Grexit: Was Germany ready to pull the trigger?

A temporary deal largely on German terms has been struck to avoid Greece crashing out of the euro. A key factor may have been that Germany was ready to contemplate Grexit - Syriza wasn't.

23 February  2015+

As we predicted and noted in our instant response to Friday’s deal to keep Greece in the euro, as things stand, Syriza spent an awful lot of political capital in return for limited result.+

There are several reasons why  Syriza’s bargaining hand is relatively weak. At the end of the day, Syriza isn’t yet prepared to contemplate Grexit, with over 70% of the Greek public still in favour staying in the euro. In contrast, it may well be the case that the German government genuinely was ready to let Greece go, absent a deal. You can credit Syriza for acting responsibly on that point. However, it also meant that in that epic stand-off between Wolfgang Schäuble and Yanis Varoufakis, only one of them had a nuclear option.+

Grexit would hit German taxpayers

If Greece defaulted on its loans and left the euro, German taxpayer would potentially face a hefty bill. As we note, German taxpayers’ exposure to Greece via the Eurozone bailout funds and ECB (including EFSF/ESM, SMP, Target 2) has doubled since late 2011 – just before the ludicrous second Greek bailout. From €32.8 billion then to €65.2 billion now. As others have pointed out, this would be legally and politically explosive in Germany – not least since Grexit is unlikely to come about as a democratic decision in the Bundestag but rather a decision behind closed doors. German politicians and central bankers will have a lot of explaining to do.

But the cost might be controllable. Still, Germany may not have been bluffing.

This only shows direct exposure, not indirect exposure or risk of contagion. In 2012, the Eurozone banking system was under-capitalised and looked incredibly fragile, meaning the risk of investor or deposit-led contagion was big. The fear of a domino effect was probably the main reason why German Chancellor Angela Merkel decided against Grexit. Since then, banks have been recapitalised, the ECB has injected €1 trillion into the Eurozone economy with a commitment to pump in another €1.1 trillion via QE. This liquidity could cushion much of the effect of Grexit as far as Germany is concerned.

In other words, whilst the public exposure to Greece is  uncomfortable, the German government now has greater ability to control the fallout from Grexit. This is highlighted by the sanguine market response to the Greek crisis so far this time around. Berlin’s calculation has changed.+

Even if Greece defaulted and left the euro, it’s unlikely, even in a worst case scenario, that Germany would get no money back, given the incentives to strike a deal. For example, Greece would certainly want to stay in the EU, which would require help from other EU members and they may extract payment concessions (caveat emptor: Germany may get repaid in Drachmas).

Grexit:  the cheaper option?

Most importantly: yes Grexit comes with a cost, but there are plenty of people in Berlin – and Frankfurt – who now consider the economic and political cost of Greece staying in higher. Let’s not forget that, even if Greece stays in the Eurozone, German taxpayers could still take a loss – in fact this is what the current Greek government is actively pushing for. The Germans do cool-headed calculations better than most, these facts will not have escaped them. It’s also interesting to see the extent to which German press and public opinion have so far united behind Wolfgang Schäuble’s very hawkish approach. In that ongoing German clash between two key WW II commitments – sound money and Europe – the former is coming out on top at the moment. This also means that the scope for guilt tripping Germany into deals is narrowing.+

Much can still happen, but if things again deteriorate (a distinct possibility given the long negotiations still to come), it would be a mistake to think Germany is bluffing.+

http://openeurope.org.uk/blog/grexit-germany-ready-pull-trigger/