It's the biggest poker game in history. On one side of the table, the dowdy, conservative German Chancellor, Angela Merkel, on the other, youthful, radical Alexis Tsipras, leader of the Greek left wing coalition, Syriza, which is expected to win increased support in today's Greek elections. Could ever a financial crisis have thrown up an odder couple? Eyeballing each other over the future of the eurozone. Waiting for the other to blink.
The stakes? Around four trillion – that's the likely cost of bailing out all of Europe's busted banks if there isn't a resolution to the eurozone debt crisis. And right now, there isn't one.
It is “the greatest crisis since the Second World War”, according to the Governor of the Bank of England, Sir Mervyn King, last week. The Spanish foreign minister, Jose Manuel Margallo, says that the euro could disintegrate “in the next few days, perhaps in the coming hours”. President Obama is calling in increasingly desperate tones for Europe to get its act together as he sees America's recovery withering in the fall out from the eurozone debt psychodrama.
If the Greeks vote today for parties opposed to the bailout terms imposed by the “Troika” (the European Central Bank,the EU and the IMF) , European financial markets will go into melt-down. The cost of borrowing for countries like Spain and Italy, already unsustainable, will rocket. This would mean imminent default for Ireland, Portugal and Greece. But it doesn't end there. Bond yields, these obscure financial indicators which have become a index of panic, are rising even in Germany. And now Britain is facing the prospect of debt deflation as exports to Europe slump. The Chancellor George Osborne, threw £140bn of cheap loans at the UK banks on Friday in the hope that it might fortify the British economy. It's called “kitchen sink” economics in Westminster because it was the only thing left to throw.
Mr Tsipsas believes that Ms Merkel, faced with this imminent crisis, will buckle and that Germany will drop the draconian conditions attached to the loans offered to the Greek government three months ago. After all, Germany would be the first to suffer if the eurozone disintegrated, igniting financial chaos and a wave of bank runs across Europe. Analysts say the cost of German exports, 42% of which go to Europe, could increase by 30% if it lost the euro. German industrial production already slumped last month as confidence fell abroad.
But this is about politics not just economics; passion as well as numbers. Merkel's tough stance on Greek debt has boosted her opinion poll ratings – 69% of Germans approve her handling of the eurozone debt crisis – and her chances of re-election in September.. The vast majority of German voters say they want nothing to do with any further bailouts of Mediterranean governments underwritten by their hard-earned cash. They may be cutting off their own noses, but the political reality is that if Merkel does blink first, she has lost the political, as well as the economic game.
Germany has persuaded itself that the eurozone could weather a Greek exit, and that it would serve as a lesson to other countries living beyond their means To outsiders, this looks like a kind of collective madness. A financial suicide pact. The ECB and most central bankers, like Sir Mervyn King, are agreed on what really needs to be done. The eurozone countries need to “mutualise” their sovereign debts – i.e. jointly guarantee the debts of countries like Spain and Greece, so that the cost of borrowing in these countries returns to normal levels. There needs to be a Europe-wide deposit guarantee scheme to stop runs on banks. And there needs to be recapitalisation of banks to prevent bank failures – much as the British government injected funds into RBS to stop it closing its ATM machines in October 2008. This called a banking union.
But while everyone seems to know what needs to be done, everyone also agrees it isn't going to happen. The Germans, as the economic paymasters of Europe, will not open their cheque books for such a banking union without an agreement from the EU nations to push forward to full political and fiscal union. No one is entirely sure what fiscal union means, but at the very least it would involve common taxation across the entire eurozone. Countries like Italy and Spain fear that the German Bundesbank would be dictating the economic policy of European governments. Nations would lose the power to borrow and tax as they saw fit, and could end up rather as Scotland is within the UK – subject to a central fiscal authority.
But is this fiscal union possible? Would France giving up the right to set its own taxes? Spain what it can borrow? Would Greece increase its retirement age to German levels? To see what the Bundesbank's austerity union might be like it's worth having a look at Baltic countries like Estonia and Latvia which have undergone what is called “internal devaluation” over the last two years. They cut their deficits through ruthless reductions in public sector salaries and services. It worked, and Latvia is now the fastest growing country in the EU, and is getting top marks from the IMF and the German press for its determined belt tightening.
But the cost? GDP collapsed by 25% and unemployment rose to 21%. Thousands of government workers lost their jobs, and wages plunged by 26% for those that remained. The rest of Europe isn't going to buy that kind of austerity – and anyway, if it did, there would be such a deep Europe-wide economic recession that the EU would surely implode. It would be like the Great Depression in America in the 1930s.
It's easy to sound anti-German in this crisis. It's true that, having put more money into the European Financial Stability Facility than the rest of Europe, Germany has the most to lose. But the present policies can only lead to further and greater losses. Only financial cooperation can save the eurozone countries – cooperation that is supposed to be the mission statement of the European Union.
And it's not just non-Germans who are saying that the ball is in Germany's court. Joschka Fischer, the former German foreign minister and Green Party leader has warned his nation to listen to history. “Germany destroyed itself, and the European order, twice in the 20th Century”, he said recently. “It would be both tragic and ironic if a restored Germany, by peaceful means and with the best of intentions, brought about the ruin of the European order a third time”. Merkel and Tspiras are gambling with the security of European civilisation.