As an academic, I am interested in the power of ideas. If ideas didn’t matter, I would probably look for another job. Fortunately, the power of ideas is all around us. This is not a reference to the terrible events in Copenhagen, although I suppose it could be. That was a conference about ideas attacked by people who have a deep fear of the power of ideas to threaten them. Slavoj Žižek made that argument about the Charlie Hebdo attacks earlier this year; his reasoning applies equally well in this more recent tragedy.
The power of ideas I find most interesting at the moment centers on the notion of credibility. The reason this is interesting is credibility can seem so solid at one moment only to collapse in another. I worry this could happen to the euro as a single currency if some accident were to happen and Greece were to leave the euro. This essay is a long way of making a simple point. Anyone who thinks that Greece can leave the euro without having dramatic consequences is underestimating the power of ideas.
To see what I mean, you should think of credibility in three different ways — in terms of consistency, context and coordination. The consistency notion is the most literal and so also the most familiar. Credibility can mean that I will do what I always do no matter what I say. This is the kind of credibility that gives us reason to believe people who have a reputation for living up to their verbal commitments (credible people) and to doubt people who have a reputation for doing one thing while saying another (people who consistently lack credibility).
This kind of credibility-as-consistency is easiest to spot in its absence. Very few people are credible in the sense always do what they promise; if there is any consistency, it tends to be in disappointment. Russian President Vladimir Putin and the most recent Minsk agreement provide a good illustration. Putin has developed a reputation — at least in the West — for saying one thing and yet doing another. Of course this is a matter of perspective. The Russians probably view him as credibly consistent; on the other side of the conflict however, Putin has a reputation for doing what is he going to do no matter what he says. In that sense he lacks credibility as a peace-maker and so the bulk of the reporting on the latest Minsk agreement focuses on how what signs we have that Putin is ready to break the agreement if, indeed, he ever really signed up to it.
The air of mistrust (or incredibility) around the new Minsk agreement is palpable and the range of options available to policymakers is getting smaller as a consequence. That is a power of credibility as an idea: it is easy to see how you can deal with a consistent partner and hard to imagine how to work with someone you cannot trust. That is why so many critics of the Minsk agreement argue that we should start arming the government of Ukraine rather than wasting time with duplicitous negotiations. If this situation doesn’t change, and Putin doesn’t somehow emerge as a more reliable negotiating partner, then the situation in Ukraine will continue to escalate.
But the situation in Ukraine will not escalate to nuclear Armageddon. There will be terrible suffering in Ukraine, but the conflict should stop far short of global conflagration because at some point ‘cooler minds’ will take charge and ‘reason will prevail’. This another notion of credibility. It is related not so much to a reputation for matching (or failing to match) words to deeds as to doing what is right in a particular context. Here the better illustration is not Putin and Ukraine but the euro area (or Germany) and Greece. At the moment, both sides in the debate between Greece and its creditors are making strong verbal commitments. The Greeks say they want an end to austerity and some kind of bridge financing until they can negotiate a work-out for their sovereign debt. The Germans and other creditors say that Greece must honour its commitments and accept whatever conditions are attached to official lending.
The politicians on both sides are ‘credible’ but we know that neither side is going to do what it says. So the question is how long it will take them to agree on doing what’s right in the context and how they will package it so that everyone saves face. The power of this kind of credibility is that it makes it easier for observers to filter out the noise. There is some market volatility as a result of the ongoing negotiations but no panic. Moreover, that should remain the case so long as the belief that eventually politicians on both sides will do what is necessary continues to hold.
A third kind of credibility is found not in consistency or context but in coordination. If you can get everyone to believe in an idea and to act accordingly, then the resulting change in behaviour will take on a life of its own. Central bankers have been experimenting with this notion of credibility in their communications strategies. ‘Forward guidance’, or the verbal pre-commitment to how the will use specific policy instruments, is one illustration; European Central Bank (ECB) President Mario Draghi’s announcement of quantitative easing, or outright purchases of marketable assets like government debt by euro area central banks, is another. Here I should apologize to anyone who doesn’t enjoy reading about central banking. I will try to make this as painless as possible.
Of the two central banking illustrations, the quantitative easing story is the easier to tell. First Draghi promised that some quantitative easing would take place and market participants began to build that future demand for marketable assets into the prices that they expected to see in the present. Interest rates (or yields) fell on government bonds as a consequence. Then Draghi announced both the size and timing of the program, and market participants began to adjust their portfolios to accommodate the ECB a a new major purchaser of Europe’s highest quality assets. Now yields are falling on lower quality ‘high yield’ assets. Moreover, the investors who bet against these movements are losing money while the investors who follow the trend stand to gain. That is the power of credibility as coordination. ECB executive board members are already pointing to the success of quantitative easing and the actually purchasing of assets by the ECB has not even started yet.
The three faces of credibility – consistency, context, coordination – are useful to distinguish but they are all interconnected insofar as credibility is a single concept. Hence credibility is highest when doing what you say makes sense given the situation and provides a clear plan of action to make the situation better. Credibility is lowest when your word is no good, what you are proposing makes no sense, and no-one in their right mind would follow you anyway. Moreover, you can swing from one extreme to the other simply by changing the way things are perceived. As I said at this outset, this is why the power of credibility as an idea is so interesting. Credibility may seem solid but it can quickly evaporate — taking all of its power to help policymakers imagine possible solutions, remain calm through tense bargaining, and organize reinforcing behaviour along with it.
This fragility can be seen in a fourth illustration, which is the notion of the euro as a single currency. The euro exists as a commitment to ‘irrevocably’ fixed exchange rates. This is a commitment that European leaders have made repeatedly. It makes sense to keep the commitment to irrevocably fixed exchange rates when you think about the consequences of swapping it out for a set of fixed-but-adjustable exchange rates like the old exchange rate mechanism that the single currency replaced. And the commitment to irrevocably fixed exchange rates makes it possible to believe that a euro held in one country is as good as a euro held in another (and to act accordingly). When market confidence in this commitment wavered in the summer of 2012, Draghi made is pledge to do ‘whatever it takes’ to safeguard the euro and lent his own credibility to the single currency. The subsequent change in market behaviour was dramatic.
The question is whether the commitment to irrevocably fixed exchange rates would remain credible if by some accident Greece were forced to exit the euro. At that point it would be worth questioning whether the parity across countries is ‘irrevocable’, no matter what European policymakers like Draghi might insist. It would also be worth recalculating whether it makes sense for Cyprus to follow Greece rather than remain in the euro. And it would be useful to consider whether market participants should all keep pretending that they face no ‘convertibility risk’ when comparing euro-denominated assets from one country to the next or whether they might be safer changing some of their bets.
If the euro loses credibility as a single currency, this is the dynamic that we will have to face. It is not a question of balance sheet exposure or market institutions. It is a question of the power of ideas. And as we see at the moment, that power is manifest.