Vorsprung durch Grexit?

17 April 2015

The German political and bureaucratic class is preparing for Grexit, and thinks the risks are containable. Angela Merkel should resist this emerging consensus in Berlin, and make every effort to keep Greece in the euro.


The brinkmanship between Greece and the euro group is entering a decisive phase. Amidst escalating threats – default by Greece, financial cut-off by the eurozone – the most pressing issue is whether Germany would allow a Greek exit from the eurozone, either on purpose (‘Grexit’) or by accident (‘Greccident’). Most of the key decision-makers in Berlin say that unless Greece starts implementing real reforms, it should leave the euro. But Chancellor Angela Merkel needs to consider the geopolitical dimension, as well as pressure from the US and the ECB to keep Greece in – in addition to the unwillingness of the Greek people to leave. For Europe’s sake, she should go the extra mile to avoid Greece departing the eurozone. But the odds of Grexit happening are rising.

Until the Greek government comes up with a serious plan for structural reform, Germany will continue to block further money for Athens. Given that Greece is finding it increasingly difficult to repay debts, and pay salaries and pensions, a Greek default and possibly exit from the euro is looking more likely with every passing week. “We have never been closer to Grexit, and we are close,” said one senior official in Berlin. Officials say they cannot detect any desire from the Greek government to commit to reforming labour markets, fighting corruption, improving tax collection, strengthening fiscal discipline or attacking vested interests. “Faced with Grexit, Tsipras might do a U-turn, and perhaps change his coalition partner. But we have no idea what he’ll do,” said an official. The German government does not know whether Tsipras is playing chicken and waiting for Germany to blink, or simply unable to control the many factions in his government. Or even whether he really wants to keep Greece in the euro.

Germans who favour Grexit argue that it would be good for the Greek economy. Greece currently has an output gap of around 13 per cent of GDP, according to the OECD; the economy is running at well below its economic potential. Autonomous Greek monetary policy and a weaker currency could therefore speed up the recovery, and avoid the further harm to the economy that a long depression would inflict. But a prerequisite for such a successful outcome would be that the exit be properly managed, with the help of the ECB, and with bridge financing for the Greek government from European institutions, to limit short-term disruptions. What is more, the new Greek monetary policy authorities would need to build up trust quickly, to avoid continued instability and high inflation.

Proponents of Grexit tend to underplay the potential downsides. Leaving the euro is more difficult than giving up a currency peg: millions of contracts would need to be rewritten, and foreign debt (in euros or dollars) would balloon when measured in new drachma, forcing companies and especially banks into default. Inflationary pressure would be strong, hurting consumers. It is not a given that, post-Grexit, the Greek financial system would be stable and inflation manageable. The deeper institutional and structural problems of the Greek state and economy would remain unresolved, leading to slow growth after the economy had returned to its potential output.

Some German officials predict that Grexit could be a gradual, drawn out process. Greece would not be pushed out following a decision by the European Council or European Central Bank, they think. Instead, the government would run out of money and have to issue IOUs as a parallel currency, while imposing capital controls and intervening heavily in the banks to prop them up. This would not be a stable situation; the economy would not grow under such a scenario. As a result, the government would probably think it best in the long run to take the plunge and devalue by formally leaving the euro – then at least the economy would regain monetary autonomy, making it easier to boost demand.

German officials are sanguine about the consequences of Grexit. “It would not be problematic for our budget, financial sector or economic growth,” said one. “And one positive result could be that other countries would do their homework and become more disciplined” – an argument that the German council of economic experts has recently made, too. Tax payers are liable for around €240 billon of Greek debt, of which Germans could lose €70 billion. The officials think that would be manageable.

Most officials think the risk of contagion is minimal. “Spain, Portugal and Ireland would be alright because they have done their homework,” said one. Although Italy and France have not done much homework, he thought their fates – and whether they reformed – would be unrelated to what happened in Greece. In any case, Greece was a special case, he said – there was no longer much bank exposure to it.

He acknowledged that if the financial markets asked for a premium before lending to other eurozone countries as a result of Grexit, Germany would have to consider further eurozone integration, such as tighter fiscal discipline or the introduction of ‘economic reform contracts’. “In that case we would need to move fast, so hopefully we would be able to avoid changing the EU treaties.” He may be too nonchalant: if the markets were panicking about the euro’s viability it is highly unlikely that modest steps towards policy-integration or risk-sharing would reassure them.

Is there a difference between the approaches of Finance Minister Wolfgang Schäuble and Angela Merkel? Officials say that on the fundamentals, there is not, even though Merkel’s rhetoric is softer. They both want to keep Greece in the euro, but not under any circumstances, and not if the Greek government cannot get its act together. Some of their officials take a harder line. “As an economist, I am not sure if Greece should stay in the euro; it is structurally uncompetitive and could become a second Mezzogiorno,” said one. He noted that Latvia, Lithuania, Spain and Ireland had known they needed to change, and therefore taken painful decisions, but he thought that sometimes pressure to reform did not work. He worried that keeping Greece in at all costs would undermine European cohesion.

Inevitably, Merkel thinks more about the geopolitical context than Schäuble. She is under discreet pressure from the Obama administration, which worries about the risk of a Greek-Russian rapprochement. The IMF, the European Commission, France and Italy also want to find a way of keeping Greece in. A lot of European governments would be reluctant to make a visible write-down of their loans to Greece. The SPD – Merkel’s coalition partner in Berlin – says in private, though not in public, that Germany has overdone the austerity during the eurozone crisis, and it is against Grexit. Another reason for keeping Greece in the euro is that if it grew strongly outside the currency, anti-euro voices elsewhere would grow bolder.

The ECB, too, remains opposed to Grexit. For now it is taking a hard line on Greece, limiting the ability of Greek banks to fund the Greek government. Yet it was the (still untested) promise of Mario Draghi to do “whatever it takes to preserve the euro” that ensured the single currency’s survival in the summer of 2012. The ECB and others worry that in a future political crisis in another member-state, financial markets might start doubting the commitment of the core countries and the ECB to preserve the integrity of the euro. At that point, the eurozone would be thrown back into the self-fulfilling crisis mode that policy-makers have scrambled to leave behind during the past few years. The ECB would not risk the unravelling of that promise over Greece, unless put under considerable political pressure.

Within Greece, too, it should not be forgotten that a recent poll found 84 per cent of Greeks in favour of keeping the euro. Syriza does not have a mandate to negotiate an exit, and its high approval ratings could soon tumble if the country took steps to prepare for leaving the euro, such as capital controls and bank closures. It may well be that a Greek government which embarked on a path towards Grexit would fall before the event.

One key point for Merkel, apparently, is that Germany should not be blamed for Grexit. One visitor reports her line as being: “If Grexit happens, people will see the cause was that Greece failed to do its homework, not that we withheld solidarity.” In this blame game, Merkel is currently succeeding. It is astonishing how those who agree with Greece that the eurozone has overdone the austerity – like France and Italy, and to some degree the European Commission and the IMF – have been alienated by Syriza’s chaotic and confrontational style of governing, its extreme rhetoric and its inept diplomacy. As a result, Paris, Rome and Brussels are not speaking out on Greece’s behalf. And there are some eurozone governments, notably Finland, the Netherlands, Slovakia and Estonia, which are encouraging Germany to take a hard line. Even the Spanish and the Portuguese, having ‘done their homework’, are in this camp.

But this blame game could easily shift if Germany facilitated or actively pushed for a Greek exit. Not only the US, the IMF and the international press but also probably France and Italy would ultimately criticise Germany for its handling of the euro crisis – during which Greece has suffered from a depression of similar magnitude to that of Germany in the 1930s, the eurozone economy has failed to recover to its pre-crisis size, and the political extremes in Europe have gained much ground. The US has long understood that in its role of the transatlantic alliance’s hegemon, it must accept some costs for the greater good of the alliance’s stability. It expects as much from the EU’s hegemon, Germany, and in the event of a Grexit would hold Berlin largely responsible.

The threats from the Greeks to default on eurozone rescue loans, and from the Germans and their allies to push the Greeks out, are part of a game of brinkmanship: both sides need to be seen as fighting for their voters. A smooth and early agreement would raise suspicion among both sides’ electorates that their politicians could have achieved more from the negotiations. This does not mean, however, that neither Greece nor Germany will step over the brink.

There is no doubt that many powerful voices, within Europe and further afield, will try to prevent Grexit. But Berlin plays a decisive role in eurozone crisis management, and in Berlin key decision-makers believe that Greek membership of the euro is becoming unsustainable. Germany’s friends should help it to see the bigger picture.

Charles Grant is the director and Christian Odendahl is the chief economist at the Centre for European Reform.