Greece's MAD Strategy - By Thomas Wright

On June 17, Greece faces its second national elections in six weeks. Alexis Tsipras, the 37-year-old leader of Syriza who wants to reject the terms of the EU bailout while remaining in the euro, has a serious shot of topping the polls. To some observers, defaulting on debt while staying in the Euro is a contradiction, but there is a clear strategic logic to Tsipras's position.

Tsipras believes his trump card is that Greece is too big to fail. So, rather than touting a graceful way out of the euro, he wants the prospect of a Greek exit to be as horrific and contagious as possible -- an economic cataclysm that would drag everyone else down, as well. Essentially, he is arguing that Greece and Germany exist in a state of Mutual Assured Destruction: Germany will never pull the plug on Greece regardless of what it does because the risk to itself is just too high. And if Tsipras can convince the Greek people of this, they may vote him in -- they'd get to have their cake and eat it too.

Tsipras explained this logic in an interview on the British television station Channel Four, saying, "I believe we find ourselves in a situation equivalent to the one the U.S. found itself in with Russia, back during the days of the Cold War. Both sides had nuclear weapons in their hands and both sides threatened to push the button and activate. When you have a Cold War, neither side will back down, so now we don't expect Mrs. Merkel or Mr. Cameron to back down either. We are quite sure that when the time comes, logic will prevail, and they will not activate their nuclear weapons."

The nuclear weapon in this analogy is exit from the euro, not rejection of the bailout. In this view, the threat of mutual destruction provides Tsipras with an umbrella to do anything he wants -- short of exit from the euro. Germany and the European Central Bank (ECB) can never force Greece out because the contagion resulting from a "Grexit" could cause the collapse of the currency: The redenomination of international contracts would destabilize the entire financial system, European banks have exposure to Greek debt, and markets would likely move on to other members of the periphery.

The contagion risk will constrain Germany and the ECB's response if Greece rejects the terms of the bailout and defaults on its debt. Berlin and Frankfurt will surely retaliate, but Tsipras expects them to stop short of completely cutting off financial support, which could precipitate the total collapse of the Greek economy. Ultimately, they will do what is necessary to keep the eurozone intact, or so the argument goes.

Germany and the ECB know what Tsipras is up to and they're worried. For three years, they have maintained a hard line against any policy that could lead to a Lehman-level event. But now, they are facing an opponent who is using that fear against them. If he wins, the other member states of the periphery may soon follow -- after all, most are significantly larger than Greece and in an even better position to blackmail the core. Spain's Prime Minister Mariano Rajoy recognized this leverage when he recently tweeted advice to Luis de Guindos, his economy minister, on the eve of his bailout negotiations with the EU: "Resist, we are the 4th power of the EZ. Spain is not Uganda." The periphery's use of leverage will grow over time, so Germany and the ECB know they must signal that their fear of a disorderly collapse is not a gun that the periphery can hold to its head.