Bond Markets Bet on Grexit

4 MAR 20, 2015 12:52 PM EDT

By Mark Gilbert

Two taboos about Greece's future as a member of the euro club were broken this week when  the German finance minister all but invited Greece to return to the drachma and the Dutch finance minister floated a temporary ban on Greeks' taking their money out of the country.

Suggestions that some German officials are less than enthusiastic about Greece remaining in the euro and that capital controls are possible aren't all that surprising. Nevertheless, the openness with which they were discussed shows the lack of progress the newly elected government has made in reaching agreement with the nation's creditors. Greece's financial future looks increasingly perilous.

The bond vigilantes are giving Greece a huge vote of no confidence, doubling the country's 10-year yield in the past six months and driving its three-year borrowing cost to a frankly unsustainable 23 percent. At that level, investors are signaling genuine concern that the country won't be able to pay its debts and can't retain its membership in the single-currency club.

German Finance Minister Wolfgang Schaeuble expects Greece to leave the euro, according to Friday's edition of Bild. The German newspaper, which didn't cite its sources, said Schaeuble "is internally anticipating: the Greeks are going to leave the euro. But German Chancellor Merkel reportedly wants to keep the Greeks in the euro -- for political reasons." While Angela Merkel has the bigger say in what happens to Greece, it's not clever to rile the finance minister of your biggest national creditor, as Greece has consistently done this year.

Last week's revelation of a now infamous video of Greek Finance Minister Yanis Varoufakis raising his middle finger to Germany at a 2013 conference won't have done anything to temper Schaeuble's obvious mistrust of his counterpart. On Monday, he accused the Greek administration of "lying to the public" in its pledges to undo economic austerity measures. On Wednesday, he said "time is running out for Greece." Last week, he suggested Varoufakis wasn't up to speed on the terms of his country's bailout: "I'm willing to lend him my copy," was Schaeuble's barbed comment. That prompted Greece's ambassador in Berlin to formally complain that his government had been insulted.

Dutch Finance Minister Jeroen Dijsselbloem broke the second taboo -- the possibility of capital controls -- when he raised the scenario that dare not speak its name in a radio interview on Tuesday. He said a temporary bank shutdown to restrict capital flows might give Greece a breathing space, much as it did in Cyprus: 

"It’s been explored what should happen if a country gets into deep trouble -- that doesn’t immediately have to be an exit scenario. We had to take radical measures, banks were closed for a while and capital flows within and out of the country were tied to all kinds of conditions, but you can think of all kinds of scenarios."

The Greek government dismissed his comments as "fantasy scenarios," while Prime Minister Alexis Tsipras said Friday that bank deposits are "secure." What else could he say?

Greece's banks are bleeding cash, with the most recent official figures showing just 148 billion euros ($158 billion) of deposits left in the banking system in January, a drop of 10 percent in just two months. Outflows surged to as much as 400 million euros on Wednesday, five times the average in previous days, according to Greek newspaper Ekathimerini. No wonder the stock-market value of Greek banks has halved this year.

As a two-day European summit ends in Brussels, Greece seems no closer to a pact. Tsipras must come up with a package of economic reforms that his lenders deem sufficiently sensible for further aid to flow to the country. He then has to sell what will effectively be a climbdown to his home audience. And the clock is ticking on when the country -- and its banking system -- might run out of money.

Locking cash in the country by imposing capital controls might help staunch the outflows, but it would probably doom the nation's banks to becoming wards of the state -- an outcome the country can ill afford. Dijsselbloem should know that, in a crisis, entertaining possibilities can rapidly create self-fulfilling prophecies.

To contact the author on this story:

Mark Gilbert at magilbert@bloomberg.net

To contact the editor on this story:

Paula Dwyer at pdwyer11@bloomberg.net