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Greece’s secret weapon: Grexit would hurt Merkel most

As soon as the decision is made, the €55 billion bill comes due. That’s why it keeps not happening

27 June 2015

9:00 AM

27 June 2015

9:00 AM

German chancellor Angela Merkel may still be the most formidable politician in Europe, but this week she lost a bit of her reputation as the scourge of Mediterranean debtor nations. Greece’s firebrand leftist premier, Alexis Tsipras, actually gets on well with Merkel, however much his countrymen enjoy burning her in effigy and adorning her portraits with Hitler moustaches. In a recent profile of their relationship in Der Spiegel, Tsipras gushed, ‘She has this East German way of telling you honestly and straightforwardly what she thinks.’ His top adviser Nikos Pappas also admires Merkel, calling her one of the few leaders in the EU who would rather look at questions politically than economically. She grew up among communists, after all.

The past two weeks have seen the umpteenth exercise in European Union brinksmanship since Greece began having trouble paying its debts five years ago. Greece owes a €1.6 billion tranche to the International Monetary Fund by the end of June, and EU authorities have been unwilling to release the funds Greece planned to pay this with. By the time Tsipras submitted his 11-page sketch of budget-plugging VAT hikes at last weekend’s emergency summit in Brussels, EU finance ministers had begun briefing about ‘Plan B’, depositors were rushing to withdraw their money from Greek banks, and negotiators were considering capital controls and a ‘balance of payments’ programme that might put Britain and other non-euro-using countries on the hook. But then things wound up resolved in the usual way, with Greece headed for yet another ‘rescue’ that would damage its economy and leave it more indebted still.

These are dark days for EU idealists. On top of the seemingly endless Greek issue, and the debt and reform problems of Spain and Italy, the EU is facing threats on several other fronts, as James Forsyth details on page 16. A growing immigration emergency in the Mediterranean is threatening the principle of free movement within the eurozone. Anti-European sentiments have moved to the centre of British politics. Antagonism is growing between Putin’s Russia and the West, and Europe is paralysed in the face of Isis’s advance in Syria. The European project starts to look feckless.

Germany’s finance minister, Wolfgang Schäuble, a passionate believer in European union in his youth, has grown rigid and categorical as only a disillusioned romantic can. Merkel is as she was. Her problem is that the EU has always been better for German business than for German democracy. This contradiction worsened with the bailouts of May 2010. Till then, Greek debt had been heavily in the hands of French and German banks and other private funders. Europe’s summiteers — the European commission and central bank, along with the IMF — paid off the banks and shifted the risk to Europe’s taxpayers.


This is not a system that recommends itself to western ideas of democratic accountability as they existed a generation ago. Germans didn’t run up Greece’s debt, so they shouldn’t pay it — that would be taxation without representation. But the single currency follows a different logic. You cannot have currency union without a political union that makes transfer payments possible from surplus-running areas to deficit-running ones. Merkel has been a shrewd enough politician to understand the contradictions in her position. First, the EU has been a good deal for Germany. Second, Germans would never knowingly tolerate the system which makes that good deal possible. The Munich economist Hans-Werner Sinn has written brilliantly about how a liquidity mechanism called Target-2 creates eurozone transfers through credit. (The US housing bubble that culminated in the global financial crisis of 2008 was not altogether different. Rich Person A doesn’t just give money to Poor Person B. His money is used to guarantee a loan, on which A might earn interest. The failure of B to pay the loan back is covered by printing money, so society as a whole pays through devaluation.)

It was in Merkel’s interest to let Europe’s institutions provide breathing room for the Greek economy, while taking a draconian line rhetorically. If Tsipras’s Syriza party had not been elected last January, she could have carried on this balancing act for ever. When responsibility for Greece’s debt shifted from European banks to European taxpayers in 2010, the negotiating advantage shifted, too. Greece could have demanded debt forgiveness from Europe before 2010, and Europe would have had little choice but to pay the banks anyway — because policymakers feared a financial ‘contagion’ otherwise. But once the debts were out of the banking system, Greece’s politicians thought they had no cards in their hand.

They were wrong. Tsipras and Varoufakis showed that Greece was not as vulnerable as it looked. Greece still possessed leverage, albeit of a new kind: if it left the euro, an itemised bill would be presented to the German taxpayer, and whichever country precipitated the rupture would be blamed. This explains the bizarre tenor of the debt negotiations ever since. Germany and its EU allies — by withholding funds that Greece believed it had already been promised — act as if they are trying to provoke Greece into leaving the eurozone in a huff, so Greece can be cast as a deadbeat. Tsipras has avoided getting suckered into such a move. If Germany wants Greece out, it will have to say so. A Greek exit would not be the worst thing (economically) for Greece but would be a very bad thing (politically) for Merkel, because the moment Greece was expelled, Germans would be presented the above-mentioned bill for €55 billion in loan guarantees. Merkel would be vulnerable for the first time to broad discontent from German voters.

Virgil was not the first to remark that Greeks are really good at negotiating. Some of those present at last week’s sessions snickered at the news that the Greek delegation had sent the wrong version of its final fiscal proposal on Sunday night. It sounds like incompetence. It is more likely the sort of university trick shrewd students use to gain extra time. Tsipras and Varoufakis have come to realise they do have leverage over their negotiating partners. Tsipras’s early diplomatic visit to Moscow was enough to bring that home to Europe’s foreign ministers in a vivid way.

Negotiators have gushed over the Greek proposal. The European Council president Donald Tusk of Poland says it has brought a ‘new dynamism’. In fact it appears to be aimed less at Merkel and her colleagues than at their publics, in order to bamboozle them. It calls for improving Greece’s fiscal position by increasing taxes on pensions, increasing certain VAT taxes, removing exemptions on other ones, and putting an emergency 12 per cent levy on corporate profits over €500 million. There are two problems. The smaller problem is that the VAT hikes might be revoked and might be evaded. The larger problem is that they would fail even if enacted. We know this because the same type of budget measure has been tried on Greece half a dozen times now. Europe is assuming you can get a man to run faster if you make him carry more weight. You can’t. The slowing effects on the economy exceed the quickening effects on revenue collection. On the European side there may be a sense that it is important to humiliate Tsipras by making him to go back on his election promises — thereby setting an example for other potentially troublesome political parties in the eurozone. This is why modest reforms affecting pensions have assumed such an outsized symbolic importance in negotiations.

The whole thing rests on attitudes that have never been countenanced in modern western countries. These VAT adjustments are supposed to raise €1.36 billion in the 2016 fiscal year — just about exactly £1 billion. That means millions of Greeks are being driven to the wall over a sum that any one of several dozen people in Britain could cover by writing a check. One begins to see the source of Tsipras’s rabble-rousing appeal.

It was much remarked in all German press coverage last week that Merkel did not repeat the line she made famous earlier in the euro crisis: ‘If the euro fails, Europe fails.’ Perhaps the euro crisis is a problem of discipline in few deadbeat countries, as Merkel believed years ago. Perhaps it is a balance-of-payments crisis, as many economists believe now. At its core is the growing likelihood that Greece would be better off outside the euro, provided it could avoid a wrenching crisis in the first transitional days. It might even accede to international credit markets sooner if it acquired a currency with a real (rather than a make-believe) value, and thus could begin building a real (rather than a make-believe) economy. The problem between Tsipras’s Greeks and Merkel’s ‘Europeans’ (as Tsipras calls them, as if he and his people were not Europeans themselves) resembles divorce in generations past. Both parties might well be happy outside this joyless and humiliating relationship. But neither side seems able to live with the shame of being the one to walk away from it.

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Christopher Caldwell is a senior editor at the Weekly Standard.


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