ANALYSIS:German talk of Athens defaulting won't be followed through on. The euro's rally is the only hopeful sign that the game is not yet up

TOMORROW MARKS the third anniversary of Lehman Brothers filing for bankruptcy. The world has not been the same since. For three solid years we have lived with the sickening fear that banks could shut and global depression take hold.

Those fears have heightened as Europe, and indeed everyone else, returns to the brink yet again.

The proximate cause of the latest panic is – again – Greece. In recent days, German government figures signalled, for the first time, that default was an option.

Are the Germans sending a signal to prepare for the first sovereign default in a developed country since the 1940s?

Such a position would not be illogical. Many observers have have concluded that Greece simply will not be able to pay back the money it owes – its economy is shrinking almost as fast as Ireland’s did in 2008-09 and its debt levels are much higher. Efforts to persuade Greek debt holders voluntarily to roll over their loans have failed.

If the socialisation of Greek sovereign debt on a European basis is ruled out and Germany decides that it won’t kick the can again, immediate default is – by a process of elimination – the only outcome.

But this is not as certain as markets think, for now at least. Yesterday, German chancellor Angela Merkel rowed back on the signals her government colleagues had sent.

Today she is scheduled to talk to her French and Greek counterparts. Expect that battered can to get another kicking in return for additional, more concrete commitments from Athens.

It is hard to think that political leaders would risk triggering a Lehman-like event almost three years to the day since US policy makers thought they could handle the effects of letting that bank go to the wall. Note, also, the similarity in the amounts involved – Greece owes €300 billion; Lehman defaulted on €440 billion.

Moreover, it is easy to see the collateral damage of Greek default being greater than that of America’s baddest bank.

Three years ago, not a living soul thought the Italian state was one bond auction away from default. Now it is. And its auction yesterday proved it – the rate of interest the Italian debt management office had to offer on very short paper was almost double the rate of a few months ago.

What’s more, many European banks are already gravely weak. Some big French banks have already seen share price declines as big as those suffered by the Irish banks before Lehman went.

Don’t be surprised if countries such as France announce bank guarantees that are not dissimilar to the kind announced here almost three years ago in an effort to break the doom loop of banks weakening sovereigns, sovereigns weakening banks, and so on.

If comments from German mavericks about letting Greece default and even booting it out of the euro caused Europe’s financial system to tremble, they may have had an unintended, and not entirely unwelcome effect.

Frustration with Greek non-implementation of reforms is at boiling point. Adding to the frustration of those bailing Greece out has been the absence of credible threat to push reform. Politicians in Athens could reasonably calculate that because the consequences of Greek default are so enormous for everyone, the cash will keep flowing regardless of their actions or inactions.

If pleading and cajoling haven’t worked, dangling them over the edge and threatening to let go might. Recent comments from Europe’s north may have made them think that the unthinkable is possible after all.

Illustrating the severity of the situation yesterday was a speech by a central banker that would have been unthinkable just a short time ago. Heresy came from the lips of Adam Posen, an American who sits on the interest rate-setting committee of the Bank of England. “Sustained high inflation is not a threat in [the current] environment,” he said. For a central banker to welcome inflation, not be obsessed with slaying it, says much about how the world has changed.

If there was any comfort yesterday, it was the euro exchange rate. It is the canary in the mine. A real run on the euro would mean the game was up.

Until last Thursday, the stability of the euro/dollar exchange rate was the best reason to think that investors believed the zone would muddle through. Then, quite suddenly, it fell sharply. Its decline accelerated on Friday. Monday morning brought a further slide. Then it steadied.

The game is not up – yet.