Photo Gallery: The Looming Grexit?


Euro Poker Greece and EU at Loggerheads Ahead of Monday Meeting

Greece is insisting on the relaxation of conditions relating to emergency aid, but the euro zone no longer fears the consequences of a Grexit. Both sides are digging in ahead of Monday's finance minister meeting.

In his first appearance before his foreign counterparts, Greek Finance Minister Giannis Varoufakis initially triggered astonishment, which then gave way to mild annoyance and finally culminated in rage and indignation.

Varoufakis, a professor of economics, used his visit to the special summit of the Euro Group -- which consists of euro-zone member state finance ministers -- last Wednesday in Brussels to give a lecture. He spent half an hour talking about his view of the crisis and the "humanitarian catastrophe" in his country. But a concept for how he intends to tackle Greece's gigantic debt load was not part of his presentation.

The response to his speech was unsurprising, with representatives of smaller countries, in particular, expressing their rage over the audacity of the newly elected Greek government's demand to renegotiate aid from its partner countries. "Your standard of living is higher than ours, and we pay for your aid," the finance minister of one of the Baltic countries said angrily, while his counterpart from Slovenia described the event as "a total waste of time." "I can't take that to my parliament," the Estonian envoy complained.

European Central Bank (ECB) President Mario Draghi was especially irate. "We can do nothing at all if you talk like that," he said. If all you do is "constantly talk about insolvency," he added, "even the healthy Greek banks will eventually be insolvent."

Ultimately, Euro Group President Jeroen Dijsselbloem proposed writing a joint statement for last Thursday's summit of EU leaders. An intense wrangling over the wording of the statement began, with Varoufakis fighting over every comma. "We are not at a Turkish bazaar here," the Slovakian finance minister said testily.

After five hours of tough negotiations that included Christine Lagarde, managing director of the International Monetary Fund (IMF), a three-paragraph joint statement was finally completed. In it, Varoufakis agreed to extend the current bailout program and continue the reform policy. In return, the partner countries stated that they were willing to support this process with additional funds to cover the next few months. Varoufakis said that he needed to make one more phone call to Athens, and German Finance Minister Wolfgang Schäuble and his counterparts began heading home.

Digging In Their Heels

But by the time Schäuble landed in Berlin, the compromise had already fallen apart. Greek Prime Minister Alexis Tsipras had refused to agree with the terms and had ordered his finance minister back to Athens. "The Greeks have broken so much porcelain," says one person who attended the meeting, "that they can't come up with enough glue to put it all back together again." At the EU summit on Thursday evening, Greek debutant Tsipras received an icy welcome from his European counterparts.

With each new day of the dispute between Tsipras and his financial backers, the likelihood grows that Greece will indeed stumble its way out of the euro . Both sides have dug in their heels.

Tsipras is demanding money  to cover Greece's acute need for financing, but promised his voters he will get rid of the attached conditions to which the previous government agreed. The rest of the euro zone, including German Chancellor Angela Merkel and Finance Minister Schäuble, are willing to negotiate, but only if Tsipras accepts the existing program and its terms, and requests an extension. They see the Greeks' proposals as wishful thinking and their behavior as extortion.

A game of poker  has begun in which each side believes it holds the better cards. Tricks, threats, bluffs -- everything is being tried. On Wednesday, it became clear that donor nations are unwilling to yield to pressure from Athens. If necessary, they will even accept Greece's exit from the euro zone, a so-called Grexit. Even the European Commission, which had shown the most understanding for the Greeks, is switching to the hardliner camp. After Varoufakis' performance, a Grexit has become "very likely," says one EU diplomat. At the beginning of the week, Finance Minister Schäuble drily remarked that if the country doesn't want help from its partner, "well, then it's over."

Schäuble believes that Greece's departure from the euro zone would be manageable. Even his counterparts from France and Italy, who have often expressed their sympathy for making concessions to Greece, want to remain tough. They fear that radical parties in their own countries could feel emboldened to demand similar concessions if Europe is too accommodating to the Greeks.

Tsipras over the weekend appears to have begun looking for a possible way out of the impasse. With another Euro Group meeting scheduled for Monday, his government has begun searching for an interim compromise deal with Greece's creditors to ensure that Athens continues to have access to liquidity. Schäuble, though, isn't optimistic. On Monday, he told German radio station Deutschlandfunk: "After what I heard about the technical talks over the weekend, I am skeptical."

'Everything Is Quiet'

But experts at the German Finance Ministry have noted with satisfaction recently that, despite the high-level game of chicken, nervousness in the capital markets has been limited in recent days. Even the news that the British government was examining the Grexit scenario and its consequences did not deter investors, as evidenced by risk premiums on bonds for countries like Italy and Portugal. Such spreads are considered an indicator of imminent danger in the euro zone. During the height of the crisis, the premiums always jumped sharply whenever new information or rumors about Greece was reported. "Everything is quiet now," one Schäuble aide said contentedly.

The financial world also seems more serene. "Greece remaining part of the euro zone would be the best solution for the country and the monetary union -- but only if the Greek government returns to a path of reason," says David Folkerts-Landau, chief economist at Deutsche Bank.

"The risks associated with an exit from the monetary union are unevenly distributed," says Moritz Kraemer, chief analyst for sovereign debt with the rating agency Standard & Poor's (S&P). "It would be a devastating move for Greece, but the consequences would likely be manageable for the euro zone." In fact, he adds, it is even conceivable that the consequences of a Greek exit would be so disastrous as to serve as a deterrent and encourage other euro countries to bring their economic and fiscal policies more in alignment. This is why the Greek government has more to lose in the current poker game than its euro partners, Kraemer explains.

Graphic: Greek 10-year bond yields in recent months.

Graphic: Greek 10-year bond yields in recent months.


Part of the poker game, of course, is the fact that Schäuble and his fellow finance minister are downplaying the potential consequences of a Grexit. They do, however, have a few good arguments, such as the precautions taken against crisis in recent years. The banking union and bailout funds are seen as effective firewalls with which to isolate the rest of the euro zone from troubled Greece, or at least that is the hope.

It isn't an unrealistic one. The European Stability Mechanism (ESM) backstop fund, which is intended to aid cash-strapped countries should the need arise, is currently swimming in money. Only €50 billion ($57 billion) of the €500 billion total in potentially available funds has been allocated. Furthermore, European capitals are betting that, in a pinch, the ECB would do everything necessary to save the euro for the remaining member states. After Varoufakis' visit to the ECB, and especially after Prime Minister Tsipras' policy address in Athens, in which he showed almost no sign of relenting, ECB head Draghi and his team are taking a deliberately intransigent approach.

Cyprus Too?

Of course, he would prefer the euro zone to remain intact, with all members on board. But even Draghi's staff members make no secret of the fact that developments could develop very soon that will make a Grexit seem unavoidable.

For instance, in December and January Greeks withdrew about €15 billion in deposits from their bank accounts. The banks could cover a similarly large volume of withdrawals in the coming months, possibly through emergency loans from the Greek central bank, but they would have to be approved by the ECB.

But if capital flight were to accelerate, it could lead to capital controls or even Greece's unwanted exit from the euro -- a Greek exit-by-accident or "Grexident," to use the latest made-up word in financial circles. Unlike three years ago, the ECB does not expect turmoil in the financial markets as a result of a Grexit, and the reason is simple: Banks in the euro zone have long since jettisoned most of their Greek securities. Therefore, a worsening crisis in Greece will no longer necessarily cause serious problems for lenders in France, Italy and Germany. The ECB recently tested the banks to see if they were prepared for a Grexit and its consequences. The stress test apparently did not trigger any significant concerns among the central bankers.

When contemplating the Grexit scenario, the monetary watchdogs in the Euro Group have also considered the possibility that after Greece, Cyprus could also be forced to leave the euro zone. The two countries are economically interdependent. But the simulations show that the euro zone could cope with such a double exit. It seems likely, however, that Cyprus would receive additional aid if it ran into trouble as a result of Greece's departure.

This is even more applicable to Portugal, another shaky candidate. "Portugal still has major structural problems," says S&P analyst Kraemer. "But the government has successfully completed a program, and there is significant willingness to help the country in an emergency with a new program."

Driving Greece into Russian Arms

There are, of course, still those among Europe's leadership who believe that the economic disruptions resulting from a Grexit are incalculable, and they warn that speculators, despite all rescue measures, could force other countries out of the monetary union. "A Greek withdrawal from the monetary union would be the costliest of all possible solutions," says Klaus Regling, head of the European Stability Mechanism (ESM), "both for Greece and Germany, along with the other countries in the monetary union."

"Of course, the euro zone is better equipped today than it was five years ago. Still, I think a Grexit would be very dangerous," says the head of German operations for a global investment firm. A Grexit would change the nature of the monetary union. "From then on, it would be more of a system of fixed exchange rates than an irreversible common currency."

But even experts who consider a Grexit to be economically manageable have other reasons to warn against such a step. "Americans are extremely concerned about the talk of a Grexit," says a senior banker. "They are worried that this could drive Greece into Russia's arms."

European leaders haven't entirely given up hope that Greece will relent in the end and the Monday meeting of European finance ministers will go a long way toward determining what path Athens has chosen to take. The Germans, for their part, are not willing to further accommodate Varoufakis and his prime minister should they decide to remain stubborn. "The (joint) statement has been agreed to, and we aren't backing away from it," says a close advisor to Finance Minister Schäuble. "The Greeks will be banging their heads against a brick wall."

Translated from the German by Christopher Sultan
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