Angela Merkel - An Unexpected U-Turn

Why Merkel Wants To Keep Greece in Euro Zone

Angela Merkel has made a surprising U-turn in her policy on Greece. The German chancellor now wants to stop Athens from leaving the euro zone at all costs -- even if it means massaging the figures in the upcoming troika report. For the German leader, it is essential to avoid the consequences of a Grexit before national elections next year.

der Spiegel,

10 September, 2012

Mantras are short, formulaic phrases that are repeated over and over for meditative purposes. They can be spoken, sung, whispered, recited mentally or even written down and eaten.

The German chancellor has recently opted for the spoken variety, which is the conventional form. Angela Merkel's mantra consists of a short German sentence. It translates as: "We are waiting for the troika report." She repeats it whenever the opportunity arises -- such as two weeks ago, when Greek Prime Minister Antonis Samaras visited Berlin.

One doesn't need to be a rocket scientist to see through Merkel's maneuver: The chancellor wants to buy time. She hopes to calm the general public and the notoriously nervous financial markets through meditative repetition -- and ultimately create the impression that it actually matters what the troika finds out during its mission to Greece.

But it doesn't. In reality, Merkel has already made up her mind. After long hesitation, she has sided with French President François Hollande and the European Commission. The report from the troika -- which consists of the European Commission, the International Monetary Fund (IMF) and the European Central Bank (ECB) and which departed on its fact-finding tour last week -- will undoubtedly conclude that Greece can remain in the euro zone.

Newfound Determination

If that happens, more money can flow again into the debt-ridden Balkan nation this fall. If the chancellor has her way, though, there will be no third aid program for Greece, which would have to be approved by the German parliament, the Bundestag.

Merkel's newfound determination to rescue Greece is a remarkable U-turn for the chancellor. Until recently, Merkel was prepared to drop the country if it failed to meet its commitments. But she now regards a Greek departure from the euro zone as entailing too many risks.

In the Chancellery in Berlin, officials fear that such an outcome could trigger a domino effect like the one caused by the Lehman Brothers bankruptcy in September 2008. At the time, the collapse of the New York investment bank plunged the entire global economy into chaos. In Germany alone, the economy shrank by 5 percent and hundreds of thousands lost their jobs.

But the political costs are also too high for Merkel. If Greece withdrew from the euro zone, her advisers fear that this could mean that it would eventually be necessary to create a common "debt union" to stabilize problem countries like Italy and Spain. It would be a paradoxical situation: Germany would take a hard-line approach with Greece, but might subsequently have to accept jointly issued euro bonds, which German voters widely oppose.

On Ice

The enormous political pressure in this direction is exemplified by the ECB's controversial decision last Thursday to purchase, if necessary, unlimited quantities of sovereign bonds from struggling euro-zone member states.

So the chancellor has made up her mind, and will now continue to muddle along as usual. The problem will be put on ice for now, and re-addressed sometime after the 2013 Bundestag election -- when the current rescue program has ended.

It's clear, though, that it will probably take decades for cash-strapped Greece to modernize itself. "Greece is an Oriental country," says former French President Valéry Giscard d'Estaing in a SPIEGEL interview.

The risks and possible side effects of Merkel's approach are obvious. Once Greece receives more money, the danger increases that the government in Athens will postpone its promised reforms. It wouldn't be the first time.

'Maximum Pressure'

When Greek Prime Minister Samaras visited Berlin recently, he was left in the dark about the degree to which the Germans' view has changed. Instead, Merkel announced internally that it was necessary to continue to exert "maximum pressure" on the prime minister so he would implement the required reforms. At the same time, she praised her counterpart from Athens. Merkel said that Samaras is playing a "historic role" for his country, adding that she was very impressed with what he had to say: "We have to give him a chance."

And Merkel intends to see that he soon gets his opportunity. Her plan calls for the troika's report to present the situation in Greece as less disastrous than previously expected, as this is a necessary prerequisite for disbursement of the next tranche of aid. "We have to find a solution," Merkel instructed her staff last week.

It is the envoys of IMF head Christine Lagarde who are primarily balking at the idea of painting a picture of Greece's situation that is rosier than the reality. But Merkel is optimistic that they will eventually go along with her approach. The IMF statutes may be strict, but the agreements with aid recipients -- in this case Greece -- nevertheless offer a great deal of leeway.

This embellishment of reality could succeed thanks to the top-down method, which is popular in the world of business. It involves doggedly changing the parameters of a model until the desired result is produced.

Changing the Variables

The core of the troika report is the so-called debt sustainability analysis. It calculates the conditions that would be needed to reduce Greece's debt to the halfway tolerable level of 120 percent of gross domestic product (GDP) by 2020. Troika insiders say that this calculation may be a great many things, but a precise scientific forecast is not one of them.

Only one variable needs to be changed to produce the desired result. The troika experts have experience in this regard. In February, when the Euro Group of finance ministers decided on the last program for Greece, they spent four hours conducting calculations before they reached a debt-to-GDP ratio of 120 percent. It's an exercise that can easily be repeated.

The troika could thus certify that the Greeks have made progress. According to this scenario, the inevitable financing gaps would be downplayed as a regrettable but merely temporary departure from the plan -- and one that must be coped with as part of the current second rescue program. After all, the shortfalls cannot be too great, or a third rescue program might be necessary.

And that is something that must be avoided at all costs. A third package, as the Germans have already indicated to their European partners, would have no chance of being approved by the Bundestag. As a result, there is not to be any additional money for Greece. Instead, Berlin intends to alter the current -- second -- rescue program to make it look like Greece is making ends meet, at least for the time being.

Kicking the Can Down the Road

But how? One variant might work like this: If the Greeks need more money in the fall, the payment tranche will be increased accordingly. Later transfers would be reduced in return. This approach would present a decisive advantage for the chancellor. It would not become apparent until 2014, when the rescue program expires, whether the money had been sufficient or not. But that would already be many months after the Bundestag election.

Amending the current rescue package doesn't require the Bundestag's approval. The chancellor nevertheless intends to submit the changes to parliament for a vote. Merkel has reportedly told close aides that she remains confident that she will be able to win majority backing for the amendments when the time comes.

Even if most members of parliament reject the idea of a third aid program, they would still be highly reluctant to support a move that would result in Greece leaving the euro zone -- and Merkel believes that this would certainly happen if the current program isn't amended.

Furthermore, it looks like the crucial troika report will be delayed. It was originally supposed to be prepared by late August, and the next tranche of funding approved in September. Last week, however, officials in Brussels said that Greece's fate would probably not be decided until early November -- partly out of consideration for the United States. President Barack Obama is not inclined to allow his re-election to be jeopardized by an escalation of the euro crisis. Sources in Brussels say that postponing the report is not a problem because the government in Athens has enough money to see it through until then.

Newfound Affection

Attentive observers already noticed the chancellor's apparent change of heart two weeks ago. Merkel, whose father was a pastor in communist Eastern Germany, has suddenly discovered a deep affection for the downtrodden people of Greece. She compassionately expressed empathy for "what many in Greece have to suffer," and said that "it does make one's heart bleed."

Up until this point in time, Merkel and her finance minister, Wolfgang Schäuble, were seen as supporters of the "chain theory." According to this theory, the monetary union is a chain in which each individual country forms a link. Since Greece is the weakest link, if it leaves, as the theory has it, the chain will become stronger overall.

But since this summer, the majority of Merkel's advisers have now become supporters of the "domino theory," which postulates that the monetary union would not become stronger if Greece exits. On the contrary: If Greece falls, one country after the other could then be in danger of toppling.

Domino theorists argue that the impact on the economy, growth and employment would be catastrophic and incalculable. But one thing remains clear: If Greece falls, Germany will have to pay -- and the bill will come to almost exactly €62 billion ($79 billion). This is the colossal sum that the Greeks and their central bank owe the Germans. The entire amount would all have to be written off.

Falling Dominos

And that wouldn't be the end of the story. In order to protect the remaining financially weak countries like Portugal and Ireland, along with Spain and Italy, hundreds of billions of euros would have to be mobilized. But how? There are three possibilities: larger rescue packages, euro bonds or a kind of mutual liability insurance. But no matter what instrument is used, it would ultimately be much more expensive for Germany if Greece leaves the euro zone.

The domino theorists won out in the end. Everything that moves in the direction of a debt or liability union is a nightmare scenario for the chancellor. She knows that the majority of Germans reject euro bonds or the notion of assuming other country's debts. It could jeopardize her re-election next year.

What's more, the domino theory fraction in Merkel's circles has received support from, of all people, a man who has tended to place himself in opposition to the chancellor over the past few weeks: Jens Weidmann, the president of Germany's central bank, the Bundesbank. Weidmann, who once served as Merkel's economic adviser, now also thinks that it would be better for Germany in the long run if Greece remained in the euro zone.

But one of Merkel's more important allies still remains a chain theorist. German Finance Minister Wolfgang Schäuble has indicated to his fellow members of the Euro Group that he sees a Greek exit as an acceptable risk.

During a visit to the Netherlands, Schäuble reportedly told his Dutch counterpart Jan Kees de Jager that this was the only way that German voters could be convinced to keep the rest of the community together and de facto subsidize countries like Spain and Italy with rescue programs for years to come. At first glance, this position might seem to contradict Schäuble's image as a dedicated European. But in reality he wants to strengthen the euro as a political project by reducing the size of the common currency zone.

'Big Picture'

Merkel takes another view. According to her close aides, she is keeping her eye on the "big picture." The chancellor reportedly feels that the EU cannot afford to allow democracy to falter in a member state. She also points out that Greece is a NATO member and an important ally in the eastern Mediterranean -- a region that has enough flashpoints as it is.

But Merkel also sees domestic politics as an integral part of the big picture. Her new, lenient approach has the advantage that it could allow her to reach the election next September without the turbulence of a Greek exit from the monetary union. In return, she is prepared to play for high stakes.

If everything goes her way, the change in tranche payments will have no serious consequences within the second rescue program. She is putting off dealing with Greece until sometime in the future. If she's lucky, the Greeks will have gotten back on their feet by then, and will need less money because the reforms pursued in their country will have finally proven effective.

If she's unlucky, Merkel will be plugging holes by making new ones elsewhere -- and it may all come to a head once the Bundestag election is over.

Another possibility is that the Greek economy performs so poorly that the money runs out before the rescue package expires. This would be the worst-case scenario for Merkel. Nevertheless, she is consciously taking this risk. She sees it as manageable -- unlike a Greek exit from the euro zone.

Translated from the German by Paul Cohen