Greece vs Germany death match

Cross-posted from Yves Smith at Naked Capitalism.

Even though the US has waded into the Greece versus Troika impasse to press Eurozone officials to soften their position on austerity, the battle lines seem only to get harder.

Today, February 11, an emergency meeting of the Eurogroup, a committee of 19 Eurozone finance ministers, officially begins to commence negotiations about a possible bailout for Greece. But keep in mind that “bailout” is a term of art, and is used to refer specifically to the Eurozone bailout that is set to end on February 28. Unless it is extended, Greece will not receive a payment of €7.2 billion of bailout funds plus an additional €1.9bn in income on Greek bonds held by the ECB that most observers think Greece desperately needs. But Syriza continues to reject taking these bailout funds, since the strings attached include austerity measures like labor-crushing “structural reforms”.

On Monday, Greece Finance Minister Yanis Varoufakis briefed the media on his reform proposals. Even though financial markets responded positively to news of US pressure on Germany, and Varoufakis’ efforts to position this draft as making concessions, neither side has budged. As the Financial Times noted, “But several officials at the G20 meeting in Istanbul said that the new compromise appeared to be neither new nor a compromise.”

And despite US entreaties, European officials are even more insistent that Greece must yield. From Bloomberg:

Schaeuble damped any expectations talks were possible on a new accord, saying in Istanbul yesterday after a meeting of finance chiefs from the Group of 20 that if Greece doesn’t want the final tranche of its current aid program, “it’s over.” Creditors “can’t negotiate about something new,” he said. Deutsche Bundesbank President and European Central Bank Governing Council member Jens Weidmann said Greek efforts to get bridge financing through debt instruments was a non-starter.

The EU economics commissioner joined the chorus of nay-sayers and told Greece it has only until February 16 to get a deal done. From Reuters:

Greece will have to ask for an extension of its current bailout to give itself and the euro zone time to hammer out a new agreement, as there is no specific plan for Athens now, the EU’s economics commissioner said on Tuesday…

Greece would have to agree to extend the bailout and apply for it by the next meeting of euro zone finance ministers on Feb. 16, he said, because otherwise there would not be enough time for parliaments in some euro zone countries to approve the extension before the program expires on Feb. 28.

The Financial Times also took note of Eurocrat annoyance with Greece:

EU officials have grown frustrated with what they believe is a misunderstanding of EU procedures by the new Greek government and hope the eurogroup meeting will offer Mr Varoufakis a chance to begin more formal talks over how Athens wants to proceed.

And these media accounts seem to be polite versions of how deep the rifts are. See EU Sources: Eu-Greek Relations Soured by Leaks; Sides Further Apart MNI Euro Insight (hat tip Jim Haygood) for an unvarished version.

It’s critical to note that the friction isn’t merely the result of the two sides being so far apart. Both are taking unheard-of measures to undermine each other outside the negotiations. As economist and former IMF staffer Peter Doyle explained at FT Alphaville:

On the one hand, in an incredible reversal of practice during the global financial crisis—when central banks were at pains to conceal which institutions were receiving their emergency assistance for fear of compounding the adverse signals and therefore the crisis—the ECB has brazenly publicized exactly which Greek banks depend on its help and how much. And it has overtly warned it would withdraw that help. In this way, the central bank is overtly threatening to blow up the Greek banking system, in order to make the euro work. Walter Bagehot, the nineteenth-century father of lenders of last resorts, would be dumbfounded.

On the other hand, Syriza would like nothing better now than to see the yields on Spanish, Portuguese, or Italian sovereign debt relative to Germany jump, signalling broader market disquiet—that Grexit may be imminent and that the rump eurozone would be badly destabilized by it—so forcing ECB retreat. So Syriza, in league with Podemos in Spain and prevailing anti-euro Italian political forces, is openly threatening to blow up its own exchange rate regime, the euro, in order to make it work. The many fathers of exchange regime credibility would be as dumbfounded as Bagehot.

I have heard today from a source with knowledge of the US discussions with Germany that they see signs of movement, and that Greece has supporters in other Eurozone bureaucracies. This is not inconsistent with what we’ve said, that there is a contingent that recognizes that austerity has failed and might use the Greek negotiation to advance their cause, and they could ride in and help rescue Greece. But that was before so many parties staked out hard line positions against Syriza’s proposals. The sympathizers don’t appear to be close enough to the negotiations to push for a climbdown, even if the principals could find a way to finesse what would otherwise look like a big loss of face.

It would be better if I were wrong, but what I am hearing of the US reading sounds like a classic American projection of our worldview. First, the Administration contingent seems to believe if it can get Germany to agree to a deal, the rest of the Eurozone will follow. But that isn’t how its structure works. If Greece continues to reject the bailout framework, Germany would need to lead some sort of funds extension outside the Eurozone structure. That has far more moving parts that just trying to settle differences over, say, how much of a break if any Greece gets on its fiscal surplus requirement. The White House/Treasury assumption seems to be that the two sides will negotiate within the current bailout framework, when Varoufakis keeps insisting that that is not on. If he does not budge tomorrow, the basic premise of the US view that the two sides can be pushed to come to a deal would seem to be far from the mark.

Moreover, with no financial market pressure on Merkel, the US seems to miss how large the downside of giving a concession to Greece would be for her. We discussed repeatedly that the Germany’s political leaders have successfully demonized the Greeks, with the result that German voters see them as slovenly, lazy, and fully deserving of their current misery. What justification could there possibly be for cutting them a break, particularly given that Germans prize honoring commitments far more than Americans do? There isn’t remotely enough time to launch a media campaign to try to shift German opinion. And as Doyle stresses, the domestic risks to Merkel are immediate and large:

That takes us to the other half of the dreadful euro dance—the Polka featuring Merkel and the markets. The last time that push came to shove on this, in 2012, as the markets, Syriza, and the ECB all now know, she blinked and we got “whatever it takes” and OMT. Back then, her Minister of Finance, Mr Schäuble, had overtly led the charge to be done with it and to push Greece out. She wavered, during which time markets across the eurozone- and world-wide boiled. But partly (largely?) as a result of their boiling, she was persuaded that Germany could not be insulated from the bedlam that would follow Grexit. So she overruled him. And Varoufakis smiled at him during their press conference last week in Berlin.

This time around, the non-Greek euro markets are quiescent, and though Greek markets are stressing, that is nowhere near the pandemonium there that would reflect imminent Grexit.

So is this because markets think, along with Syriza, that she will ultimately cave as in 2012 if the Greeks hold their line? Or is it because markets are becalmed by QE and believe what those VSPs are all telling her, that the euro defences to deal with Grexit have all been “improved” since 2012? The answer is unknowable in advance.

But the risks of mutual misreading between Merkel and the markets on this are potentially catastrophic. If she wrongly finds affirmation from markets’ quiescence that defenses are strong enough to withstand Grexit and so lets Greece go, but markets’ quietude actually reflects QE and their belief that she will again crumble, bang goes the euro. But if she buckles for a second time rather than risk misreading, it is hard to see Schäuble tolerating that further humiliation at her hand, not least right after his defeat on QE. And if he goes, that would be a prelude to unprecedented German political turmoil. Merkel always prefers the less risky option. But in this context, it is not clear what that is for her. Thus is her dance with the markets.

Recall Schäuble’s remark that if Greece refuses to accept the current bailout, on pretty much the current terms, there was nothing further to discuss. That statement reflects Schäuble’s Dr. Strangelove-level fervor for austerity. But it may also have been to box Merkel in in the face of US arm-twisting.

There is another possibly ugly piece in this equation. Greece has been given a drop-dead date of February 16 for asking for a bailout extension. The next ECB board meeting is right on its heels, February 18. The ECB board rotates, and the group coming up on the 18th is skewed heavily toward the parties most hostile towards Greece. That board could conceivably uses a Greek rejection of the bailout to justify changing its posture, using the justification that the refusal resulted in a considerable increase in risk, and use that rationale to kick Greece on its way to default and/or a presumed Grexit. The big point of vulnerability is the Greek central bank’s continued access to an ECB banking system backstop through the Emergency Liquidity Assistance program, or ELA. If you read the ELA rules, it is meant for solvent institutions and to operate below a certain threshold and only for a “pre-specified short period of time.” The voting members on the 18th could impose time limits or even take the more brutal step of lowering the ELA limit from €60 billion. While Draghi would presumably try to moderate their actions, he might not get far enough.

Further confirmation of how unlikely it will be to get the Eurozone countries to relent from their hostility towards Greece, or indeed come up with any lasting solutions in the current framework comes from the Telegraph. It suggests that the US and the UK need to provide support to prod a reluctant Europe to pony up:

The Whitehouse’s approach to date appears to have been focused on trying to persuade Berlin to compromise and accept the reality of Greece’s can’t pay, won’t pay position. It also wants Germany to ease back on austerity in the round, in the hope of securing wider economic recovery in Europe.

This is unlikely to work. Europe is not a single country, and is still decades away from acting like one. Too much time and energy has already been expended trying to keep the Eurozone together. Even if a way of forestalling the immediate crisis is found, it will only be until the next time. Greece, and perhaps others too, demand different solutions, immediate exit from the Eurozone being the first step, allowing the debt overhang to be redenominated in devalued drachmas, and creditor haircuts to be imposed appropriately.

Greece then needs to be supported with a realistically constituted programme of international support, including American and British bilateral loans, in place of the nonsense imposed on it by the Troika. Without the adjustment mechanism of devaluation, this was always doomed to fail.

And there are much bigger issues in play, as Swedish Lex points out by e-mail:

I hope that Obama is experienced enough by now (i.e. cynical enough) to understand that he needs to apply a lot of pressure on the Europeans for them to avoid self destruction. Such pressure in my guess comes through security policy arguments, not economic arguments. A Greek implosion would derail U.S. recovery, send the USD to the sky (did you see Coke’s numbers which were down a lot on the USD) and make Putin the happiest man on the planet. Putin’s plans and ambitions, long term, would get an incredible boost if/when the EU starts to unravel. Do not forget that Putin skillfully has been nurturing his relationships with e.g. Le Front National in France.

Divide and conquer. In this case, Putin would not even have to divide. The Europeans, “lead” by Germany, would do it to themselves.

This confrontation is stark, so it is no wonder that commentators are taken with the personal drama as well as the high stakes.

But here we are not dealing just with the theater of highly public, high stakes negotiations. This pitched battle is a symptom that the failure to address the fundamental contradictions of the Eurozone cannot be delayed much longer. Even if Syriza capitulates in the next few days, the even bigger threat of Marine Le Pen looms. It is now Merkel, not Varoufakis, who needs to take up the mantle of the convention-defying leader, but her history strongly suggests she is too cautious and blinkered a player to assume the role that Europe desperately needs her to take on.

Houses and Holes
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  1. It appears to me that the Germans (reasonably confident in where they stand with Greek sovereign debt not on the books of their banks unlike circa 2011/2012 – and presumably confident the Greek sovereign debt is not on the books of the banks who have debt on the books of German banks) are quite prepared for a Grexit.

    I think Syriza are quite prepared for Grexit too, but recognise this will involve a lot of social pain at home and are going through the motions to show the Greek public they have tried to renegotiate first (before putting them through that pain) and to nut out a plausible alternative. I reckon they will be a one term government [and maybe not that long] if they fold in negotiations on debt reduction.

    • Finally a politician willing to sacrifice their political career to further the interest of their country in the long term.

      In generations to come Syriza will be treated like a patriot for ridding their country from the shackles of debt.

      • Maybe I have this all wrong, but are you supporting the prospect that a sovereign nation, having totally stuffed up their economy through decades of profligate over-spending, and having been rescued boy other more economically prudent countries, is justified in defaulting on their obligations?

        The decades of financial corruption in Greece are well documented and now they must pay the piper.

        My view is that they incurred the debt, so they should pay it back. If they want to renegotiate the terms so be it, but do so in an honourable manner.

      • When people are hungry burn the bondholders!

        Especially when innocent people are hungry.

        The people of Greece did not assume this debt. The bondholders knew the commercial risk which was priced accordingly. The hoped to make lots of money out of Greece, or if not out of Greece out of other people because of Greece. Predatory lending must be allowed to fail when it has so comprehensively failed to deliver the good times that the EU promised if Greece kept its side of the bargain. Greece did. The Troika’s forecasts were rubbish.

      • “My view is that they incurred the debt, so they should pay it back.”

        My view is that debts that can’t be paid, won’t be.

        Both borrowers and lenders are free to do what they like as long as they are prepared for the consequences of their actions.

        If you lend to someone who can’t or won’t pay back the debt then you’ll lose money.

        if you borrow money from someone and can’t or won’t pay back the debt then you won’t be able to easily or cheaply borrow more money in the short- to medium-term future.

        This is not an inevitable scenario. Governments are sovereign with regard to their creditors. They still posses the alternative power to wipe out the debts – along with the savings that are their counterpart on the opposite side of the balance sheet. The German Currency Reform of 1948 remains a model. But it calls for creditors to take a loss.

        This has happened again and again in history for the past five thousand years. Until recently it was the normal result of financial crashes – the final stage of the business cycle, so to speak. But as economies have been financialized, creditors have gained political power – and also the power to disable realistic academic discussion of the debt problem. What they fear most of all are thoughts of how to avoid today’s arrangements that have given them a free lunch at the rest of the economy’s expense.

  2. I think the biggest fear of the US is that Russia will step in and bail Greece out post grexit. Greece resumes it’s former role as a pawn in the great game…