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German Chancellor Angela Merkel was full of praise and recognition for Greek Prime Minister Georgios Papandreou. His government, Merkel said on Friday evening after the two leaders had met to discuss the Greek financial crisis, had performed "a massive feat of strength." The Greeks, Merkel continued, had implemented a package of measures, which impressed the capital markets, "in a remarkably short space of time."
Merkel said that she was pleased to see how successful the placement of the Greeks' new government bond issue had been. "It worked out well," she said. Papandreou also seemed pleased as he listened to the German leader, thanking her profusely for her support and making it clear that he had not asked for financial assistance.
Both politicians seemed to have emerged as winners. Last Wednesday, Papandreou unveiled a series of austerity measures that imposed billions in cuts on Greek retirees, drivers and civil servants. The next day, Greek government negotiators easily managed to secure €5 billion ($6.8 billion) in new loans in the international capital market. Merkel called it a "very, very important signal." "This is the only way Greece can secure its future," Papandreou said. Two winners appeared to be celebrating their triumph, and the message they sought to convey to the public was that the Greek crisis is over.
Breathing Room
If only that were the case. The truth is that the two leaders have won, at best, a battle, but not the entire war. Europe has given itself a few weeks' breathing room. But the doubts over whether Greece and the common currency can be defended in the long run, and whether the country will truly make it on its own, as Alternate Greek Foreign Minister Dimitris Droutsas insisted in a SPIEGEL interview, have hardly been diminished.
The risks are considerable. Greece's trade unions and other special interest groups have announced new strikes and large-scale protests. The economic forecasts for the highly indebted country are deteriorating from week to week. And speculators on the international financial markets are firmly convinced that Athens will be in financial difficulties again, perhaps as soon as April, when the country is scheduled to repay loans worth €12 billion, or in May, when another €8 billion will come due.
"We seriously doubt that Greek politicians have the necessary political capital to push through their reforms," New York hedge fund manager Jonathan Clark wrote to his investors. And Hans-Günter Redeker, the chief foreign currency strategist at major French bank BNP Paribas, predicts that the country and its neighbors will experience "a deflationary shock."
At issue are the stability of the euro, Europe's political unity and the eternal question of who will prevail in the struggle over the future of a currency. One side consists of the international financial industry, which is betting billions on a Greek bankruptcy or the demise of the euro. The other side comprises European governments, which are determined to defend their common currency, introduced 11 years ago, at all costs.
Battle between Good and Evil
The war of nerves reached an initial climax last week. It was a struggle characterized by bluffs and threats, gambling and trickery, complete with dramatic scenes reminiscent of Hollywood films in which two drivers race toward a cliff: Whoever slams on the brakes first is the loser.
And, again in typical Hollywood fashion, European governments tried to frame the conflict as a final battle between good and evil: between politicians acting for Europe's common good and greedy financial sharks interested purely in their profits and capital gains.
But it isn't quite that easy. Many of the most notorious gamblers don't work on the trading floors of international financial centers, but in government offices in Athens, Madrid, Berlin and Brussels. They have either used the euro, along with tricks and falsification, to live for years at the expense of others, or they have deliberately looked the other way.
The notion that the European common currency is based on nothing but a series of lies is now taking its toll. All of the founders of the euro knew that the new currency could only be stable if all member states committed themselves to sound financial policy and, in the long run, spent only as much as they collected in tax revenue. But many ignored this principle right from the start.
Violating the Rules
The euro had hardly been introduced before the monetary union turned into more of a debt union. Violating the union's self-imposed rules of solid budget practice soon became routine, and not only in Greece. Sometimes it was done openly, and sometimes not. Sometimes it triggered conflict among the member states, while at other times there was mutual agreement over the practice. In general, the offenders seemed to believe that things would work out in the end, and that others would foot the bill.
But in a monetary union, almost every economic decision has consequences for the partner countries. When wage costs fall in Germany, business owners and workers are affected in even the most remote corners of Ireland or Portugal.
In the past, exchange rates cushioned the consequences of diverging developments. When a country gained in economic strength, the value of its currency rose. If it loosened the reins, its currency was devalued.
This adjustment mechanism is absent in the monetary union, with dramatic consequences. For instance, if a country has gone too deeply into debt, the government can no longer choose the gentle option of devaluing its currency. Instead, it must impose austerity measures that directly affect the standard of living of its citizens, as is currently the case in Greece, where wages and pensions are being reduced and government expenditures slashed.
This is the unavoidable consequence of monetary union. But European governments were in denial about the risk, and they were certainly unwilling to openly own up to their mistakes. Instead, they maintained the status quo and took a devil-may-care attitude. For a while, it even went well. But now the imbalance can no longer be covered up. Not just Greece, but other euro countries, as well, have accumulated towers of debt that now threaten to collapse. A number of countries, known informally by the acronym PIIGS (Portugal, Ireland, Italy, Greece and Spain), are at risk.
If one of the large nations on the continent were to go bankrupt, Europe would face two equally unpalatable alternatives. If such a bankruptcy were simply accepted, it could trigger a disastrous chain reaction in the financial markets, much like the one that occurred after the Lehman Brothers bankruptcy in 2008. But if the remaining euro countries decided to come to the bankrupt country's aid with loans, "Germany's creditworthiness would eventually be threatened," says Deutsche Bank chief economist Thomas Mayer.
No wonder the poker game over Greece has caused such frayed nerves in Europe's capitals. The stakes are high, and the many players are financially strong. They can be found in Manhattan office buildings, luxury condominiums on the Cayman Islands or at the headquarters of major international banks. They all share a common interest: to make money from the Greek drama, or at least to ensure that they don't lose any money because of it.
The latter is the objective of many European banks, which have significantly expanded their holdings of Greek bonds in the last two years. German financial institutions like Commerzbank or HRE currently have about €32 billion worth of Greek treasury bonds on their books, while the Greek holdings of French banks are almost twice as high.
Tempting Deals
The deals were simply too tempting. During the course of the financial crisis, banks were able to borrow money from the European Central Bank at lower and lower rates, culminating at a mere 1 percent. When they used the cheap money to buy Greek bonds, with yields upwards of 5 percent, it was a -- supposedly -- surefire deal, practically a license to print money.
The credit managers were all the more horrified when their supposedly highly solvent customer turned out, in recent weeks, to be a candidate for bankruptcy. Since then, they have been urging European governments to come to the Greek government's aid with comprehensive state-backed assistance as quickly as possible.
The pressure is being amplified by influential major investors who are at home in the trading rooms of powerful investment banks and on the executive floors of hedge funds. For some of them, the fall of the euro is a done deal, and they are doing their utmost to make sure that their predictions come true.
One of the attackers is New York hedge fund manager John Paulson, who controls a fund worth $30 billion. He has been considered a guru in the investment community ever since, beginning in 2005, he bet on a collapse of the American real estate market -- with resounding success. He told a hearing before the US Congress a few weeks ago that he just wanted to "protect our investors' money." He sounded as cold and unemotional as if he were ordering a plate of French fries.
Betting against the Euro
The enemies of the common currency also include John Taylor and Jonathan Clark, two major American speculators who run New York-based FX Concepts, one of the world's largest hedge funds. The traders in their Global Currency Program alone have $3 billion at their disposal. "We are betting on a decline in the price of the euro," Clark said in early February. At about the same time, speculative net short positions in the euro rose sharply on the Chicago Mercantile Exchange.
An investigation launched by the US Justice Department two weeks ago suggests that the attackers may have taken a conspiratorial approach at times. The authorities suspect that hedge funds run by Paulson and other industry giants, including the fund headed by legendary investor George Soros, were planning a concerted attack against the euro. They also believe that the players may have reached illegal agreements over speculation.
Germany's Federal Financial Supervisory Authority (BaFin) also has significant evidence that speculators have increasingly targeted Greece recently. In doing so, they have apparently employed their favorite toy, the credit default swap (CDS), which already played a notorious role in the financial crisis.
Insurance Policy
A CDS is a contract under which one side pays an annual fee to buy protection against default, while the seller promises to cover losses in the event of a default. They are in effect an insurance policy against defaults of bonds and other debt. The buyer gets a payoff if the underlying bond goes into default.
In February, investors held CDS's for Greek government bonds worth $85 billion, twice as much as only a year earlier, according to a report BaFin officials prepared for the German Finance Ministry.
The German bank regulators warn that these CDS's could grow into a real problem for the Greek government's money-raising efforts, as well as for the cohesion of the monetary union. As CDS's for Greece become more and more expensive, investors could lose confidence in Greek bonds. This, according to the BaFin report, could lead to a "buyers' strike" for Greek bonds, which would create "the risk that the refinancing is unsuccessful, resulting in default."
To curb future speculation with CDS's, the bank regulators propose establishing a central European authority where the controversial financial instruments would be registered. This would enable authorities to recognize immediately where trouble is brewing as a result of speculation. The BaFin experts are opposed to a general ban on CDS's, however, arguing that it would be "counterproductive."
Keeping an Eye on Bankers
In addition to CDS's, financial regulators are also keeping a watchful eye on top bankers, who have been meeting with European leaders. One of them is Deutsche Bank CEO Josef Ackermann, who flew to Athens two Fridays ago to meet with Prime Minister Papandreou and discuss how the country could borrow fresh capital at reasonable terms.
After meeting with Papandreou, Ackermann spoke by phone with Jens Weidmann, an advisor to Chancellor Merkel. To solve its problems, Ackermann said, Greece would need €15 billion in loans. How, he wanted to know, would the German government feel about a consortium of private banks and government institutions, like the state-owned bank KfW, dividing up the amount? Deutsche Bank, he added, could manage the deal.
But Weidmann rebuffed Ackermann, arguing that the deal he was proposing would not only have violated the European monetary treaties, but it would also have reduced a large share of the credit risk of the participating commercial banks -- at the expense of German taxpayers. "Under those circumstances, we might as well have issued the loan ourselves," German government representatives said indignantly.
A few days later, politicians in Berlin were in for a surprise that was no less unpleasant. Despite Berlin's rejection of the idea, British papers reported that the German government was developing a rescue package based on Ackermann's plan.
It was a deliberate disruptive maneuver, which the government in Berlin speculates was launched by precisely those financial institutions in London and New York that have always been opposed to the European common currency. Now the euro's opponents apparently felt that the time had come to go in for the kill on the weakened currency.
The European governments retaliated with a two-pronged strategy. Behind the scenes, they put together a government bailout package for the event that Greece does indeed file for bankruptcy. Publicly, however, they made it clear that the government in Athens would have to help itself for the foreseeable future. Their goal was to make it less attractive for speculators to bet on a Greek bankruptcy and, at the same time, to chip away at the foundation of the European Monetary Union.
The campaign, which began last week, had been long in the making. Last Wednesday, Prime Minister Papandreou unveiled his catalog of harsh measures: an increase in the rate of value-added tax from 19 to 21 percent; additional taxes that would increase the prices of gasoline and diesel, liquor and cigarettes, yachts, precious stones and luxury cars; a freeze on pensions; and a cap on wages and salaries for civil servants.
In return, Papandreou received the "direct reaction" he had been promised. Before the Greek premier had even disclosed the details of the new austerity plan, it was "welcomed" in Brussels, praised in Berlin as a "very important signal," and lauded in Paris as "tough and concrete."
None of what happened in Athens came as a great surprise. The EU finance ministers had even agreed to the financial scope and precise figures of the government's austerity program in mid-February.
'Torture Instruments'
The pressure on Athens was followed by part two of the government's strategy: the threat against the financial markets. The head of the euro group, Luxembourg Prime Minister Jean-Claude Juncker, began the attack. If the financial markets did not stop speculating against the euro, despite the ambitious plan for Greece, he warned, they could expect to see "decisive and coordinated action." He added that he still had a few "torture instruments" up his sleeve.
European government representatives and central bankers soon made it clear what Juncker meant. Some ignited a debate over the possibility of enacting a law to put a stop to trading in highly speculative derivatives. Others let it be known that the private rating agencies could be getting some competition in the future, if the European Central Bank were given the power to assess the creditworthiness of countries itself, rather than relying on private rating agencies such as Standard & Poor's. The rating agency Moody's reacted quickly, expressing uncharacteristic praise for the Greek austerity program.
That was followed by a successfully placed Greek government bond issue and corresponding declarations of victory from Berlin, Paris and Brussels.
Now the protagonists are hopeful, but not truly sure of success. Will the Greeks actually implement its brutal cost-cutting program? Will the government survive this trial? And will the speculators back off?
Preparing for the Worst-Case Scenario
No one knows the answers to those questions -- which is why a second Europe, which remains largely concealed from the public, currently exists in parallel to the public Europe of summit meetings, government statements and official visits. Behind the closed doors of government headquarters, finance ministries and central banks, European governments are preparing for the worst-case scenario: Greece is unable to avert bankruptcy on its own steam, forcing its European partners to intervene.
A top-secret team of half a dozen experts has been working on the bailout measures for weeks. The team includes Jörg Asmussen, a senior official in the German Finance Ministry, and his French counterpart. The ECB is represented by its chief economist, Jürgen Stark, and a senior official represents the European Commission. Alternating representatives of other potential donor countries are also taking part in the discussions.
The team is far along in its preparations. "We could pay out the money in 48 hours, if necessary," Asmussen recently told his boss, German Finance Minister Wolfgang Schäuble, a member of the conservative Christian Democratic Union (CDU). The bailout package will consist of loans and loan guarantees that the participating euro countries will make available to Greece. The package would be worth up to €25 billion, with Germany assuming about 20 percent of the burden. The team has dismissed concerns that a bailout could be in violation of European Union treaties. For them, the top priority is to preserve the integrity of the monetary union. If the program were implemented, the guaranteed bonds would essentially no longer be Greek bonds, but securities with a German risk premium.
It would be the worst-case scenario for a German government that has consistently emphasized its intention to avoid assistance payments to other euro countries at all costs. It would also serve as proof that the European Monetary Union is poorly designed, and that the euro zone's members are tied together in a way that German politicians have always categorically ruled out: namely that Greek debts are German debts.
It would also be the definitive euro lie, because Article 125 of the Treaty on the Functioning of the European Union, the so-called "no bailout" clause, states unequivocally: " A Member State shall not be liable for or assume the commitments of central governments, regional, local or other public authorities, other bodies governed by public law, or public undertakings of another Member State."
'Muddled Vision'
More than two decades ago, when the first serious discussions about a common European currency began, many experts feared that this would be a fair-weather clause. At the time, in the late 1980s, French politician Jacques Delors, the then-president of the European Commission, proposed a common European currency. The idea met with head-shaking and resistance in Germany, particularly among central bankers in Frankfurt.
The Delors proposal was "a muddled vision" with "wild ideas," Karl Otto Pöhl, the then-chairman of Germany's central bank, the Bundesbank, later told author David Marsh. Pöhl didn't believe that a monetary union would materialize within the foreseeable future. "I thought that maybe it would happen sometime in the next 100 years," he said.
But Germany's top central banker had underestimated the sheer force of political events. The fall of the Berlin Wall triggered the resurgence of old fears of German economic dominance, particularly in France. At the time, French President François Mitterrand believed that a monetary union was a suitable means of destroying the dominant position of the German currency. In return for agreeing to part ways with the German mark, Chancellor Helmut Kohl secured France's approval of German reunification and, for himself, a second entry into the history books: Not only was he the chancellor behind German unity, he could also take credit for a common European currency.
Political factors carried the euro to victory, while the concerns of economists were swept aside. Former German Economics and Finance Minister Karl Schiller, for example, complained that the German mark would dissolve in the new monetary union "like a sugar cube in a glass of tea." Critics warned that the monetary union could only work if accompanied by a political union, otherwise the member states' diverging decisions on financial and economic policy would soon tear apart the monetary union.
The public was also not particularly enamored of the idea of a European monetary union. Sixty percent of Germans were opposed to it. One of their fears was that they would eventually be held liable for the debts of financially unsound member states.
The politicians in Bonn, aware of the concerns of their citizens, did everything in their power to provide additional safeguards for the European currency. For one, they incorporated a clause into the Maastricht Treaty that stated that no EU nation was permitted to pay the debts of another. In addition, the then-German Finance Minister Theo Waigel pushed for the so-called Stability Pact.
Only financially sound nations were to be accepted, and to satisfy this criterion, the pact stipulated so-called stability criteria for the member states. Under these criteria, no country was permitted to accumulate debts exceeding 60 percent of its gross domestic product. In addition, member states were only permitted to take on new debt if the scope of the loans did not exceed 3 percent of their GDP. "Three point zero is three point zero," Waigel's rule stated. Violations were to be rigorously punished.
Not surprisingly, the Germans were skeptical when the euro was introduced on Jan. 1, 1999, initially as an accounting currency, at an exchange rate of $1.1789. The notes were issued three years later, in the biggest monetary exchange program in human history. In a ceremony at Berlin's Brandenburg Gate, DJs played records as then-Finance Minister Hans Eichel exchanged 200 old German marks into brand-new euros.
Economic Bonanza
To the Germans' surprise, the new money proved to be an economic bonanza at first. The monetary union created a common economic zone, which now includes 16 countries and 320 million people. Prices remained stable and, perhaps most importantly, the euro established itself as a second reserve currency next to the US dollar.
All of Europe benefited from the new currency, but no other country gained quite as much from the euro as Germany, for many years the world's leading exporter. In the past, German industry had been forced to accept heavy losses whenever the Italian lira or the French franc was devalued once again, automatically making German goods more expensive. The euro, on the other hand, even guaranteed German exporters stable prices in a turbulent global economy. During the most recent financial crisis, for example, the common currency "proved to be beneficial," says German constitutional law expert Paul Kirchhof.
From the very beginning, however, the euro was actually far more vulnerable than investors and politicians were willing to admit. Several member states used the façade of a strong global currency primarily to blatantly live beyond their means. They accumulated enormous mountains of debt and immersed themselves in a bizarre competition to circumvent the European stability rules as cleverly as possible.
Ironically, it was the Germans who proved to be particularly creative. On one occasion, then Finance Minister Theo Waigel tried to raid the gold reserves of the Bundesbank. Another time, his successor Hans Eichel sold part of the government's stakes in Deutsche Post and Deutsche Telekom to private investors. Both measures were intended to artificially spruce up Germany's debt statistics. It was Germany, of all countries, that was the second member state after Portugal to be subjected to an excessive deficit procedure by the European Union.
'Sickly Premature Birth'
In actual fact, the Brussels-based Commission should have set the sanction mechanism in motion earlier than it did. But then Chancellor Gerhard Schröder, who had once denigrated the euro as a "sickly premature birth," promised improvement. By ingratiating himself around Europe, the chancellor long managed to avoid being sanctioned.
It was Schröder's finance minister who, in light of a pending EU excessive deficit procedure against Germany, achieved an "improvement in the implementation of the Stability and Growth Pact" at a special meeting of the Ecofin Council on March 20, 2005. The lofty title was more than misleading, however. After the meeting, "exceptional and temporary" violations of the deficit reference value could occur much more frequently than in the past.
The Bundesbank ruled that the changes would "decisively weaken the rules of sound financial policy." As a consequence, the central bank wrote, "the goal of achieving sustainable public finances in all member states of the monetary union is being jeopardized."
By that point, the pact had clearly been weakened. The infractions accumulated, as did the tricks used by members of the monetary union to satisfy the stability criteria: Revenues were antedated, expenditures were concealed and debts were hidden.
Creative Tricks
Since joining the euro zone, the 16 euro countries have violated the deficit rule, under which net new debt cannot exceed 3 percent of GDP, 43 times. Most of the infractions have occurred in the last two years. Greece is at the top of the list of violators. Only once did the country manage to push its deficit rate below the magic limit, and only with an extremely creative trick: The Greeks sugarcoated their statistics by including prostitution, black-market trade and gambling in the calculation of economic output. As a result, GDP rose by a stunning 25 percent in 2006, and the deficit dropped to 2.9 percent.
Major investment banks also played a key role in fudging the numbers. With the help of complex financial instruments, the Greeks obtained additional loans that did not appear in the Eurostat deficit statistics. The concealed borrowing centered around so-called swaps "with which the Maastricht rules can be circumvented, completely legally," says a trader with one bank.
In early 2002, the US bank Goldman Sachs provided the Greeks with an additional loan for roughly $1 billion, triggering a wave of indignation throughout Europe. Even German Chancellor Merkel was outraged, saying that it would be "a disgrace if it turns out that banks, which have already taken us to the brink of disaster, were also involved in the falsification of statistics in Greece."
Cosmetically Enhancing Debt
Merkel could soon have even more reason to be outraged. A year after the Goldman deal, Deutsche Bank's London office set up a questionable deal for the Greeks. Together with the government financing division of Eurohypo, now a subsidiary of Commerzbank, it provided Athens with a loan for the purchase of military equipment.
"In 2003, Eurohypo took over a loan to the Greek government worth around €1 billion, which was repaid last year," confirms a Eurohypo spokesman. "The transaction was based on two swaps, which a bank in London had made available to the Greek government."
Deutsche Bank is unwilling to comment on the details of the transaction. Behind the scenes, it is said that Eurostat investigated the deal, and its goal was never to engage in cosmetically enhancing debt -- even though it can hardly be denied that this was precisely what the deal was intended to achieve. It meant that the Greeks did not need to enter the loan in its books right away, but only several years later, when the weapons were delivered.
It isn't just the culture of trickery that undermines the basis of the euro. It is also harmful that each country continues to pursue its own financial policy, lowering taxes or government spending as it pleases. As a result, a level economic playing field has not developed among the member states as hoped. In fact, they have drifted further apart.
On the one side are the EU's heavyweights, headed up by Germany. The new currency has made them more competitive, and they now produce far more than they consume. On the other side are countries like Spain and Ireland, which attracted large amounts of foreign capital, and where wages and asset prices rose rapidly. In the past, these countries' central banks would have promptly devalued the peseta or the Irish pound, thereby strengthening exports. But this safety valve has been sealed off by the common currency.
Another design flaw in the Maastricht Treaty is the no-bailout clause. Under this principle, each country must take responsibility for its own national debts. Of course, this rule has never been credible.
Otmar Issing, the former chief economist at the European Central Bank, insists that the clause allows no room for compromises. Current German President Horst Köhler was one of the architects of the Maastricht Treaty back when he was a senior official in the Finance Ministry. When asked in a 1992 SPIEGEL interview whether the monetary union could allow a country to go bankrupt, he replied: "Why not?" But such assurances seem to lose their value as soon as push comes to shove.
A De Facto Agreement
Last February, then-Finance Minister Peer Steinbrück openly stated that if one of the euro countries encountered financial difficulties, "the community will have to come to its aid." There is a de facto bail-out agreement among the euro countries, says Hamburg economist Dirk Meyer, noting that the no-bailout clause is "not workable."
Many now feel vindicated, including Harvard Professor Martin Feldstein, a prophet of the euro's demise for many years. This is the sort of thing that happens when different countries are forced to live with one interest rate that isn't appropriate for all members, says Feldstein, who warns of something he already predicted 15 years ago: the dissolution of the monetary union.
The German foes of the euro, led by economist Wilhelm Hankel and Wilhelm Nölling, a former chairman of the State Central Bank in Hamburg, are also feeling revitalized. They have even threatened to file a complaint in Germany's Constitutional Court if Greece, in violation of treaty provisions, does in fact receive help from Germany.
Naive Considerations
It has long been under discussion whether Greece should simply be ejected from the monetary union or should voluntarily abandon the euro. The boldest critics have even suggested that Germany reintroduce the German mark, so that it will not have to take responsibility for foreign debts.
But such considerations are naïve. It's possible that the euro was indeed introduced too soon. But that is by no means an argument to abolish it prematurely.
It is clear that a fracture in the monetary union would not just be a political disgrace, but also an economic catastrophe. For 10 years, European businesses and banks have become accustomed to a uniform European basis of calculation. Reversing it would trigger economic disruptions so severe that the Greek crisis pales by comparison.
Europe doesn't need a new currency. What Europe does need is the culture of stability, transparency and credibility that its governments have promised citizens, but have never created. Although the euro zone has a common monetary policy, it lacks a shared financial and economic policy.
'The Stability Pact Is Not Enough'
The crisis has exposed the deficiencies. "It has become clear that the Stability Pact is not enough," says Clemens Fuest, an economics professor at Oxford University and chairman of the economic council in the German Finance Ministry. But he also believes that the remainder of the treaty that gives the euro its legal framework is inadequate.
Government experts are already thinking about whether the monetary union needs its own stabilization fund, modeled after the International Monetary Fund. They also believe that the Stability Pact needs to be strengthened.
Some are considering ways to beef up the treaty so that the fraudulent culture of past years can be eliminated once and for all. One idea is to require member states to obtain the approval of the remaining nations if they intend to run deficits above the 3 percent threshold.
Even if the Germans are far from supporting a European economic government, as the French have long advocated for the euro zone, the German government believes that cooperation on economic policy must be coordinated far more closely and intensified in the future.
Bearing the Burden
Government officials have also thought about creating an insolvency statute for member states of the monetary union. Economic Council Chairman Clemens Fuest has already envisioned what it could look like. With such a statute in place, an affected country would be able to petition for its own insolvency.
In return for debt relief, it would be subject to harsh conditions from partner countries. It is important, says Fuest, that the donor nation be required to bear a portion of the burden by cancelling some of the troubled country's debt. He reasons that donors will be more cautious from the start if they are stuck with a portion of their loss.
The changes could arrive more quickly than expected, because there has been a noticeable change of awareness in the governments of the euro zone. In the past, it was assumed that small economies on the periphery could not pose a threat to the monetary union. This assumption was one of the arguments that was used to dispel doubts over whether Greece was even ready to be a member of the euro zone.
The recent crisis shows, however, that even small countries can jeopardize the entire common currency project. "European leaders are now realizing that the members of the monetary union are all in the same boat," says one senior Brussels diplomat, "and that its members, for better or worse, are dependent on each other."
In the past, exchange rates cushioned the consequences of diverging developments. When a country gained in economic strength, the value of its currency rose. If it loosened the reins, its currency was devalued.
This adjustment mechanism is absent in the monetary union, with dramatic consequences. For instance, if a country has gone too deeply into debt, the government can no longer choose the gentle option of devaluing its currency. Instead, it must impose austerity measures that directly affect the standard of living of its citizens, as is currently the case in Greece, where wages and pensions are being reduced and government expenditures slashed.
This is the unavoidable consequence of monetary union. But European governments were in denial about the risk, and they were certainly unwilling to openly own up to their mistakes. Instead, they maintained the status quo and took a devil-may-care attitude. For a while, it even went well. But now the imbalance can no longer be covered up. Not just Greece, but other euro countries, as well, have accumulated towers of debt that now threaten to collapse. A number of countries, known informally by the acronym PIIGS (Portugal, Ireland, Italy, Greece and Spain), are at risk.
If one of the large nations on the continent were to go bankrupt, Europe would face two equally unpalatable alternatives. If such a bankruptcy were simply accepted, it could trigger a disastrous chain reaction in the financial markets, much like the one that occurred after the Lehman Brothers bankruptcy in 2008. But if the remaining euro countries decided to come to the bankrupt country's aid with loans, "Germany's creditworthiness would eventually be threatened," says Deutsche Bank chief economist Thomas Mayer.
No wonder the poker game over Greece has caused such frayed nerves in Europe's capitals. The stakes are high, and the many players are financially strong. They can be found in Manhattan office buildings, luxury condominiums on the Cayman Islands or at the headquarters of major international banks. They all share a common interest: to make money from the Greek drama, or at least to ensure that they don't lose any money because of it.
The latter is the objective of many European banks, which have significantly expanded their holdings of Greek bonds in the last two years. German financial institutions like Commerzbank or HRE currently have about €32 billion worth of Greek treasury bonds on their books, while the Greek holdings of French banks are almost twice as high.
Tempting Deals
The deals were simply too tempting. During the course of the financial crisis, banks were able to borrow money from the European Central Bank at lower and lower rates, culminating at a mere 1 percent. When they used the cheap money to buy Greek bonds, with yields upwards of 5 percent, it was a -- supposedly -- surefire deal, practically a license to print money.
The credit managers were all the more horrified when their supposedly highly solvent customer turned out, in recent weeks, to be a candidate for bankruptcy. Since then, they have been urging European governments to come to the Greek government's aid with comprehensive state-backed assistance as quickly as possible.
The pressure is being amplified by influential major investors who are at home in the trading rooms of powerful investment banks and on the executive floors of hedge funds. For some of them, the fall of the euro is a done deal, and they are doing their utmost to make sure that their predictions come true.
One of the attackers is New York hedge fund manager John Paulson, who controls a fund worth $30 billion. He has been considered a guru in the investment community ever since, beginning in 2005, he bet on a collapse of the American real estate market -- with resounding success. He told a hearing before the US Congress a few weeks ago that he just wanted to "protect our investors' money." He sounded as cold and unemotional as if he were ordering a plate of French fries.
Betting against the Euro
The enemies of the common currency also include John Taylor and Jonathan Clark, two major American speculators who run New York-based FX Concepts, one of the world's largest hedge funds. The traders in their Global Currency Program alone have $3 billion at their disposal. "We are betting on a decline in the price of the euro," Clark said in early February. At about the same time, speculative net short positions in the euro rose sharply on the Chicago Mercantile Exchange.
An investigation launched by the US Justice Department two weeks ago suggests that the attackers may have taken a conspiratorial approach at times. The authorities suspect that hedge funds run by Paulson and other industry giants, including the fund headed by legendary investor George Soros, were planning a concerted attack against the euro. They also believe that the players may have reached illegal agreements over speculation.
Germany's Federal Financial Supervisory Authority (BaFin) also has significant evidence that speculators have increasingly targeted Greece recently. In doing so, they have apparently employed their favorite toy, the credit default swap (CDS), which already played a notorious role in the financial crisis.
Insurance Policy
A CDS is a contract under which one side pays an annual fee to buy protection against default, while the seller promises to cover losses in the event of a default. They are in effect an insurance policy against defaults of bonds and other debt. The buyer gets a payoff if the underlying bond goes into default.
In February, investors held CDS's for Greek government bonds worth $85 billion, twice as much as only a year earlier, according to a report BaFin officials prepared for the German Finance Ministry.
The German bank regulators warn that these CDS's could grow into a real problem for the Greek government's money-raising efforts, as well as for the cohesion of the monetary union. As CDS's for Greece become more and more expensive, investors could lose confidence in Greek bonds. This, according to the BaFin report, could lead to a "buyers' strike" for Greek bonds, which would create "the risk that the refinancing is unsuccessful, resulting in default."
To curb future speculation with CDS's, the bank regulators propose establishing a central European authority where the controversial financial instruments would be registered. This would enable authorities to recognize immediately where trouble is brewing as a result of speculation. The BaFin experts are opposed to a general ban on CDS's, however, arguing that it would be "counterproductive."
Keeping an Eye on Bankers
In addition to CDS's, financial regulators are also keeping a watchful eye on top bankers, who have been meeting with European leaders. One of them is Deutsche Bank CEO Josef Ackermann, who flew to Athens two Fridays ago to meet with Prime Minister Papandreou and discuss how the country could borrow fresh capital at reasonable terms.
After meeting with Papandreou, Ackermann spoke by phone with Jens Weidmann, an advisor to Chancellor Merkel. To solve its problems, Ackermann said, Greece would need €15 billion in loans. How, he wanted to know, would the German government feel about a consortium of private banks and government institutions, like the state-owned bank KfW, dividing up the amount? Deutsche Bank, he added, could manage the deal.
But Weidmann rebuffed Ackermann, arguing that the deal he was proposing would not only have violated the European monetary treaties, but it would also have reduced a large share of the credit risk of the participating commercial banks -- at the expense of German taxpayers. "Under those circumstances, we might as well have issued the loan ourselves," German government representatives said indignantly.
A few days later, politicians in Berlin were in for a surprise that was no less unpleasant. Despite Berlin's rejection of the idea, British papers reported that the German government was developing a rescue package based on Ackermann's plan.
It was a deliberate disruptive maneuver, which the government in Berlin speculates was launched by precisely those financial institutions in London and New York that have always been opposed to the European common currency. Now the euro's opponents apparently felt that the time had come to go in for the kill on the weakened currency.
The European governments retaliated with a two-pronged strategy. Behind the scenes, they put together a government bailout package for the event that Greece does indeed file for bankruptcy. Publicly, however, they made it clear that the government in Athens would have to help itself for the foreseeable future. Their goal was to make it less attractive for speculators to bet on a Greek bankruptcy and, at the same time, to chip away at the foundation of the European Monetary Union.
The campaign, which began last week, had been long in the making. Last Wednesday, Prime Minister Papandreou unveiled his catalog of harsh measures: an increase in the rate of value-added tax from 19 to 21 percent; additional taxes that would increase the prices of gasoline and diesel, liquor and cigarettes, yachts, precious stones and luxury cars; a freeze on pensions; and a cap on wages and salaries for civil servants.
In return, Papandreou received the "direct reaction" he had been promised. Before the Greek premier had even disclosed the details of the new austerity plan, it was "welcomed" in Brussels, praised in Berlin as a "very important signal," and lauded in Paris as "tough and concrete."
None of what happened in Athens came as a great surprise. The EU finance ministers had even agreed to the financial scope and precise figures of the government's austerity program in mid-February.
'Torture Instruments'
The pressure on Athens was followed by part two of the government's strategy: the threat against the financial markets. The head of the euro group, Luxembourg Prime Minister Jean-Claude Juncker, began the attack. If the financial markets did not stop speculating against the euro, despite the ambitious plan for Greece, he warned, they could expect to see "decisive and coordinated action." He added that he still had a few "torture instruments" up his sleeve.
European government representatives and central bankers soon made it clear what Juncker meant. Some ignited a debate over the possibility of enacting a law to put a stop to trading in highly speculative derivatives. Others let it be known that the private rating agencies could be getting some competition in the future, if the European Central Bank were given the power to assess the creditworthiness of countries itself, rather than relying on private rating agencies such as Standard & Poor's. The rating agency Moody's reacted quickly, expressing uncharacteristic praise for the Greek austerity program.
That was followed by a successfully placed Greek government bond issue and corresponding declarations of victory from Berlin, Paris and Brussels.
Now the protagonists are hopeful, but not truly sure of success. Will the Greeks actually implement its brutal cost-cutting program? Will the government survive this trial? And will the speculators back off?
Preparing for the Worst-Case Scenario
No one knows the answers to those questions -- which is why a second Europe, which remains largely concealed from the public, currently exists in parallel to the public Europe of summit meetings, government statements and official visits. Behind the closed doors of government headquarters, finance ministries and central banks, European governments are preparing for the worst-case scenario: Greece is unable to avert bankruptcy on its own steam, forcing its European partners to intervene.
A top-secret team of half a dozen experts has been working on the bailout measures for weeks. The team includes Jörg Asmussen, a senior official in the German Finance Ministry, and his French counterpart. The ECB is represented by its chief economist, Jürgen Stark, and a senior official represents the European Commission. Alternating representatives of other potential donor countries are also taking part in the discussions.
The team is far along in its preparations. "We could pay out the money in 48 hours, if necessary," Asmussen recently told his boss, German Finance Minister Wolfgang Schäuble, a member of the conservative Christian Democratic Union (CDU). The bailout package will consist of loans and loan guarantees that the participating euro countries will make available to Greece. The package would be worth up to €25 billion, with Germany assuming about 20 percent of the burden. The team has dismissed concerns that a bailout could be in violation of European Union treaties. For them, the top priority is to preserve the integrity of the monetary union. If the program were implemented, the guaranteed bonds would essentially no longer be Greek bonds, but securities with a German risk premium.
It would be the worst-case scenario for a German government that has consistently emphasized its intention to avoid assistance payments to other euro countries at all costs. It would also serve as proof that the European Monetary Union is poorly designed, and that the euro zone's members are tied together in a way that German politicians have always categorically ruled out: namely that Greek debts are German debts.
It would also be the definitive euro lie, because Article 125 of the Treaty on the Functioning of the European Union, the so-called "no bailout" clause, states unequivocally: " A Member State shall not be liable for or assume the commitments of central governments, regional, local or other public authorities, other bodies governed by public law, or public undertakings of another Member State."
'Muddled Vision'
More than two decades ago, when the first serious discussions about a common European currency began, many experts feared that this would be a fair-weather clause. At the time, in the late 1980s, French politician Jacques Delors, the then-president of the European Commission, proposed a common European currency. The idea met with head-shaking and resistance in Germany, particularly among central bankers in Frankfurt.
The Delors proposal was "a muddled vision" with "wild ideas," Karl Otto Pöhl, the then-chairman of Germany's central bank, the Bundesbank, later told author David Marsh. Pöhl didn't believe that a monetary union would materialize within the foreseeable future. "I thought that maybe it would happen sometime in the next 100 years," he said.
But Germany's top central banker had underestimated the sheer force of political events. The fall of the Berlin Wall triggered the resurgence of old fears of German economic dominance, particularly in France. At the time, French President François Mitterrand believed that a monetary union was a suitable means of destroying the dominant position of the German currency. In return for agreeing to part ways with the German mark, Chancellor Helmut Kohl secured France's approval of German reunification and, for himself, a second entry into the history books: Not only was he the chancellor behind German unity, he could also take credit for a common European currency.
Political factors carried the euro to victory, while the concerns of economists were swept aside. Former German Economics and Finance Minister Karl Schiller, for example, complained that the German mark would dissolve in the new monetary union "like a sugar cube in a glass of tea." Critics warned that the monetary union could only work if accompanied by a political union, otherwise the member states' diverging decisions on financial and economic policy would soon tear apart the monetary union.
The public was also not particularly enamored of the idea of a European monetary union. Sixty percent of Germans were opposed to it. One of their fears was that they would eventually be held liable for the debts of financially unsound member states.
The politicians in Bonn, aware of the concerns of their citizens, did everything in their power to provide additional safeguards for the European currency. For one, they incorporated a clause into the Maastricht Treaty that stated that no EU nation was permitted to pay the debts of another. In addition, the then-German Finance Minister Theo Waigel pushed for the so-called Stability Pact.
Only financially sound nations were to be accepted, and to satisfy this criterion, the pact stipulated so-called stability criteria for the member states. Under these criteria, no country was permitted to accumulate debts exceeding 60 percent of its gross domestic product. In addition, member states were only permitted to take on new debt if the scope of the loans did not exceed 3 percent of their GDP. "Three point zero is three point zero," Waigel's rule stated. Violations were to be rigorously punished.
Not surprisingly, the Germans were skeptical when the euro was introduced on Jan. 1, 1999, initially as an accounting currency, at an exchange rate of $1.1789. The notes were issued three years later, in the biggest monetary exchange program in human history. In a ceremony at Berlin's Brandenburg Gate, DJs played records as then-Finance Minister Hans Eichel exchanged 200 old German marks into brand-new euros.
Economic Bonanza
To the Germans' surprise, the new money proved to be an economic bonanza at first. The monetary union created a common economic zone, which now includes 16 countries and 320 million people. Prices remained stable and, perhaps most importantly, the euro established itself as a second reserve currency next to the US dollar.
All of Europe benefited from the new currency, but no other country gained quite as much from the euro as Germany, for many years the world's leading exporter. In the past, German industry had been forced to accept heavy losses whenever the Italian lira or the French franc was devalued once again, automatically making German goods more expensive. The euro, on the other hand, even guaranteed German exporters stable prices in a turbulent global economy. During the most recent financial crisis, for example, the common currency "proved to be beneficial," says German constitutional law expert Paul Kirchhof.
From the very beginning, however, the euro was actually far more vulnerable than investors and politicians were willing to admit. Several member states used the façade of a strong global currency primarily to blatantly live beyond their means. They accumulated enormous mountains of debt and immersed themselves in a bizarre competition to circumvent the European stability rules as cleverly as possible.
Ironically, it was the Germans who proved to be particularly creative. On one occasion, then Finance Minister Theo Waigel tried to raid the gold reserves of the Bundesbank. Another time, his successor Hans Eichel sold part of the government's stakes in Deutsche Post and Deutsche Telekom to private investors. Both measures were intended to artificially spruce up Germany's debt statistics. It was Germany, of all countries, that was the second member state after Portugal to be subjected to an excessive deficit procedure by the European Union.
'Sickly Premature Birth'
In actual fact, the Brussels-based Commission should have set the sanction mechanism in motion earlier than it did. But then Chancellor Gerhard Schröder, who had once denigrated the euro as a "sickly premature birth," promised improvement. By ingratiating himself around Europe, the chancellor long managed to avoid being sanctioned.
It was Schröder's finance minister who, in light of a pending EU excessive deficit procedure against Germany, achieved an "improvement in the implementation of the Stability and Growth Pact" at a special meeting of the Ecofin Council on March 20, 2005. The lofty title was more than misleading, however. After the meeting, "exceptional and temporary" violations of the deficit reference value could occur much more frequently than in the past.
The Bundesbank ruled that the changes would "decisively weaken the rules of sound financial policy." As a consequence, the central bank wrote, "the goal of achieving sustainable public finances in all member states of the monetary union is being jeopardized."
By that point, the pact had clearly been weakened. The infractions accumulated, as did the tricks used by members of the monetary union to satisfy the stability criteria: Revenues were antedated, expenditures were concealed and debts were hidden.
Creative Tricks
Since joining the euro zone, the 16 euro countries have violated the deficit rule, under which net new debt cannot exceed 3 percent of GDP, 43 times. Most of the infractions have occurred in the last two years. Greece is at the top of the list of violators. Only once did the country manage to push its deficit rate below the magic limit, and only with an extremely creative trick: The Greeks sugarcoated their statistics by including prostitution, black-market trade and gambling in the calculation of economic output. As a result, GDP rose by a stunning 25 percent in 2006, and the deficit dropped to 2.9 percent.
Major investment banks also played a key role in fudging the numbers. With the help of complex financial instruments, the Greeks obtained additional loans that did not appear in the Eurostat deficit statistics. The concealed borrowing centered around so-called swaps "with which the Maastricht rules can be circumvented, completely legally," says a trader with one bank.
In early 2002, the US bank Goldman Sachs provided the Greeks with an additional loan for roughly $1 billion, triggering a wave of indignation throughout Europe. Even German Chancellor Merkel was outraged, saying that it would be "a disgrace if it turns out that banks, which have already taken us to the brink of disaster, were also involved in the falsification of statistics in Greece."
Cosmetically Enhancing Debt
Merkel could soon have even more reason to be outraged. A year after the Goldman deal, Deutsche Bank's London office set up a questionable deal for the Greeks. Together with the government financing division of Eurohypo, now a subsidiary of Commerzbank, it provided Athens with a loan for the purchase of military equipment.
"In 2003, Eurohypo took over a loan to the Greek government worth around €1 billion, which was repaid last year," confirms a Eurohypo spokesman. "The transaction was based on two swaps, which a bank in London had made available to the Greek government."
Deutsche Bank is unwilling to comment on the details of the transaction. Behind the scenes, it is said that Eurostat investigated the deal, and its goal was never to engage in cosmetically enhancing debt -- even though it can hardly be denied that this was precisely what the deal was intended to achieve. It meant that the Greeks did not need to enter the loan in its books right away, but only several years later, when the weapons were delivered.
It isn't just the culture of trickery that undermines the basis of the euro. It is also harmful that each country continues to pursue its own financial policy, lowering taxes or government spending as it pleases. As a result, a level economic playing field has not developed among the member states as hoped. In fact, they have drifted further apart.
On the one side are the EU's heavyweights, headed up by Germany. The new currency has made them more competitive, and they now produce far more than they consume. On the other side are countries like Spain and Ireland, which attracted large amounts of foreign capital, and where wages and asset prices rose rapidly. In the past, these countries' central banks would have promptly devalued the peseta or the Irish pound, thereby strengthening exports. But this safety valve has been sealed off by the common currency.
Another design flaw in the Maastricht Treaty is the no-bailout clause. Under this principle, each country must take responsibility for its own national debts. Of course, this rule has never been credible.
Otmar Issing, the former chief economist at the European Central Bank, insists that the clause allows no room for compromises. Current German President Horst Köhler was one of the architects of the Maastricht Treaty back when he was a senior official in the Finance Ministry. When asked in a 1992 SPIEGEL interview whether the monetary union could allow a country to go bankrupt, he replied: "Why not?" But such assurances seem to lose their value as soon as push comes to shove.
A De Facto Agreement
Last February, then-Finance Minister Peer Steinbrück openly stated that if one of the euro countries encountered financial difficulties, "the community will have to come to its aid." There is a de facto bail-out agreement among the euro countries, says Hamburg economist Dirk Meyer, noting that the no-bailout clause is "not workable."
Many now feel vindicated, including Harvard Professor Martin Feldstein, a prophet of the euro's demise for many years. This is the sort of thing that happens when different countries are forced to live with one interest rate that isn't appropriate for all members, says Feldstein, who warns of something he already predicted 15 years ago: the dissolution of the monetary union.
The German foes of the euro, led by economist Wilhelm Hankel and Wilhelm Nölling, a former chairman of the State Central Bank in Hamburg, are also feeling revitalized. They have even threatened to file a complaint in Germany's Constitutional Court if Greece, in violation of treaty provisions, does in fact receive help from Germany.
Naive Considerations
It has long been under discussion whether Greece should simply be ejected from the monetary union or should voluntarily abandon the euro. The boldest critics have even suggested that Germany reintroduce the German mark, so that it will not have to take responsibility for foreign debts.
But such considerations are naïve. It's possible that the euro was indeed introduced too soon. But that is by no means an argument to abolish it prematurely.
It is clear that a fracture in the monetary union would not just be a political disgrace, but also an economic catastrophe. For 10 years, European businesses and banks have become accustomed to a uniform European basis of calculation. Reversing it would trigger economic disruptions so severe that the Greek crisis pales by comparison.
Europe doesn't need a new currency. What Europe does need is the culture of stability, transparency and credibility that its governments have promised citizens, but have never created. Although the euro zone has a common monetary policy, it lacks a shared financial and economic policy.
'The Stability Pact Is Not Enough'
The crisis has exposed the deficiencies. "It has become clear that the Stability Pact is not enough," says Clemens Fuest, an economics professor at Oxford University and chairman of the economic council in the German Finance Ministry. But he also believes that the remainder of the treaty that gives the euro its legal framework is inadequate.
Government experts are already thinking about whether the monetary union needs its own stabilization fund, modeled after the International Monetary Fund. They also believe that the Stability Pact needs to be strengthened.
Some are considering ways to beef up the treaty so that the fraudulent culture of past years can be eliminated once and for all. One idea is to require member states to obtain the approval of the remaining nations if they intend to run deficits above the 3 percent threshold.
Even if the Germans are far from supporting a European economic government, as the French have long advocated for the euro zone, the German government believes that cooperation on economic policy must be coordinated far more closely and intensified in the future.
Bearing the Burden
Government officials have also thought about creating an insolvency statute for member states of the monetary union. Economic Council Chairman Clemens Fuest has already envisioned what it could look like. With such a statute in place, an affected country would be able to petition for its own insolvency.
In return for debt relief, it would be subject to harsh conditions from partner countries. It is important, says Fuest, that the donor nation be required to bear a portion of the burden by cancelling some of the troubled country's debt. He reasons that donors will be more cautious from the start if they are stuck with a portion of their loss.
The changes could arrive more quickly than expected, because there has been a noticeable change of awareness in the governments of the euro zone. In the past, it was assumed that small economies on the periphery could not pose a threat to the monetary union. This assumption was one of the arguments that was used to dispel doubts over whether Greece was even ready to be a member of the euro zone.
The recent crisis shows, however, that even small countries can jeopardize the entire common currency project. "European leaders are now realizing that the members of the monetary union are all in the same boat," says one senior Brussels diplomat, "and that its members, for better or worse, are dependent on each other."
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