crisis have been more severe there (big exceptions in smaller countries like Ireland, Latvia, and Greece, but also Spain). That the housing bubble triggered the crisis has made it easy to blame the entire crisis on America. Increasingly, though, Europe is beginning to look very weak. These problems, though, are homegrown.

Everyone is aware of Greece's current liquidity issues. It now appears that European leaders will head off a crisis in Greece by bailing the country out. Although many political and legal problems remain unresolved in doing this, it does look like it will be done. As The Economist argues, Greece will then have about three years to resolve its budget issues.

It also points out, however, that even with help from the EU and severe budget tightening (of which the actual application is questionable), Greece's debt will stabilize at around 150% of GDP, a huge amount by any standards (except Japan's, which is a different case, however, with lots of domestic savings, domestic financial repression, and assets abroad). Even assuming Greece manages to cut its deficit from something around 12% of GDP to under 3% in the next three years (a highly questionable assumption given the country's economic and political prospects), there is still every possibility the country could decide not paying back its debts was a better option. Indeed, that might even be true for Greece. Such a massive debt burden would hinder growth and spread economic and social malaise for years to come. In a country where social unrest bubbles beneath the surface, such austerity measures might simply be too unpalatable.

So why not let Greece default now and save ourselves the trouble (and extra money) of bailing it out? EU law stipulates that bailouts are illegal, and Germany has been opposed to them until recently. Why the change of heart? Cold calculation. Germany's Chancellor, Angela Merkel, has realized that a Greek default could sweep other countries with it, most notably Portugal, but possibly Ireland, Spain, or even Italy. Assuming that did not happen, though, the damages would be bad enough. European banks hold a lot of Greek bonds, and German banks are among the largest holders. If Greece goes down, bank bailouts may be necessary instead of a country bailout.

So a homegrown banking crisis could hit Europe. Apparently, Europe's banks are even more leveraged than American ones and even more thinly capitalized. Several banks would be unlikely to withstand a large-scale Greek default, never mind one involving several Euro-area countries. It seems the Europeans are not invulnerable to bad investment decisions, either.

Of course, this is no time for schadenfreude; such a disaster would ripple throughout the globe, nailing already weak economies and overly stretched government budgets. It was a couple of years after the 1929 crash before the Great Depression hit its deepest point. Let us hope that we are not about to repeat the false optimism that prevailed into 1930 again...

Time to Recognize Hamas

An article from this week's edition of The Economist provides a startling look into Hamas's success at providing the Gaza Strip with just about everything it needs. Prices have fallen, businesses have flourished, cafés and universities have re-opened. This adds yet another reason to the list of why the "West," insofar as it has not already done so (I believe Norway already has, for example), should recognize Hamas as the legitimate government of the Gaza Strip. It exercises de facto control over the territory and has apparently succeeded in bringing security and a degree of economic prosperity (when compared with the past few years) to the area. No other group (including the UN and the Israelis) could make this claim. These accomplishments have also made Hamas popular in the Gaza Strip, further diminishing prospects that Fatah could ever enjoy any real influence there again without serious (and deleterious) changes to conditions in Gaza. What are the other reasons Hamas should be recognized and worked with?

• It has moved away from the West and relies on other contacts for its stability and prosperity. This is working (comparatively speaking). While economic and personal security in Gaza are certainly to be welcomed, from a western political standpoint, this indicates that western influence in Gaza has waned even more than it had previously. If the Israelis and the US hope to have more influence in Gaza, they must engage with Hamas, which has effective control there. Furthermore, trying to force influence by removing Hamas would be transparent (i.e. Gazans would know what was going on and resent the action, making it counterproductive) and would lead to chaos and suffering, while carrying a very high risk of ultimate failure. Keeping Hamas in isolation would only further push it into the arms of other actors the West would rather it not deal with (e.g. Iran).
• Terrorists and extremest organizations become more moderate when they achieve real power. This could be seen with the PLO as well, which was also initially shunned by the West but was later accepted (albeit too late, I would argue, as its acceptance among the people it claimed to represent was already in decline). Hamas is now responsible for providing not just physical protection for the residents of Gaza, but also for their economic welfare. The constraints of power are already moderating its actions, if not its rhetoric.
• As The Economist mentions, Hamas may soon be embroiled in competition with Muslim extremist groups in Gaza. This implies that Hamas is a relatively moderate force there now (as would be expected from the logic of the point above). Denying recognition to Hamas will make it more likely that extremer forces will take hold in Gaza, making the situation there even worse for the people of Gaza and further harming any chance at cooperation with Israel and/or the US and their allies. As mentioned, this was the case with the PLO as well.

In conclusion, I am arguing to recognize Hamas not because I am an idealist and believe in the good of all people. On the contrary, I am a realist and believe that recognizing Hamas is in everyone's interests. It's a win-win situation, and Israel, the US, the UK, France, etc. would be fools not to take advantage of it. It is sure to be a short-lived opportunity in an ever-unstable Middle East. True, it is by no means a guarantee of success, but letting idealistic notions like "we don't negotiate with terrorists" get in the way of what is, granted, only a shimmer of hope for progress, would be reckless and unconscionable.

Waltz on Nuclear Defenses

"The best one can say about missile defenses is that they won't work. (If they did, an offense-defense race would result, with all too familiar consequences). Missile defenses are easily thwarted. In the nuclear business, offensive weapons are much cheaper than defensive ones. Other states can multiply their warheads; they can confound defenses by deploying decoys and spreading chaff; they can outflank defenses by delivering warheads in any of many different ways - by plane, by ships, by cruise missiles, by missiles fired on depressed trajectories. Missile defenses would be the most complicated system ever mounted, and the system would have to work with near perfection in meeting its first realistic test - the test of enemy fire. Some warheads may get through, and both the attacked and the attacker will know that. No president will rely on such a system but instead will avoid actions that might provoke an attack. With or without defenses, the restraints on American policy are the same."¹

So what could the point of the current missile defense shield in Europe be, including Obama's new plans for a primarily sea-based one? My guess is that it is purely a political gamble:

• Domestically: voters in the US like the idea of being "protected" from incoming nukes.
• Internationally: Bush and Obama might hope that Iran will scrap its nuclear ambitions if they can be made to believe that their weapons would be ineffective.

 This second idea seems unlikely. After all, Iran has nuclear ambitions because it feels insecure, not because it necessarily hopes to use the bomb. Anyway, it would be more likely to use its nukes against another Middle Eastern country (probably even excluding Israel!) than against the United States or Europe.

Conclusion? The "defense shield" is domestic political pandering for electoral gain. "But Bush couldn't get re-elected again after 2004, but continued to push the shield" you say? No problem, the shield was an aid to his party, and can still be used as evidence the republicans are tougher protectors of American safety than democrats (regardless of the fact that Obama's plans would eventually be more costly, but also more effective, than the land-based Bush plan).

Say "no" to "missile defense!" Say "yes" to arms control!

1. Waltz, Kenneth. "The Continuity of International Politics." In Realism and International Politics, 246-250. New York: Routledge, 2008.