Why Did Schauble Almost Use The "Nuclear Option" - Tim Geithner Explains

While a Greek (pre) deal in some format was largely expected this weekend (especially following the unprecedented humiliation of Greece that would allow the Troika to repay... the Troika) the biggest stunner from the past 48 hours was Schauble's insistence (which as we subsequently learned had been coordinated with Merkel) that either Greece accepts draconian terms which will strip the country of its sovereignty, or it will suffer a 5 year "time out" from the Eurozone.

To wit:

The Greek authorities reiterate their unequivocal commitment to honour their financial obligations to all their creditors fully and timely.


[Provided that all the necessary conditions contained in this document are fulfilled, the Eurogroup and ESM Board of Governors may, in accordance with Article 13.2 of the ESM Treaty, mandate the institutions to negotiate a new ESM programme, if the preconditions of Article 13 of the ESM Treaty are met on the basis of the assessment referred to in Article 13.1.]


[In case no agreement could be reached, Greece should be offered swift negotiations on a time-out from the euro area, with possible debt restructuring.]

But while Schauble's "time out" language never made it into the final documents, its presence alone was sufficient to remind the members of the Eurozone that the monetary union has quiet specific loopholes to push any member out that infuriates the German finance minister. It was also enough for FT's Wolfgang Munchau to write earlier today that "The Eurozone As We Know It Is Destroyed."

But why did Schauble insist on this "nuclear option"? For the answer we turn to none other than former NY Fed president (and leaker) and US Treasury advisor and current Warburg Pincus president, whose 2014 memoir Stress Test lays it all out:

A few days later [i.e., late July 2012], I flew to meet Wolfgang Schäuble for lunch during his vacation at a resort in Sylt, a North Sea island known as Germany’s Martha’s Vineyard. Schäuble was engaging, but I left Sylt feeling more worried than ever. He told me there were many in Europe who still thought kicking the Greeks out of the eurozone was a plausible — even desirable — strategy. The idea was that with Greece out, Germany would be more likely to provide the financial support the eurozone needed because the German people would no longer perceive aid to Europe as a bailout for the Greeks. At the same time, a Grexit would be traumatic enough that it would help scare the rest of Europe into giving up more sovereignty to a stronger banking and fiscal union. The argument was that letting Greece burn would make it easier to build a stronger Europe with a more credible firewall.

Naturally, Geithner who himself is atavistic to debt relief and instead urged the Fed and Treasury to fix debt with even more debt, "found the argument terrifying."

He adds that "letting Greece go could create a spectacular crisis of confidence, regardless of what Europeans committed to do afterward."

For now, at least, Grexit - whether temporary or permanent - has been delayed for a few months until Greece violates Bailout #3 and Europe is back to he drawing board. At that point not even fellow debt sinner Italy and France will have enough sway to convince "northern Europe" that bailout #4 is merited.

But the question is: was Schauble wrong, especially when considering the alternative that Greece is now presented with: handing over its sovereignty to Berlin on a silver platter, and an outcome which "leaves Greece in a permanent debt trap, under neo-colonial control, and so economically fragile that it is almost guaranteed to crash into a fresh crisis in the next global downturn or European recession."

Telegraph's Ambrose Evans-Pritchard believes Schauble's "solution" was the right one for Greece:

In an odd way, the only European politician who was really offering Greece a way out of the impasse was Wolfgang Schauble, the German finance minister, even if his offer was made in a graceless fashion, almost in the form of diktat.


His plan for a five-year velvet withdrawal from EMU – a euphemism, since he really meant Grexit – with Paris Club debt relief, humanitarian help, and a package of growth measures, might allow Greece to regain competitiveness under the drachma in an orderly way.


Such a formula would imply intervention by the ECB to stabilise the drachma, preventing an overshoot and dangerous downward spiral. It would certainly have been better than the atrocious document that Mr Tsipras must now take back to Athens.

Alas, Tsipras ignored this option and instead of doing the honorable thing and resigning following his "mental waterboarding" by Europe, in the process not only salvaging the disastrous Syriza negotiating tactics of the past 6 months and cementing himself as a martyr in the public's eye thus assuring himself a landslide victory in the next elections but also putting the ball once again back in Merkel's court, he conceded to everything, in the process starting the clock on the next Greek default and bailout, with Grexit - either temporary or permanent - merely delayed.

In this regard, AEP's conclusion is spot on:

For the eurozone this “deal” is the worst of all worlds. They have solved nothing. Germany and its allies have for the first time attempted to eject a country from the euro, and by doing so have violated the sanctity of monetary union.


Rather than go forward in times of deep crisis to fiscal and political union to hold the euro together – as the architects of EMU always anticipated - they have instead gone backwards.


They have at a single stroke converted the eurozone into a hard-peg currency bloc, a renewed Exchange Rate Mechanism that is inherently unstable, at the whim and mercy of populist politicians playing to the gallery at home. The markets are already starting to call it ERM3.

Schauble will get the last laugh yet.