In Germany, considering a eurozone minus Greece

Athens’s inability to get a grip on the debt problem is rattling markets and giving rise to talk of a notion that until recently has been considered taboo: a eurozone without Greece.

Greece's introduction last weekend of a new real estate tax and reduction in elected officials' pay are being called too little, too late to address its deep debt. And in Germany, which holds the purse strings when it comes to euro bailouts, rising unease about coming to the aid of ailing European economies is changing longstanding assumptions about Greece's future.

“If we want to stabilize the euro, we can’t afford having taboos any longer,” said German economy minister Philipp Rösler in a Sunday TV interview. “We should think about the possibility of an orderly sovereign default in Greece.”

Even though financial experts have insisted for some time that Greece is de facto insolvent, cabinet ministers and senior politicians in Berlin have refused until now to speculate about this possibility. The fear was that even a debate about a default might scare already nervous investors into taking even more money out of the markets, creating further problems for other eurozone member states and particularly for international banks.

Market reactions yesterday seemed to confirm this fear: The euro dropped to a 10-year low against the yen and a seven-month low against the dollar. Shares of French banks in particular – still holding considerable amounts of Greek debt and under threat of being downgraded by rating agency Moody’s – fell sharply.

In Germany, domestic politics is playing an important role in influencing attitudes about Greece. The debate here about a possible sovereign default led to an open split in the coalition government.

Mr. Rösler, who is also leader of the Free Democrats (FDP), the junior partner in Chancellor Angela Merkel’s coalition government, was the first to break ranks. Horst Seehofer, leader of the Christian Socialists and prime minister of Bavaria, followed suit, but went a step further by suggesting Greece's possible exclusion from the eurozone.

In an attempt to distance herself from these positions, Mrs. Merkel went on public radio Tuesday and urged her fellow politicians to chose their words carefully. "It is our top priority to prevent a Greek default which would cause a domino effect on other eurozone countries. But we can’t fix overnight what has been neglected for years,” she said, referring to the Greek economy.

Resistance grows

“You have a division between those believing that giving up on Greece will worsen the crisis for other eurozone members and those who think we can’t afford to pay for Greece any longer,” says Janis Emmanouilidis, senior policy analyst at the Brussels-based European Police Centre think tank. “Particularly many Free Democrats object to bailouts in general. And later this month the German parliament will vote on the planned expansion of the European rescue fund, the EFSF. What you see now is the formation of resistance against this expansion.”

The FDP can count on the support of a number of parliamentarians from Merkel’s own party, and on the German public.

Seventy-six percent of Germans are against an expansion of the eurozone rescue fund, while only 18 percent are in favor, according to a poll commissioned by the public broadcaster ZDF.

Germany is the biggest contributor to the rescue fund, it already accounts for 123 billion euros ($168 billion) of the 440 billion euros ($602 billion) of EFSF guarantee commitments. Parliament will vote on increasing this amount to 230 billion euros ($314 billion) – two thirds of the entire German budget.

Meanwhile German media report that Finance Minister Wolfgang Schäuble is working on two scenarios for a Greek default. One has Greece still in the eurozone, while the other assumes the reintroduction of the Greek drachma. Current eurozone regulations do not provide for this option and officials were keen to stress that this was just a thought experiment.

“The eurozone treaty does not foresee a country leaving the common currency,” chancellery spokesman Steffen Seibert told reporters. Merkel has repeatedly spoken of her conviction that the eurozone as a political project was vital to stability in Europe and should be preserved at all costs.

But it’s not just German politics that has added to the debate about a Greek default – news out of Athens don’t help either.

The recession in Greece is worse than expected, figures released in recent days suggest. The Greek economy is not just shrinking by 3.8 percent this year as forecast in May, but by more than 5 percent. Representatives of the so-called troika – European Central Bank, EU, and International Monetary Fund – last week found a gap of 1.7 billion euros ($2.3 billion) in the Greek budget. And of the 50 billion euros ($68 billion) the government hoped to raise by selling state assets, only 400 million have materialized so far.

On Wednesday, Merkel and French President Nicolas Sarkozy will urge Greek Prime Minister in a telephone conference to increase his efforts in solving the crisis. But given the lack of progress, Merkel’s argument that Greece would need more time to get its debt problem under control does not convince critics that a default can ultimately be prevented.

“The politicians have tried pretty much everything to help Greece out of this predicament,” says Hanno Beck, economics professor at Pforzheim University. “Now they realize it didn’t work, so they just bow to the inevitable.”