Consider the following scenario. After a victory by the left-wing Syriza party, Greece’s new government announcesthat it wants to renegotiate the terms of its agreement with the InternationalMonetary Fund and the European Union. German Chancellor Angela Merkel sticks to her guns and says that Greece must abide by the existing conditions.
Fearing that a financial collapse is imminent, Greek depositorsrush for the exit. This time, the European Central Bank refuses to come to therescue and Greek banks are starved of cash.The Greek government institutes capital controls and is ultimately forced toissue drachmas in order to supply domesticliquidity.
With Greeceout of the eurozone, all eyes turn to Spain. Germany and others are at first adamant that they will do whatever it takes toprevent a similar bank run there. The Spanish government announces additionalfiscal cuts and structural reforms. Bolsteredby funds from the European Stability Mechanism, Spain remains financially afloatfor several months.
But the Spanish economy continues to deteriorate andunemployment heads towards 30%. Violent protests against Prime Minister Mariano Rajoy’s austerity measures leadhim to call for a referendum. His governmentfails to get the necessary support from voters and resigns,throwing the country into full-blown political chaos. Merkel cuts off further support for Spain, saying that hard-workingGerman taxpayers have already done enough. A Spanish bank run, financial crash,and euro exit follow in short order.
In a hastily arranged mini-summit, Germany, Finland,Austria, and the Netherlandsannounce that they will not renounce theeuro as their joint currency. This only increases financial pressure on France,Italy,and the other members. As the reality of the partial dissolutionof the eurozone sinks in, the financial meltdown spreads from Europe to the United States and Asia.
Our scenario continues in China, where the leadership faces acrisis of its own. The economy’s slowdown has already exacerbatedsocial conflict, and recent developments in Europehave added fuel to the fire. With European export orders canceled en masse, Chinese factories are faced with theprospect of massive layoffs. Demonstrationsbegin in major cities, calling for an end to corruption among party officials.
China’s government decides that it cannot risk further strife and announces a package of measures toboost economic growth and prevent layoffs, including direct financial supportfor exporters and intervention in the currency markets to weaken the renminbi.
In the US,President Mitt Romney has just taken office, following a hard-fought campaign in which he derided Barack Obama for being too soft on China’seconomic policies. The combination of financial contagion from Europe, whichhas already led to a severe credit crunch,and a sudden flood of low-priced imports from China leaves the Romneyadministration in a bind. Against the adviceof his economic advisers, he announces across-the-boardimport duties on Chinese exports. His TeaParty backers, who were critical in mobilizing electoral support for him, urgehim to go further and withdraw from the World Trade Organization.
Over the next few years, the world economy slumps into what future historians will call theSecond Great Depression. Unemployment rises to record-high levels. Governmentswithout fiscal resources are left with little option but to respond in waysthat will only exacerbate problems for other countries: trade protection andcompetitive exchange-rate depreciation. As countries sink into economic autarky, repeated global economic summits yieldfew results beyond empty promises of cooperation.
Few countries are sparedthe economic carnage. Those that dorelatively well share three characteristics: low levels of public debt, limiteddependence on exports or capital flows, and robust democratic institutions. So Brazil and India are relative havens, even though their growth prospects areseverely diminished as well.
As in the Great Depression, the political consequences aremore serious and hold longer-termsignificance. The eurozone’s collapse (and, for all practical purposes, that ofthe EU itself) forces a major realignment ofEuropean politics. Franceand Germanycompete openly as alternative centers of influence vis-à-vis the smallerEuropean states. Centrist parties pay the price for their support of theEuropean integration project, and are repudiatedin the polls by parties of the extreme rightor extreme left. Nativist governments beginto kick out immigrants.
For nearby countries, Europeno longer shines as a beacon of democracy.The Arab Middle East takes a decisive turn towards authoritarian Islamicstates. In Asia, economic strife between theUS and China spills over into military conflict, with increasingly frequentnaval clashes in the South China Sea threatening to erupt into a full-scale war.
Many years later, Merkel, who has withdrawn from politicsand become a recluse, is asked whether shethinks that she should have done anything differently during the eurocrisis.  Unfortunately, her answer comes too late to change the course ofhistory.
A remote scenario? Perhaps, but not remote enough.