Only the players on the pitch really have any idea of what they are thinking and how this will play out. But here is what I think.
Merkel and Germany have made it clear that they have their eyes on the longer game. After Greece comes Spain, Italy and Portugal. Spain particularly is headed, I think, for a major day of reckoning. There is only so long that you can suffer 17% unemployment before tax going in one direction (down) and unemployment benefits and property defaults going in the other (up) tear a ragged hole in the tissue of lies you are telling about your bank and sovereign debts.
Germany has an eye to this longer game. Greece does not. They are drowning today and that tends to concentrate the mind on the immediate.
The EU must keep a full panic about Greek default at bay. It must be seen to be supportive without committing too much actual cash. The solution, I see to this, is to offer direct bilateral and possibly coordinated loans to Greece but make them staged or staggered. Tell the markets you have agreed a ‘lending facility’ but not till Greece asks for it. Then tell the Greeks NOT to ask but instead go back to the bond markets and raise debt there. The hope, is that the loan facility will bring borrowing rates down further. Then also tell the Greeks and maybe the markets as well, that the loans are staged and dependent upon a schedule of government austerity measures. ONLY if these measures actually take effect ( and you just have to hope you can measure if they are happening or not) will the loans flow.
This makes them look capitalised and you look prudent. IF the markets believe you. If or when they don’t then you’re done for.
It is also designed to avoid the Argentina outcome, where cuts are promised but never happen, leading to a blow-up down the road. This would also fit with Merkel saying how there needs to be an EU mechanism for expulsion of fiscally irresponsible states, aka Greece.
In the end, I think the German strategy is to deploy an armada of words-of-support around a row boat of commitment. Either Greece does make the cuts, and then the loans can be released (hopefully the bond market will perk up and lend the money instead) or they don’t make the promised cuts, and all that has been lost is some hot air – and expulsion follows.
So warm words followed by petrified inaction followed by nasty crisis.
That nasty crisis will be months off if the markets buy into warm words at the European meeting on March 25-26. If they don’t and call Germany and Greece’s bluff then the end comes much quicker. Germany has laws forbidding it to bail out another nation. And it has courts who will uphold these laws vocally – unlike the essentially lawless situation in the US.
Essentially I still doubt Germany will agree to a bail out until Default and EU ruination are staring them incontrovertibly in the face. If Germany knuckles under the political fallout in Germany will be immense. If it doesn’t then Greece would face either expulsion from the EU and then devaluation, or force some classic EU smoke and mirrors circumvention of the EU’s own laws and bail Greece out by backdoor methods including getting the IMF involved. That in itself would be acid in the guts of the EU experiment. Washington might like it though.
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