The Germans will not bail out Greece


In my view, there is little chance the Germans are going to allow the EU to ride to the rescue of the Greeks. All of the bailout chatter does not really consider the domestic political constraints in Germany.

First, a bit of quick background.  Germany was traumatized by two world wars and an intervening period of irrelevance and hyperinflation.  As a result, the German national psyche is very much geared toward preventing anything resembling these outcomes in future. First and foremost, that has meant integration with the rest of Europe and a weak military in order to prevent economic nationalism from becoming militaristic in Western Europe’s largest country. Second, this has meant an extreme aversion to high rates of inflation or anything that could lead to inflation or currency revulsion.

As a result, the Germans entered into monetary union with the likes of Italy and Greece despite these nations perceived fiscal profligacy, high inflation and weak currency policies. The thinking at the time was that the stability and growth pact (SGP) would rein in any excesses.  However, when France and Germany both breached the magic 3% federal government deficit hurdle of the SGP during the Schroeder government, all bets were off; now Italy and Greece could deficit spend and point to core Europe’s biggest nations as an excuse – and this is exactly what has transpired.

Now, it has to be remembered that the Euro was adopted in Germany without any democratic vote by the German electorate. It was imposed by fiat from the Federal Government unlike in Denmark where the Euro was put to vote before the electorate and rejected. In fact, there was a lot of concern in Germany at the time that the Germans would have rejected the Euro had it been voted upon – and this is the very reason a vote was not held.

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Many ordinary Germans feel their good money is now being trashed. They already had a currency union between Ostmark and Deutsche Mark, with Western Germans submitting to a “solidarity tax” in order to finance the upgrading of Eastern Germany’s infrastructure. So, to this day, many Germans look at larger Euro notes to determine if they were printed by the Germans, Italians, or Greeks – sometimes rejecting notes printed in countries viewed with suspicion like Italy (see the Telegraph’s 2008 story on this here).

With this as background, you should see the 2009 election of the CDU/CSU/FDP coalition as a signal that the German government is unlikely to submit to a bailout.  With the FDP replacing the SPD in government, the likelihood of a Greek bailout decreases. The FDP is the libertarian junior partner in this new coalition (the same coalition which produced the SGP, by the way) and they are under enormous pressure from their constituents not to permit any bailouts.  If Germany allows German tax dollars to go to the EU in order to bail out the perceived profligacy of Italy or Greece, there would be riots.  Spain is another story – but Greece is known as fiscally profligate in Germany – so bailing them out is unacceptable politically. Let’s not forget that Germany has its own problems in banking as well.

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That’s the politics of the issue in Germany. And I see this as important now that Greece is the country under pressure in Europe instead of, say, Austria. This is one reason I have predicted the IMF would likely be used as a ‘bailout’ vehicle.

However, Marshall Auerback has pointed me to a recent NYTimes article which gives more direct evidence of the thinking of German policy makers.  The article reports:

If Greece needs a bailout, it would be far better for it to seek one from the International Monetary Fund than from other euro-zone countries, Otmar Issing, a former top official of the German and European central banks, said Friday.

“I don’t think that the E.U. can impose the kind of sanctions that would be needed, and it would make Brussels too unpopular,” Mr. Issing said during an interview by telephone from his office near Frankfurt. “A better way is for Greece to approach the I.M.F. It is the only institution that can impose strict enough conditions.”

Mr. Issing was chief economist of the European Central Bank from 1998 to 2006 and one of its most influential executive board members. Previously he spent eight years as a board member of the Bundesbank, an institution that expressed doubts about the wisdom of expanding the euro zone beyond core West European economies.

Bailing out Greece would involve “a more or less disguised transfer of taxpayer money,” he said, “and I don’t see any support for that from the people in Germany or elsewhere.”

Bottom line: The Germans will not support a bailout of Greece via the EU.  Those who see this as a remedy are not watching the internal politics in Germany.

See The European problem from February 2009 for a more comprehensive Europe-wide view.  These issues are all still at play.

Update: Reuters has now confirmed the speculation about a bailout is premature. See FT Alphaville’s piece “Oh yes they will… oh no they won’t!”  Marc Chandler of Brown Brothers Harriman sent out a note this afternoon saying:

Greece and the EU have only just agreed to a strategy to address the deficit.  They have also worked out a review schedule as the program is implemented.  Additionally EU aid to Greece carries with it moral hazard and opens the door for aid to other countries, notably Spain and Portugal.  In related news, the German-based Spiegel On-Line has an article that is attracting market attention.  It claims that a large US investment house helped arrange a cross currency swap for Greece that helped to conceal another $1 bln in debt.  Although this amount seems relatively small given the huge debt and deficit problems, many suspect it could be just the tip of the iceberg.  It is not unusual for sovereigns, including Greece, to borrow in foreign currencies, like dollars, yen and Swiss francs and swap back into euros.  The article claims that the US investment house arranged a cross currency swap for Greece back in 2002 but gave exchange rates that in effect created for Greece an extra billion dollars.  Of course, the swap will have to be unwound, but likely was in effect off-balance sheet and was not picked up by the stats office.  Many observers have already noted problems with the Greek accounting methods which have sometimes not included defense spending in the budget calculations and have also sometimes not included the debt owed to hospitals under its social programs.  Greek bonds as well as the other weaker credits in the euro zone are rallying, but this could very well prove to be a one day wonder if we are right and no EU bail out will be forthcoming.  Market attention will focus on the Thurs EU summit, and euro vulnerable to disappointment.

I see it as unlikely that any deal – bailout via the EU, IMF bailout or backdoor help via quasi-fiscal measures from the ECB – can be reached unless Greece agrees to austerity measures. While this is the Eurozone – and that makes a difference – countries like Latvia will be looking to determine if Greece gets differential treatment.  And Spain, Portugal or Ireland would then be next in line. Any agreement must take these factors into account.

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