For several months I have been saying that Ms Merkel was going to push Greece out of the Eurozone (EZ). That prediction I fear is about to become a nasty reality. With the deal on a private sector write down still not agreed, Roubini’s RGE Monitor reports the ‘troika’ as saying: whatever the result of the PSI deal, Greece will need to “legally commit itself to giving absolute priority to future debt service” and “accept shifting budgetary sovereignty to the European level”. Greece is being asked to give its creditors absolute priority over its own citizens, as well as to formally cede its budgetary sovereignty to the German-led troika.
Ms Merkel knows that such ‘conditions’ are quite unacceptable — with parliamentary elections due to take place in April, any Greek government agreeing to such conditions would be toast. Therefore, the German centre-right must be betting that financial markets have already factored in a Greek departure, and that the markets, far from being panicked into attacking the rest of the Eurozone, will be calmer once Greece goes. Additionally, Ms Merkel believes the size of the EFSF hedges the Eurozone sufficiently against the downside risk.
The mechanics of Greece’s departure are clear. It must roll over €14.5bn by the end of March, or else it will be unable to fund its external primary deficit (ie, its deficit net of interest payments abroad). In the absence of troika funds, and with no access to the international financial market, Greece must default, leave the euro and return to a ‘new drachma’ (ND). As I (and many others) have written elsewhere, the domestic pain will be severe. As for the rest of the Eurozone, one can only pray that Ms Merkel’s put is a wiser bet than was Alan Greenspan’s. The consequences of her being wrong are truly horrendous — not just for the EU but for the world economy.