Anschluss Economics – The Germans Launch A Blitzkrieg on the Greek Debt Negotiations

By Marshall Auerback

News stories continue to suggest that Greeceonce again appears on the verge of reaching a deal with its private sectorcreditors on how much of a loss they would be willing to accept on their bondholdings. The latest numbers suggest a 70% write-down. A pretty strikingcomedown for what is supposed to be a “voluntary default” and, hence,not subject to the triggers of a credit default swap on Greek debt.

Naturally, the spin surrounding the proposedagreement is that this is a “one-off” and that other troubledperiphery nations shouldn’t even begin to think of securing a comparable deal.But the inherent tension between securing a write-down on Greek debt which moreclosely mirrors the disaster which is now the Greek economy, and the desire tominimise the potential contagion effect is rearing its ugly head already, andmay help to explain some of Germany’s recent machinations.

Peter Spiegel of the Financial Times publishedthe German government’s proposal for Greece’s “improvement of compliance” withthe terms of the bailout, and all of a sudden Greek PSI positively pales incomparison. According to Germany’s proposal, whatever the result of the PSIdeal, Greece would need to “legally commit itself to giving absolute priorityto future debt service” and “accept shifting budgetary sovereignty to theEuropean level”. If the Greek government is not willing to do this, the troikawould presumably turn off the taps of bailout money and Greece would default.With no access to market or official financing, Greece would be forced to exitthe eurozone.

Now, polls appear to indicate that a bunch of the Greek middle classes mightactually welcome EU control over their finances, as opposed to a bunch ofcorrupt Greek politicians, but overall, it’s almost certainly guaranteed totrigger a violent reaction. In any case, given that a deal with Athens isseemingly so close, why did Berlin choose this particular moment to make thisdemand, and place the entire deal potentially at risk?

I think we have to look beyond Greece for the answer to that question.

One suggestion by Megan Greene is that Berlin’s proposal is a by-product of the unintendedconsequences of the ECB’s three year long term refinancing operation (LTRO):”If eurozone banks have as much access to cheap, three-year ECB funding astheir collateral allows, perhaps Germany and the troika have decided thateurozone banks can survive a Greek default.”

In the absence of the ECB hoovering up all ofGreece’s debt via its Securities Market Programme (“Not gonna happen;wouldn’t be prudent,” as George Bush the Elder/Dana Carvey might havesaid), Greece is, as Greene argues, clearly insolvent and would likely have toleave the eurozone to eventually return to growth. The German proposal, arguesGreene, may have accelerated the inevitable.

But there’s another, more sinister interpretation. The question which has beenpersistently asked since the debt renegotiations started with Greece is: whatwill stop Portugal, Ireland, or indeed Spain from demanding the same deal? AndI continue to believe that Spain is the domino which is too big to fail. Itsliabilities are too big to be covered by the existing firewall established bythe EFSF and ESM. An expansion of the LTRO might address the solvency/bankingcrisis, but not the broader problem of deficient aggregate demand, highunemployment, and rising social turmoil.

So to repeat the question: how do you preclude Portugal, Ireland and, indeed,Spain from asking for the same deal as Greece, if the negotiations succeed?

Answer; you can’t. So theGermans throw a politically impossible demand in front of the Greeks, in effectsaying, “No more money unless you effectively surrender your nationalsovereignty.” And that’s the implied warning ahead for the other peripherycountries which look to secure the deal currently on the table for Greece.

In effect, the Germans (behind the auspices of the troika) are saying,”It’s fiscal austerity on our terms. You try to renegotiate like theGreeks and we take you over. The other alternative is that you leave.”.

Anschluss economics, plain and simple.

Is this too harsh an assessment? Well, when their national interests are atstake, the Germans are perfectly prepared to shed the “good European” personaand play hardball. Think back to how the Bundesbank engineeredthe departure of Britain from the ERM back in the early 1990s, and you’ve gotthe template for today. By publicly suggesting that sterling was overvalued andrefusing to offer support to the British pound (in contrast to its subsequentdefence of the French franc), then BUBA President Helmut Schlesinger virtuallyassured the UK’s ejection from the Exchange Rate Mechanism. Let’s face it:history shows that Germany doesn’t do “subtle”very well. This looks like a blitzkrieg, plain and simple. Spain, Ireland,Portugal and Italy – you have been warned.