reflections

Jul 13, 2015 | 23:37 GMT

9 mins read

Germany Considers Worse Outcomes Than a Grexit

(Stratfor)
It can be difficult to separate the important from unimportant on any given day. Reflections mean to do exactly that — by thinking about what happened today, we can consider what might happen tomorrow.

Last Monday, and indeed for most of the past six months, all eyes were on Greece. Since it was voted into power in January, the new government has been like a circus act whose main attraction was the motorcycle-riding economist-turned-finance minister Yanis Varoufakis, who calmly preached macroeconomic reason to a group of creditors who only wanted to discuss microeconomic issues, such as Greece's plans for enacting reforms. For six months, the question has been whether the Greeks could shift their creditors' bargaining position, and if not, if they would take the ultimate step and take the home of democracy out of Europe.

Last week, the question was answered. Following a "no" vote in the referendum that empowered Greece to truly test the creditors' resolve on reforms, the Syriza government caved instead, jettisoning Varoufakis on Monday and meekly acquiescing Wednesday to the same terms that the public had rejected. Syriza's capitulation earned the resounding approval of the Greek parliament on Friday night. The Syriza delegation entered Brussels on Saturday as a defeated people preparing to sign the terms that would decide the nature of the peace with the conquering empire.

But this weekend, it became clear that the world has been following the wrong story. The creditors — more specifically, the German delegation that has set the tone throughout negotiations — has been undergoing its own realization process, and when the Greeks arrived they were presented with an impossible choice. The terms of the peace offered to new Finance Minister Euclid Tsakalotos on Saturday, and then Prime Minister Alexis Tsipras on Sunday, were Carthaginian in their harshness. The Syriza government was being asked not just to undertake the stipulated reforms but to unravel all of the changes it had made since it took office, essentially erasing any trace of Syriza having ever been in power — assuming, that is, that the government lasts long enough to implement these reforms before getting booted out of office by a disillusioned public. The alternative the Germans offered was a "time out" from the eurozone — an opportunity for Greece to leave the monetary union for five years and undertake the necessary reforms before rejoining after rehabilitation. The sweetener offered was that once Greece was out of the eurozone, the creditors could consider a proper restructuring of its debt.

The influence of other parties in the negotiations seemingly softened these extreme terms later, but the German offers are still out of line with the previous narrative. Such extreme harshness is uncharacteristic of contemporary Germany, a country haunted by its past and always at pains not to be seen as a malign hegemon while it slowly takes up the reins of the Continent. The erosion of Greek sovereignty implied seemed to make the Germans' double offer one designed to be rejected, since no elected government could willingly accede to it.

What is more surprising, though, is the German acquiescence to Greece leaving the monetary union. Despite the time out euphemism, any departure is unlikely to be temporary, and either way it would have the same destructive effect on the monetary union's structure. That Germany proposed a Grexit suggests a dramatic change in German policy. Knowing, just as well as the world's economists do, that a Grexit would probably lead to an unraveling of the entire eurozone, it is somewhat notable that this appears to be the route down which Germany is willing to escort Greece.

Entering the weekend, the Germans faced a no-win situation. The last-minute Greek surrender convinced no one that the Syriza government would be willing to actually undertake any of the reforms that it might agree to. In addition, there were no alternative parties, no reliable partner waiting in the wings to take over from Syriza in the event that it was deposed. All of the respectable opposition parties had proved incapable of undertaking reforms in previous iterations of the crisis. Moreover, if new elections were held, the likely winner would probably be Syriza once more. An opinion poll taken July 10 showed that 46 percent of respondents would vote for Syriza.

From Germany's perspective, no solution existed in which Greece would undertake substantial reforms, but it could not just kick the Greeks out. For one thing, the legal mechanism to do so does not exist. For another, Germany needed to show its reasons. So it formulated an offer that demonstrated all the things it would need to see for Greece to become an acceptable monetary union partner, even if it never expected them to be agreed to, and at the same time offered Greece the door, with some sweeteners behind it.

But why would Germany be willing to deal this blow to the European Project and set in motion a chain of events that would ultimately lead to the single currency's end? The reason is that the Greek experience is revealing the flaws inherent in the euro and the futility of continuing to fight to preserve it. The single currency was not a German plan, but a French one. Inspired by European Commission President Jacques Delors, the Germans agreed to join the currency in return for its reunification. It is often argued that Germany has been a great beneficiary of the euro, and this is true. The euro's comparative weakness has enabled German exporters, having been released from the deutschmark's strength, to thrive.

However, the market Germany developed in the euro's first decade was particularly in the eurozone, and it was largely powered by debt — the debt that now sits on eurozone balance sheets. With every day that passes, this debt grows larger in countries such as Italy, Spain, Portugal and Greece, and every day it becomes less sustainable. To Germany, then, the Greek request for debt forgiveness was not just a Greek request but also an inevitable request from the whole eurozone. For if it became clear that this debt would be forgiven if it reached a certain size, then the other indebted countries would believe they are also in the clear, since Germany provided them with a backstop.

Thus, the Greeks are the leading edge of a broader wave that could reshape Europe into a German nightmare, in which all the productivity of the Rhine Valley factories is diverted to support perceived South European inefficiency. The past five years have shown Germany that a country cannot be forced to change and that the roots of Greek intransigence go deeper than just difficult politicians. Moreover, Germany has learned that Greek history, geography and culture has created a society that is extremely different from Germany's and that the German public is unwilling to support a people they do not see as being of their own.

And what is true of Greece is ultimately true of all the other European countries that have suffered similar problems. On Jan. 4, 2002, three days after physical euros were introduced across the Continent, Stratfor wrote, "The euro's toughest tests will come when recession grips part or all of the eurozone. Europe lacks the economic synchronization of a single country. As a result, a recession will affect various countries differently, requiring distinct and sometimes conflicting policy responses. What's good for Germany may not be good for Greece." Thirteen years later, the Germans have finally come to recognize this truth.

But Germany's decision has not come out of nowhere. Signs have emerged, particularly in 2015, that the Germans have been preparing for a change. From the German perspective, the manner in which Germany lost two major battles in a row at the start of the year was notable. In January the European Central Bank went against its wishes and undertook a quantitative easing program the Germans had long resisted, seeing it as a way of reallocating resources across the eurozone. However, the notable aspect was the terms under which the Germans relented: They allowed quantitative easing to take place so long as the assets remained on each separate central bank's balance sheet, a prenuptial agreement that was recognized at the time as making it easier to separate countries' assets in case of a eurozone breakup. Then, the European Commission went against Germany's wishes and allowed Italy and particularly France to get away with severe budget laxity — another battle that Germany could afford to lose if it was not to be indefinitely bound by currency to those countries.

All of this is not to say that Germany would be ready to turn its back on the European Project altogether. Ever since World War II, Germany has understood the importance of creating reliable economic power. This economic power rests on exports, and thus Germany has been committed to maintaining and preserving the European free trade area, which prohibits its neighbors from raising tariffs against it. This, rather than the single currency, is the arrangement that Germany cares about, and this will be the platform for Germany to fall back on. As the single currency fails, Germany will have to make sure that the failure does not also damage the free trade zone and the entire European Project, which its goals rely upon.

On Monday morning, after 14 hours of talks, the two sides committed to a deal. Tsipras submitted to the Carthaginian peace and set off for Greece wondering how he was going to sell it to his people. In fact, there is a high possibility that it will be impossible to sell. The Greek people may look at the terms of remaining with the eurozone and rebel against it, postponing a Grexit by a matter of weeks rather than averting it. Alternatively, the Greeks may be as exhausted as Tsipras, and the rebellion may be delayed until a later stage, with the crushing terms merely eroding Europe's popularity for now. Either way, a momentous line was crossed over the weekend as Germany recognized that monetary union should not be preserved at all costs and that, in fact, there are many worse things that can happen than a Grexit. 

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