Will Grexit topple Obama?

By Felix Salmon
May 25, 2012
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One of the hardest questions to answer, when people ask about the European crisis in general and the Greek crisis in particular, is “why should we in the US care?” The simple answer is that well, this is an important part of the world, and it’s big news. But if you only care about news insofar as it directly effects the US, then the answer is harder.

One possible answer — I’ve heard this given in a number of places — is that another major crisis in Europe would spill over into the US, cause serious economic damage here, and could quite possibly make the difference between an Obama and a Romney victory. But just how likely is that? I’m no expert when it comes to assigning probabilities to events, but we can at least come up with a general framework which lets us answer the question.

Let’s start with the fiscal pact. Will all of Europe credibly commit to fiscal austerity going forwards? If so, that increases the chances of crisis and Grexit, since southern European countries in general, and Greece in particular, simply can’t operate under an austerity regime in the way that, say, the Baltics have managed, painfully, to do. On the other hand, everybody seems quite likely to break the fiscal pact in one way or another — which means that there has to be a good chance the pact will end up being honored mostly in the breach. Let’s call the probability of a Europe-wide austerity regime A; my best guess for A is roughly 15%, or 0.15.

So the next question is — what is the probability of Grexit, any time soon? That’s really two questions. First, what is the probability of Grexit if there’s Europe-wide austerity. Let’s call that B, and I’ll peg it at 85%, or 0.85. Second, what’s the probability of Grexit if Europe-wide austerity slips a bit? We’ll call that C, and I’ll say it’s 65%, or 0.65. Overall, we can define the chance of Grexit, D, as A * B + (1-A) * C. If you’re playing along at home, that’s 0.68, or 68%.

But just because Grexit happens, doesn’t mean it will necessarily affect the US election. For one thing, by definition, Grexit can’t affect the US election if it hasn’t happened by the time the election takes place. So the next question is: if there’s Grexit, what are the chances that it will happen by November? The Europeans have proven themselves very good at kicking the can down the road, so even if Grexit is inevitable, it’s still not inevitable by November. In any case, let’s define E as being the conditional probability of Grexit by November, given Grexit. I’ll say that’s 50%. Which means that the overall probability of Grexit by November, F, is D * E, or 34%.

Grexit, if and when it happens, will cause a lot of disruption in European markets, and certain deposit flight out of Spanish and Portuguese banks. Again, there are two ways this can play out. Either it will cause a series of further dominoes to fall, or else it will concentrate the Europeans’ mind and force them to build a large and genuinely effective firewall, drawing a line in the sand and saying “this far, but no further”. Will Europe let the Grexit crisis go to waste? Let’s say the probability of a credible, coordinated and constructive pan-European response to Grexit is G. Then the probability of Grexit causing a big European crisis is 1-G. What’s G? That’s a tough one, but I’ll put it at 35%.

For the purposes of this calculation, we’ll assume that Greece alone is too small to cause a big global crisis: you need contagion, for that. So we’re looking for H, the chance of a big European crisis before the US election. We can calculate that as F * (1-G), or 22% — that’s the chance of Grexit before November, multiplied by the chance of a bigger crisis if Grexit happens. (Note that a big European crisis can happen at any time; the chance of that is D * (1-G), which works out at 44%.)

If we have a big European crisis before the election, then that will certainly send US stocks falling. But will a sharp drop in the US stock market have any effect on the outcome of the election? Probably only if the election is reasonably close — and certainly not if Romney is in the lead. A European crisis, and consequent plunge in US stocks, would only be good for Romney and bad for Obama, just as the crisis in the fall of 2008 was good for Obama and bad for the incumbent Republicans. So what we’re looking for, here, is I, the probability that Obama will have a narrow lead over Romney — one small enough to be erased by a big stock-market plunge. I’ll peg I at 65%.

And thus, finally, we get to the big answer: what is X, the probability of Grexit toppling Obama? That is H * I, which using my off-the-top-of-my-head probabilities, works out at about 14%. But you should work this out for yourself. Come up with your own values for all these:

A: What is the probability of a Europe-wide austerity regime?
B: If we get Europe-wide austerity, what are the chances of Grexit, any time soon?
C: If we don’t get Europe-wide austerity, what are the chances of Grexit, any time soon?
D: What, then, is the probability of Grexit? This is calculated as A * B + (1-A) * C.
E: If we have Grexit, what are the chances it’ll happen before the election?
F: This is the overall probability of Grexit before the election, and is D * E.
G: If we have Grexit, what are the chances of it eliciting a credible, coordinated and constructive pan-European response?
H: This is the probability of a big European crisis before the election, it’s F * (1-G).
I: What is the probability of Obama having a narrow enough lead over Romney that it would be erased by a plunging stock market?

Put these all together, and you can finally come up with a number for:

X: The probability of Grexit toppling Obama. It’s H * I.

I’d be interested to know what results you get, but my guess is that most of them will come up with a number which is low and yet still significant. It’s something to bear in mind, but of course it’s also something which is pretty much entirely out of Obama’s control. That’s the way that crises work: individual politicians are rarely personally responsible for them, but whomever’s in power when they happen nearly always ends up getting the blame.

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