The blackmailers

Greece's financial situation is becoming more precarious by the day. Paradoxically, it is not its debt that is weighing Greece down nor the greed of its lenders, but it is the lack of trust by its own population that is making life harder by the day. Greeks are still withdrawing millions of Euros every day from their bank accounts, clearly anticipating that this will all end in tears, i.e. the Greek exit from the Euro.

The sad aspect of this Greek saga is that it was entirely preventable. Greece's debt burden was heavy yet entirely manageable at the time of the election, and the budget ran a first initial surplus. The economy showed some signs of recovery and investments picked up. All that has now stalled due to the insecurity created by the zig zag course of the new government.

So what's the case for the strategy pursued by the Greek government? Let's look back at the last six weeks. Starting with the election, the Greek government had a very strong lever at their disposal. Germany as well as all other main players signalled that they would make sure that Greece remained within the Euro. This was a solid foundation from which to build within the Euro zone a coalition around change for growth and investment. At about the same time, the recently appointed Commission President Juncker announced that he was working on something similar which chimed with the intentions of the Greek government to move from austerity to investment for growth, a (now approved) 350 billion Euro programme.

Yet, within two weeks after the elections, the Greek government managed to antagonise not just its main lender (Germany and the IMF) but also its smaller European partners, such as Slovenia and Slovakia, who notably contributed millions of Euros to the Greek bailout programme despite being much poorer than Greece. Talk by the Prime Minister Tsipras and his thin-skinned Finance Minister Varoufakis about Greece's entitlement to other countries taxes ensured that they lost all good will by their European counterparts. Eventually, the Greek government had to climb down and accept a four month extension of the existing bailout programme to the old conditions. This can only be called a phenomenal failure of policy on the part of the Greek government given that they actually had a strong negotiating position at the start.

Why did this go so horribly wrong for the Greek government? The main reason appears to lie in their inability to differentiate between electoral campaigning and negotiating with European partners. Both Tsipras and Varoufakis appeared to believe that their electoral campaign rhetoric would bear just as much weight in negotiations with their European partners as it had with the Greek electorate. Their maximalist demand (access to taxpayer's money of other countries without any budgetary control) may have made sense within the domestic national debate, but its logic fell apart quickly when articulated within European institutions. Confronted with this failure to get their way, Tsipras and Varoufakis resorted to blackmail, indicating that they would violate ECB rules if their European partners would not meet their demands.

In a way, this strategy ensured that Euro zone members are now seriously thinking whether a Greek exit from the Euro would indeed weaken the Euro, or whether in fact it may strengthen the currency. Which is exactly where the Greek government does not want to be in the larger scheme of things. Once their main negotiating asset, the unwillingness of their partners to allow a Grexit is gone, they will have no levers for negotiating further debt relief. The Greek negotiating tactic resembled a high wire act which they embarked on with several heavy suitcases stuffed with maximalist demands instead of travelling the rope as light as possible. This whole episode may soon feature in university handbooks on policy making as a prime example of poor strategy. Once safely back in his university post, Professor Varoufakis may be able to read up on it.

It's the rules, stupid

As the drama of the Greek show down moves to the second stage, observers and commentators cast around for interpretations. Austere Germans versus profligate Greeks is one of the popular topoi, and so is responsible versus irresponsible governments. Yet, what is often forgotten is the main protagonist: the Euro itself.

The Euro as a common currency originated in the German re-unification and the desire of France's president Mitterrand to have the German Mark. And it was Chancellor Kohl's bargaining chip in the negotiations to reconcile France with the fact of a resurgent German economic powerhouse. Attached to the deal was the so-called fiscal stability pact which was promptly broken by Germany and France. The former failed to stick to the pact because national finances spiralled out of control in the wake of re-unification and the costs of upgrading East German infrastructure to West German standards. The latter, France, failed to keep its budget under control because ... well, because they was little incentive to do so. 

To be clear, all this happened well before the financial crash of 2008. In fact, it was Chancellor Schroeder, a social democrat, who, in 2004 embarked on a fundamental reform of employment regulations which set Germany on a path to fiscal rectitude. This first drama of the Euro stability pact is often forgotten in public debate today. But it was a key experience for German politicians. Embarrassed and shamed into a climbdown on the rules they had formulated themselves, they learned a simple but important lesson. A currency is only stable if the budgetary rules are enforced that come with it. 

That's the main reason why German politicians (Social Democrats and Christian Democrats alike) are playing hardball with Greece today. It has little to do with fears of inflation Weimar style. Nor is it to do with spite or resenting the Greeks their living standards financed by debt. Rather, it is the realisation that enforcing the rules strengthens the currency rather than weakens it. Seen this way, a Greek exit (though highly undesirable for everyone involved) may actually send a strong signal to the markets: we are determined to enforce the Euro rules, to safeguard the currency's stability.