Of all the dilemmas facing Europe’s leaders, what to do about Greece could prove the most vexing. After two rounds of bailouts, Greece is still struggling to get its deficits under control. So the rest of Europe can either give Greece more time (and money) to solve its debt woes — or eject the country from the euro altogether, with all the chaos that might bring.
There are heated arguments on both sides. But a new report from Der Spiegel suggests that German Chancellor Angela Merkel is now leaning toward bailing out Greece yet again. The prospect of a Greek exit and a euro zone implosion has become too frightening — German officials call this the “domino theory.” Yet helping Greece out is a tricky situation in itself. For one, further bailouts won’t sit well with German voters. What’s more, Europe’s leaders might have to fudge a few numbers to make it look like Greece is actually meeting its debt goals.
A quick recap: Greece is broke and still carries a high debt to GDP ratio of around 150 percent. Back in March, the European Community, the European Central Bank and the International Monetary Fund (IMF) — the so-called “troika” — got together and approved a new $170 billion rescue package for Greece. In return for the aid, Greece was supposed to carry out a series of steep austerity measures and shrink its debt to 120 percent of GDP by 2020.
The betting line is that Greece won’t meet that target. The Greek government under Antonio Samaras recently proposed a package of pension cuts and public salary reductions worth $14.6 billion next year. But repeated layoffs and cutbacks are unpopular in Greece. If Samaras pushes too hard with cuts, his center-left coalition partners will balk and the government could collapse. And the main opposition party, Syriza, wants to tear up the bailout agreement altogether. Worse still, Greece is also going through one of the worst depressions in modern history, and spending cuts are hurting the economy further. That makes whittling down the debt even more daunting.
So, with Greece stumbling, the troika has two broad options. It can either give Samaras a bit more money and flexibility to meet his deficit goals. Or European leaders can say “enough’s enough” and boot Greece out of the currency union. According to Der Spiegel, Merkel sounds like she’s no longer quite so sanguine about the fallout from a Greek exit:
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.
Indeed, many analysts have worried about just this aspect of a Greek exit. First Greece goes. Then the financial markets start betting that Portugal or Spain or Italy will be next. All of the sudden, few investors want to lend those countries money. Bank runs commence. Spain decides it has no choice but to leave as well. At that point, the euro implodes. This domino scenario isn’t inevitable, but it’s realistic enough that German advisers are jumpy.
So the alternative is for the troika—the IMF, the European Community, and the European Central Bank—to go a bit easier on Greece. By some estimates, Greece needs another €20 to €30 billion to stay afloat (at least for now). So how could the troika rationalize giving Greece even more aid? By massaging a few key numbers:
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.
Christine Lagarde, head of the IMF, has already signaled some willingness to be flexible. “The IMF never leaves the negotiating table,” she said last month, adding that Greek efforts to curb deficits since 2009 were “impressive.” Now it sounds like Merkel, too, is ready to be a bit more accommodating. The tricky part, for Merkel, is selling this to German voters.