When faced with the nuclear option of a Grexit, will Germany blink?
On June 17, Greece faces its second national elections in six weeks. Alexis Tsipras, the 37-year-old leader of Syriza who wants to reject the terms of the EU bailout while remaining in the euro, has a serious shot of topping the polls. To some observers, defaulting on debt while staying in the Euro is a contradiction, but there is a clear strategic logic to Tsipras's position.
Tsipras believes his trump card is that Greece is too big to fail. So, rather than touting a graceful way out of the euro, he wants the prospect of a Greek exit to be as horrific and contagious as possible -- an economic cataclysm that would drag everyone else down, as well. Essentially, he is arguing that Greece and Germany exist in a state of Mutual Assured Destruction: Germany will never pull the plug on Greece regardless of what it does because the risk to itself is just too high. And if Tsipras can convince the Greek people of this, they may vote him in -- they'd get to have their cake and eat it too.
Tsipras explained this logic in an interview on the British television station Channel Four, saying, "I believe we find ourselves in a situation equivalent to the one the U.S. found itself in with Russia, back during the days of the Cold War. Both sides had nuclear weapons in their hands and both sides threatened to push the button and activate. When you have a Cold War, neither side will back down, so now we don't expect Mrs. Merkel or Mr. Cameron to back down either. We are quite sure that when the time comes, logic will prevail, and they will not activate their nuclear weapons."
The nuclear weapon in this analogy is exit from the euro, not rejection of the bailout. In this view, the threat of mutual destruction provides Tsipras with an umbrella to do anything he wants -- short of exit from the euro. Germany and the European Central Bank (ECB) can never force Greece out because the contagion resulting from a "Grexit" could cause the collapse of the currency: The redenomination of international contracts would destabilize the entire financial system, European banks have exposure to Greek debt, and markets would likely move on to other members of the periphery.
The contagion risk will constrain Germany and the ECB's response if Greece rejects the terms of the bailout and defaults on its debt. Berlin and Frankfurt will surely retaliate, but Tsipras expects them to stop short of completely cutting off financial support, which could precipitate the total collapse of the Greek economy. Ultimately, they will do what is necessary to keep the eurozone intact, or so the argument goes.
Germany and the ECB know what Tsipras is up to and they're worried. For three years, they have maintained a hard line against any policy that could lead to a Lehman-level event. But now, they are facing an opponent who is using that fear against them. If he wins, the other member states of the periphery may soon follow -- after all, most are significantly larger than Greece and in an even better position to blackmail the core. Spain's Prime Minister Mariano Rajoy recognized this leverage when he recently tweeted advice to Luis de Guindos, his economy minister, on the eve of his bailout negotiations with the EU: "Resist, we are the 4th power of the EZ. Spain is not Uganda." The periphery's use of leverage will grow over time, so Germany and the ECB know they must signal that their fear of a disorderly collapse is not a gun that the periphery can hold to its head.
This is why after warning that a Greek exit from the eurozone could cause a global economic collapse, European officials are now suggesting it might not be so bad. German Finance Minister Wolfgang Schauble said "protective mechanisms" mean "the risks of contagion for other countries of the euro zone have been reduced and the euro zone as a whole has become more resistant." EU Economic and Monetary Commissioner Olli Rehn said that an exit would hurt Greece, but that the rest of Europe is "certainly more resilient" to a Greek exit than it was two years ago when the bloc would have been "massively underprepared."
Don't be fooled by these reassuring words. Fears of contagion are as high as ever but, to prevent a Greek exit, European leaders must pretend it doesn't matter very much for anyone but the Greeks. So now they are going over Tsipras's head to tell the Greek people to tell their leaders that if they reject the bailout they will be forced from the euro, which will only hurt Greece. If the rest of Europe can convince Greeks of this, they may decide not to risk a Tsipras-led government.
Needless to say, this situation is fraught with potential for miscalculation. The German position is not particularly credible if for no other reason than German officials are on the record as warning about the dangers of a Greek exit. For his part, Tsipras may not understand that Germany cannot write the entire periphery a blank check. In the Cold War, each side had red lines that the other could not cross. Tsipras seems to think he has no limits, which is certainly a mistake. By digging their heels in, both Tsipras and Germany could also reduce their room for maneuver after the Greek elections, thus making a disorderly exit much more likely.
The core will see this as a strategy of blackmail; Greeks, and potentially other members of the periphery, will see it as compensation for a crisis response that concentrates the pain in a handful of countries. Such emotions will complicate the negotiations and make a compromise very difficult to reach.
If Tsipras is indeed the next Greek prime minister, the fate of the world economy will be dependent upon someone blinking in Europe. If not, another strategy might come in useful: duck and cover.