Each passing day brings the runaway trains closer to collision.

The European strategy to scare the Greek people into voting for pro-austerity parties was always risky.  My tendency is to think it will drive voters in the other direction, this is especially the case if voters come to believe they hold the real leverage.  And that is exactly the strategy that is emerging.  From the Wall Street Journal:

The head of Greece’s radical left party says there is little chance Europe will cut off funding to the country and if it does, Greece will repudiate its debts, throwing down a gauntlet that could increase tensions between Greece’s recalcitrant politicians and frustrated European creditors…

…”Our first choice is to convince our European partners that, in their own interest, financing must not be stopped,” Mr. Tsipras said in an interview with The Wall Street Journal. “If we can’t convince them—because we don’t have the intention to take unilateral action—but if they proceed with unilateral action on their side, in other words they cut off our funding, then we will be forced to stop paying our creditors, to go to a suspension in payments to our creditors.”

Europe and Greece are locked in a battle of mutually assured financial destruction.  Nor can European leaders afford to take Tsipras’ threats lightly:

According to recent opinion polls, Mr. Tsipras’ party is poised to win the most votes in repeat elections next month, bettering its surprise second-place finish in an inconclusive May 6 vote that left no party or coalition with enough seats in Parliament to form a government. With Mr. Tsipras poised to win pole position in the coming vote, it raises the risk that Greece will soon face a showdown with its European creditors over the contentious austerity program that Athens must implement in order to receive fresh aid.

If Europe caves and gives in to Greek demands, however, a new set of challenges to the austerity agenda will arise.  How long would it be before the people of Spain or Italy or Portugal or Ireland realize that they too have much more leverage than they ever imagined.  Can the Troika cave to Greece while remaining credible with other troubled economies?   I doubt it – which I think increases the risk that the core of Europe will believe it necessary to create a moral hazard example out of Greece.

Of course, this worked so well with Lehman Brothers. We will just forget about that little detail for the moment.

This post originally appeared at Tim Duy’s Fed Watch and is posted with permission.