Will Berlin blink?

July 9, 2015

A disorderly Grexit grows closer. One can sense a lot fear and anxiety building up. Nobody knows what will happen if Greece is ejected from the eurozone but its probably not going to be good for anyone. Now it all hinges on Berlin, if the German government steps back from its insane instistance that ‘rules must be obeyed’ then a disaster maybe be averted.

Eurozone leaders told the Greek government on Tuesday in no uncertain terms that if it did not produce credible proposals by Sunday 12th July Greece would be thrown out of the Eurozone. “We have a Grexit scenario prepared in detail”, said European Commission president Jean-Claude Juncker.

The President of the European Council and former Prime Minister of Poland Donald Tusk, who has generally been a calm and reasonable voices in this drama, said that inability to find agreement may lead to the bankruptcy of Greece and the insolvency of its banking system. And he warned that there would be serious – possibly irreparable – geopolitical repercussions for the European Union. “If someone has any illusion that it will not be so,” he said, “they are naive”.

There have been other warnings about the geopolitical risks and the threat to the Euro project that a Grexit would create. In an interview on BBC Radio 4, the former head of the ECB, Jean-Claude Trichet, warned that Grexit would cause a “loss of credibility for Europe” and increase instability in a geopolitically sensitive region.

The U.S. and the International Monetary Fund this week issued their most forceful calls yet for Europe to restructure Greece’s debt. Tuesday evening President Obama telephoned both Angela Merkel and Alexis Tsipras urging that a deal be struck, there are reports that the US administration is growing increasingly irritated by the refusal of Berlin to budge. On Wednesday U.S. Treasury Secretary Jacob Lew and IMF Managing Director Christine Lagarde said that Greece’s debt burdens would overwhelm the country without eurozone lenders reducing its overall debt load. “Greece’s debt is not sustainable,” Mr. Lew said. “The real question is, can [Greece] make the changes that will satisfy Europe to put in place the kind of debt restructuring that needs to be there.” Ms. Lagarde, speaking at a separate event, also said euro leaders must agree to debt relief to ensure the country can return to health.

The IMF, as one of the primary lenders to Greece since 2010, had largely tiptoed around the subject of debt restructuring, at least in public. Late last week, however, the fund changed its public message, taking the unusual step of publishing a preliminary assessment of the county’s debt in which it said Europe needed to extend Greece’s debt maturities by 20 years “at a minimum.” It warned that a debt write-down might be necessary to ensure its burdens are sustainable.

With spectacular understatement and without a trace of self criticism Lagarde said Wednesday “It may well be that the numbers have to be revisited,”. No shit Sherlock!

But despite all these warnings, Grexit now appears to be the default position of most European leaders. Eastern European leaders, particularly, are strongly opposed to any more help for Greece, while Germany would apparently consider money for humanitarian relief after a Grexit but not for debt restructuring to avoid it. France and Cyprus appear to be Greece’s only friends. The only thing that could shift the hardline consensus position in the eurozone is if Berlin shifts its position.

The U.S. has previously said a financing solution should consider Greece’s debt sustainability. But officials have been cautious and diplomatic in their language, and have tried to avoid pressing Germany too strongly in public. Mr. Lew, for example, told German Finance Minister Wolfgang Schäuble, Greek Prime Minister Alexis Tsipras and other eurozone officials last week that a deal should include “a discussion of potential debt relief for Greece,” according to the Treasury Department. Berlin has previously expressed openness to discussing potential debt relief, but only if Athens implemented all of the creditors’ demands for economic overhauls.

But now the U.S. and IMF appear to be stepping up the pressure on Germany to reach a deal as a Greek euro exit looks increasingly possible. In his remarks on Wednesday, Mr. Lew said Greece’s government likely won’t be able to persuade a bailout-fatigued nation to approve all of the budget cuts and economic overhauls that creditors are requiring “without some sense of what the debt sustainability looks like.”

Germany’s position is the same as ever: no debt relief, no bridge finance, reforms must be delivered before any money is released, and the IMF must continue to be involved. If it sticks to these, Grexit is a certainty, since the IMF’s involvement is now incompatible with lack of debt relief. Christine Lagarde, speaking in Washington DC, reiterated the IMF’s position that debt relief is required in addition to further cost cutting by Greece:

“The other leg is debt restructuring, which we believe is needed in the particular case of Greece for it to have debt sustainability. That analysis has not changed. It well may be that numbers may have to be revisited but our analysis has not changed.”

The claim that the IMF analysis has not changed is completely disingenuous. It was the decision of the IMF to embrace the original 2010 bail out program without debt restructuring, a decision opposed internally by its own officials but pushed through by the Europeans on its board and by its Managing Director Dominique Strauss-Kahn, that set in motion this whole disaster.

Lagarde’s repetition of “our analysis has not changed” is actually a reminder to the Germans that in fact the IMF has shifted significantly in recent weeks, probably under pressure from the US, to explicitly support an immediate and up front debt restructuring deal. The shift in the IMF position is very significant because continued involvement of the IMF in the Greek program is now impossible unless the creditors agree to debt relief. And without the IMF there is no Troika, all that’s left to carry the can are just the eurozone leaders and institutions operating under German leadership. If a disorderly Grexit happens, and great damage is done to the single currency and the broader European project, then it will be entirely the fault of the eurozone leaders and specifically of its German leaders. It is not surprising that this week there have been pieces in the German magazines Der Spiegel and Handelsblatt that are highly critical of Angela Merkel’s handling of the Greek crisis.

Greece has now formally requested a third bailout, and will present its proposals to the Eurogroup today. The letter from Euclid Tsakalotos appears to be couched in a more more conciliatory tone than previous letters from his predecessor Yanis Varoufakis, and offers to commence reform of tax and pensions immediately. Greece, therefore, has made the first move and what is needed now is a concrete and specific offer on debt restructuring. Without debt restructering being part of the deal this week it is likely a disorderly Grext will commence this weekend. Even if the Greeks completely surrender and sign whatever is put in front of them it makes no difference, without debt restructuring the destruction of the Greek economy will continue and the whole crisis will merely erupt again in a few weeks or months.

Donald Tusk has called a European summit for Sunday July 12th. This summit will involve the leaders of all 28 European Union nations, not just the Eurozone leaders. Its going to be a tense few days.

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