How Merkel's fiction is writing Greece's future

When will we finally get a lasting solution to the Greek problem? Not a stop-gap measure, but one that actually puts the country on a sustainable path towards recovery?

The answer to this question is simple: sometime after September 15, 2013. And the reason for this answer is even simpler: it is the most likely date of the next German election when Angela Merkel will run for a third term as chancellor.

Under normal circumstances, German elections are won or lost like elections in every other – on domestic issues. Not so next year's German election. Its outcome will, to a large degree, be decided by the situation in Greece.

Though it would be wrong to suggest that Merkel's economic reputation is built entirely on her management of the euro crisis, making German taxpayers pay for a Greek default would ruin her reputation and wreck her electoral chances overnight. This is why Merkel is fighting an increasingly lonely fight to keep Greece technically solvent. Not because she cares much about Greece but because it's her only chance of political survival.

Merkel's eurozone colleagues, the European Commission, the European Central Bank and the International Monetary Fund are visibly annoyed with Berlin's behaviour. And they are correct. It seems stubborn, erratic, self-righteous, or dogmatic – or indeed all of the above. But one thing it is not: irrational.

To be clear, it is not rational as far as good policy-making is concerned. With their insistence that Greece may under no circumstance default, receive another bailout package or, heaven forbid, leave the eurozone, the Germans have demanded the impossible. At least one of these alternatives, and maybe two, will happen.

This is not a question of political will but of mathematical certainties. With the Greek economy shrinking by more than 6 per cent this year, a budget deficit of the same magnitude, and Greece's total debt burden on course to reach almost twice its annual economic output by 2014, there is no way that Athens will just neatly stabilise, grow out of its trouble and repay its creditors.

But alas, it is precisely this cloud-cuckoo land scenario that Merkel has pledged to her voters. And that's why it is entirely rational for her to pretend it is achievable – it is a political necessity, at least until her next election.

Throughout the Greek crisis, Merkel has shifted her technical positions several times. However, the basic narrative for her domestic audience has been consistent, namely that 'rescuing' Greece will not cost German taxpayers a single cent. Whatever was committed to Greece, and in whatever way, Merkel made it sound like a prudent investment rather than a permanent transfer of wealth from one country to another.

To uphold this piece of political fiction, she had to pretend that everything was going according to plan while defining away all the obvious disasters along the way. Greece's budget deficit does not go down? The Greeks just need more time for the reforms to work. The second bailout package is not sufficient? The European Central Bank will fix such temporary problems. Greece's youth unemployment is up to 58 per cent? That's very sad but with a bit more internal devaluation Greece will soon be able to recover its competitiveness and create more jobs.

To any sane observer of the Greek drama, such official views coming out of Merkel's chancellery are absurd. It does not require a PhD in economics to see that Greece is going nowhere and that none of the EU/ECB/IMF medicines have cured the Greek patient. Merkel and her finance minister Wolfgang Schuble may rule out both a Greek default and another Greek bailout package ad nauseam as, indeed, they do. But these mantras cannot change the basic economic facts about Greece.

Greece's economy has not only been contracting for five years, but this contraction is accelerating. At the same time, Greece's debt situation has not improved despite the first round of default which wiped off some of the debt held by private investors. To make the policy disaster complete, Greece's banking system is clinically dead and only kept alive thanks to constant infusions of new central bank money. By the way, the same is true of the Greek government as well because it now has to rely on short-term funding from this very banking system.

In short, Greece's economic situation is a complete, total and utter catastrophe. It was undoubtedly terrible before the EU 'rescuers' began their work more than three years ago thanks to decades of Greek mismanagement. But the EU, led by the Germans, has made a terrible situation in Greece worse. Under their guidance, Greece has achieved the transition from a state in trouble to a failed state.

And why? Because of domestic political considerations, Germany has not allowed Greece to do what it should have done in the first place; default on its debt, leave the economic corset of the euro, and implement economic reforms. Merkel and her government lacked the courage to let this happen, and the longer the delay the worse the situation has become.

Unfortunately for everyone involved, this sad state of affairs will continue for at least another ten months until the Germans finally go to the polls. Admitting their policy errors prior to the federal election is not an option for Merkel's government. A Greek default would cost tens of billions of euros and blow a hole in her budget. Another bailout package, categorically ruled out by Merkel, would also leave her reputation in tatters.

To have any chance of re-election, Merkel must continue muddling through on Greece until September 2013, just doing enough to keep Greece above water. She may even achieve it – her government has made such trickery an art form.

The consequences of Merkel's mismanagement of the Greek problem will be with the Greeks for years. They will eventually cost the Germans dearly and they have set a bad precedent for Europe's other crisis countries.

Even if Merkel somehow wins her next election, it will be a Pyrrhic victory that leaves nothing but losers.

Dr Oliver Marc Hartwich is the executive director of The New Zealand Initiative.