The probable end state of most Prisoner's Dilemmas is the defection of the party who first realizes the advantage of abandoning a compromise solution. The first to defect maximizes their own self-interest. The classic formulation of this dilemma presumes that the two primary parties do not know each others' intentions. The European troika and Greece's Syriza know each other's intentions exactly, so an immediate defection from a negotiated solution is not likely. The problem is that Syriza's absolutist campaign rhetoric leaves little room for a negotiated solution. Electing amateurs who have never strategized or negotiated beyond a marketing campaign places a crisis-riddled nation at a distinct negotiating disadvantage.
The troika's bankers and economists have obviously considered several scenarios, including a Greek debt default and exit from the euro. Their negotiating position includes consideration of the cost to Europe of Greece's untenable positions. Greek Prime Minister Alexis Tsipras has until the Feb. 12 EU summit in Brussels to telegraph any softening of his demands for lifting austerity. He has stated a willingness to "negotiate" but has not budged on his commitment to reinvigorate the Greek welfare state.
Game theory indicates several possible outcomes if we assume the Greek position is fixed. One set of scenarios should include some form of renewed European generosity that is insufficient to meet Greek demands. Another should include hard European demands that Greece adhere to its debt covenants if it wants a loan lifeline after Feb. 28. The least likely scenario is Greek capitulation to any demand, even a temporary one, to secure said lifeline. A turnabout acceptance of austerity would shatter Syriza's governing coalition and prompt snap elections again.
The likely range of outcomes under game theory is thus some sort of Greek default that prompts the country's withdrawal from the euro. Europe's leaders have calculated this cost and believe it to be manageable, but they are tempting fate by inviting Greece to negotiate. The public statements of both EU and Greek leaders indicate that this is the full range of policy outcomes, yet one outcome is also a possibility. Systemic stability has emerged as an overriding policy consideration on both sides of the Atlantic since the 2008 financial crisis. Printing euros to maintain a unified eurozone is the most powerful option available to Continental leaders committed to a unified currency.
The negotiations may be mere political theater if the troika is sufficiently confident that ECB monetary stimulus can paper over Greece's problems long enough for a renewed bailout to push the country into growth. The math gets complicated depending on how enthusiastic economists are for the effects of debt on growth, but the philosophy is not complicated at all. The ECB quantitative easing timetable can immediately shift to accommodate bond purchases that support further Greek bailouts, The cost of that option is the decimation of the euro's buying power against the US dollar. Brussels has yet to indicate whether the cost of the euro's dismemberment or the cost of its devaluation is more tolerable. Mr. Tsipras' conduct in Brussels will trigger Europe's choice. Alfidi Capital judges a Grexit to be just as likely as a quantitative easing bailout.
Full disclosure: Bearish on the euro; long put position against FXE.