If a deal is going to be struck that avoids a Greek exit from the euro zone and restores confidence in the currency bloc, it is going to have to be big and convincing to markets. As one UK politician put it last week, the German Chancellor needs to fire a “Big Bazooka” if she is to save the euro zone from its current crisis.
Angela Merkel made it clear in a CNBC interview last week that she wants Greece to stay in the euro, and she indicated that a growth plan for Europe is on its way as long as troubled nations stay the route with austerity. "On the one hand we have the pillar of sound fiscal policy, and the second pillar will then be the growth component,” the chancellor said.
A few days later, Merkel met with other G8 leaders at Camp David and agreed to a communiqué that pointed toward a new growth strategy but made it clear that Greece needs to do what it promised in terms of debt restructuring.
"We commit to take all necessary steps to strengthen and reinvigorate our economies and combat financial stresses, recognizing that the right measures are not the same for each of us," said the G8, which also singled out Greece: "We reaffirm our interest in Greece remaining in the euro zone while respecting its commitments.”
Stocks have rallied sharply since that meeting, amid market speculation about what a European growth strategy might look like. A European deposit protection scheme to stop a run on periphery banks, further European Central Bank support for the financial sector, or increased borrowing to fund investment have all been suggested. But it is by no means clear how far Merkel and the German public are willing to go to avoid a so-called “Grexit” and all the problems that could cause.
New French President Francois Hollande has put Eurobonds on the table for Wednesday’s head of state summit, something which up until now Germany has refused point blank to accept. Underwriting the euro zone debt market would significantly raise Germany’s cost of borrowing and would be a very difficult sell for any German politician going into 2013’s election.
Germany’s old ally Austria has made its view on Hollande’s plan equally clear.
"Growth financed by debt? Those are the recipes from the day before yesterday. The arguments that France's new president Francois Hollande is putting forward again are nonsense and got us into this whole mess in the first place," Austrian Finance Minister Maria Fekter said on Tuessday to newspaper Oberoesterreichische Nachrichten, in a sign that Hollande is not going to have this debate all his own way.
The Greek Conundrum
Up until now, the EU and International Monetary Fund’s carrot-and-stick approach to Greece has been very heavy on the stick and lighter on the carrots. This led to an anti-austerity result in the recent election, and if Merkel wants to avoid Greece voting for a renegotiation of its bailout terms, she and her peers across Europe need to find a way to sweeten the deal.
There are less than four weeks to achieve this aim, and left-wing leader Alexis Tsipras is making gains in the polls with his anti-austerity, pro-euro rhetoric.
“With this policy we are going to hell,” said Tsipras over the weekend in an interview with CNN. “To save Europe we need a change of direction.”
If Europe wants to avoid Tsipras forming the next government in Greece, it needs to nullify this message. But with so little time on the clock, it could prove very difficult to agree to a series of measures that will be credible with Greek voters, German voters and investors, all at the same time.
Previous attempts at getting ahead of the crisis have ultimately failed due to their scale. On the one hand, public opinion in the north of Europe will not support any bailout or package that costs too much; on the other hand, the market has consistently refused to back plans that do not address the scale of the problem. The so-called “firewall” that’s designed to contain any damage stemming from a Greek exit, has been a good example of this: Euro zone countries fought over the amount of funds to commit, while investors pointed out 800 million euros wouldn’t cover the cost of preventing contagion spreading to bigger, peripheral economies such as Spain and Italy.
With this dynamic in mind it would be a surprise if Europe could get its act together on finding a solution to the Greek crisis and the risk of contagion over just the next four weeks. The market has been surprised by EU support for the euro before, notably when the ECB’s Long Term Refinancing Operation program was introduced late last year, but time is now running out to secure a deal.
Writing over the weekend in the Sunday Times, the historian Niall Ferguson said the only possible outcome for the euro zone debt crisis is a federal Europe led by Germany. Noting that the euro’s founders always saw the single currency as a backdoor route to fiscal union, Ferguson believes the great European project will ultimately lead to this outcome. If he is right, it is probably going to need a major crisis to create the conditions necessary to make such an outcome politically acceptable to much of Europe. The chances of such a crisis over the coming days and weeks is now very high.