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How Germany Can End the Eurozone's Crisis Teaser: STRATFOR examines steps Germany can ta e to reso!

"e the #inancia! crisis in the eurozone$ Summary: The eurozone's #inancia! crisis has entered its %&th month$ Germany' the most power#u! country in Europe current!y' #aces constraints in its choices #or chan(in( the European system$ Howe"er' there is a way )er!in cou!d rescue the eurozone: E*ect Greece #rom the economic +!oc and mana(e the #a!!out with a +ai!out #und$ Ana!ysis: The eurozone's #inancia! crisis has entered its %&th month$ There are more p!ans to modi#y the European system than there are eurozone mem+ers' +ut most i(nore constraints on Germany' the one country in the eurozone in a position to reso!"e the crisis$ Howe"er' STRATFOR sees an approximate roadmap the German (o"ernment cou!d #o!!ow$ ,h-.Germany's Constraints,/h-. 0hi!e Germany is +y #ar the most power#u! country in Europe' the European 1nion is not a German creation$ 2t is a portion o# the %&34s French "ision that enhances French power on #irst a European' and second a (!o+a!' sca!e$ Howe"er' since the Co!d 0ar ended France has !ost contro! o# Europe to a reunited and rein"i(orated Germany$ Germany is now wor in( piecemea! to rewire the European structures more to )er!in5s !i in($ Germany5s primary too!s #or assertin( contro! are its #inancia! acumen and stren(th6 )er!in exchan(es access to its wea!th #or a(reements #rom other European states to re#orm their economies a!on( German !ines' ma in( most o# them de #acto German economic co!onies$ This +rin(s us to the eurozone crisis and the "arious p!ans to modi#y the +!oc$ 7ost o# these p!ans i(nore that Germany's reasons #or participatin( in the eurozone are not pure!y economic' and those non8economic reasons (reat!y !imit )er!in's options #or chan(in( the eurozone$ Germany in any a(e cou!d +e descri+ed as "u!nera+!e$ 2ts coast!ine is sp!it +y 9enmar ' its three na"i(a+!e ri"ers are not natura!!y connected and the mouths o# two o# those ri"ers are not under German contro!$ Germany's peop!e c!in( to re(iona! rather than nationa! identities and' most' important!y the country #aces sharp competition #rom +oth east and west$ Germany has ne"er +een !e#t a!one: 0hen its is wea its nei(h+ors shatter it into dozens o# pieces' o#ten ru!in( some o# those pieces direct!y' and when it is stron( its nei(h+ors #orm a coa!ition to +rea Germany's power$ The post8Co!d 0ar' there#ore' is a (o!den a(e in Germany history$ 2t was a!!owed to

reuni#y a#ter the Co!d 0ar' and its nei(h+ors ha"e not yet #e!t su##icient!y threatened to attempt to +rea )er!in's power$ 2n any other era' a coa!ition to contain Germany wou!d a!ready +e #ormin($ Howe"er' the European 1nion's institutions 88 particu!ar!y the euro 88 ha"e a!!owed Germany to participate in Continenta! a##airs in an arena in which they are eminent!y competiti"e$ Germany wants to eep European competition in the #ie!d o# economics' as on the #ie!d o# +att!e it cou!d not pre"ai! a(ainst a coa!ition o# its nei(h+ors$ This simp!e #act e!iminates most o# the eurozone crisis so!utions under discussion$ E*ectin( states #rom the eurozone that are traditiona! competitors with Germany cou!d trans#orm them into ri"a!s$ Thus' any re#orm option that cou!d end with Germany not in the same currency zone as Austria' the :ether!ands' France' Spain or 2ta!y is not "ia+!e i# )er!in wants to pre"ent a core o# competition #rom arisin($ Germany a!so #aces mathematica! constraints$ A ;trans#er union'; as many ha"e de+ated' wou!d re(u!ar!y shi#t economic resources #rom Germany to Greece' the eurozone5s wea est mem+er$ The means o# such a!!ocations 88 direct trans#ers' ro!!in( de+t restructurin(s' mana(ed de#au!ts 88 are irre!e"ant$ 0hat is re!e"ant is that such a p!an wou!d esta+!ish precedent and +e repeated #or 2re!and and <ortu(a! 88 and in time 2ta!y' )e!(ium' Spain and France$ This ma es anythin( resem+!in( a trans#er union a dead issue$ Co"erin( a!! the states that wou!d +ene#it #rom the trans#ers wou!d !i e!y cost around % tri!!ion euros annua!!y$ E"en i# this were a po!itica! possi+i!ity in Germany =and it is not>' it is we!! +eyond Germany5s economic capacity$ These !imitations !ea"e a narrow window o# possi+i!ities #or )er!in$ 0hat #o!!ows is the approximate path STRATFOR sees Germany +ein( #orced to #o!!ow$ This is not )er!in's exp!icit p!an' necessari!y' +ut i# the eurozone is to a"oid mass de#au!ts and disso!ution' it appears to +e the so!e option$ ,h-.Cuttin( Greece ?oose,/h-. Greece's domestic capita! (eneration capacity is "ery !imited' and its ru((ed topo(raphy comes with extreme!y hi(h capita! costs$ E"en in the +est o# times Greece cannot #unction as a de"e!oped' modern economy without he#ty and re(u!ar in*ections o# su+sidized capita! #rom a+road$ =This is primari!y why Greece did not exist +etween the @th century )$C$ and the %&th century and is the main reason why the European Commission recommended a(ainst startin( accession ta! s with Greece in the %&A4s$> A#ter Greece5s modern re8creation in the ear!y %B44s' those in*ections came #rom the 1nited Cin(dom' which used the new!y independent Gree state as a #oi! a(ainst #a!terin( Ottoman Tur ey$ 9urin( the Co!d 0ar the 1nited States was the externa! sponsor' wantin( to eep the So"iets out o# the 7editerranean$ 7ore recent!y Greece used its E1 mem+ership to a+sor+ de"e!opment #unds' and in the D444s its eurozone mem+ership a!!owed it to +orrow hu(e "o!umes o# capita! at we!! +e!ow mar et rates$ 1nsurprisin(!y' durin( most o# this period Greece +oasted the hi(hest (ross domestic product =G9<> (rowth rates in the eurozone$

Those days ha"e ended$ :o one has a (eopo!itica! need #or a!!iance with Greece at present' and e"o!utions in the eurozone ha"e put an end to cheap euro8denominated credit$ Thus Greece has #ew capita! (eneration possi+i!ities and a de+t approachin( %34 percent o# G9<$ Add in +an o"erindu!(ences and the num+er c!im+s #urther$ This de+t is we!! +eyond the a+i!ity o# Gree state and society to pay$ ?uc i!y #or the Germans' Greece is not a potentia! threat$ 2t is disposa+!e$ And i# the eurozone is (oin( to +e sa"ed' it needs to +e disposed o#$ This cannot' howe"er' +e done c!ean!y$ Greece has more than -34 +i!!ion euros in outstandin( (o"ernment de+t' o# which rou(h!y A3 percent is he!d outside o# Greece$ 0ere Greece cut o## #inancia!!y and e*ected #rom the eurozone' it must +e assumed that Athens wou!d Euic !y 88 perhaps e"en immediate!y 88 de#au!t on its de+ts' particu!ar!y the #orei(n8he!d portions$ The nature o# the ,European +an in( system http://www$strat#or$com/ana!ysis/D4%44F-4GeuropeGstateG+an in(Gsystem. means this wou!d cripp!e Europe$ European +an s are not !i e 1$S$ +an s$ 0hereas the 1nited States' #inancia! system is a sin(!e uni#ied networ ' ,the European +an in( system is seEuestered +y nationa!ity http://www$strat#or$com/ana!ysis/D4%%4A4F8port#o!io8european8and8us8+an in(8 systems.$ And whereas the (enera! dearth o# direct' constant threats to the 1nited States has resu!ted in a #air!y hands8o## approach to the industry' the crowded competition in Europe has o#ten !ed states to use their +an s as too!s o# po!icy$ Each mode! has +ene#its and draw+ac s' +ut in the current eurozone #inancia! crisis the structure o# the European system has three critica! imp!ications$ First' +ecause +an s are re(u!ar!y used to achie"e nationa! and pu+!ic 88 as opposed to economic and pri"ate 88 (oa!s' +an s are o#ten encoura(ed or #orced to in"est in ways that they otherwise wou!d not$ For examp!e' durin( the ear!y months o# the eurozone crisis' eurozone (o"ernments pressured their +an s to purchase prodi(ious "o!umes o# Gree (o"ernment de+t' thin in( that such demand wou!d +e su##icient to sta"e o## a crisis$ 2n another examp!e' in order to ma e Spanish society more uni#ied' 7adrid #orced Spanish +an s to treat some % mi!!ion recent!y natura!ized citizens as ha"in( prime credit despite their utter !ac o# credit history' direct!y contri+utin( to Spain5s current rea! estate and constriction crisis$ ConseEuent!y' European +an s ha"e su##ered more #rom credit +in(es' carry tradin( and toxic assets =whether 1$S$ or ,home8(rown su+prime http://www$strat#or$com/ana!ysis/D44B%%%%GeuGcomin(Ghousin(Gmar etGcrisis.> than their counterparts in the 1nited States$ Second' +an s are #ar more important to (rowth and sta+i!ity in Europe than they are in the 1nited States$ )an s 88 as opposed to stoc mar ets in which #orei(ners participate 88 are seen as the trusted supporters o# the nationa! systems$ As such they are the !i#e+!ood o# the European economies' on a"era(e supp!yin( more than A4 percent o# #undin( needs #or consumers and corporations =#or the 1nited States the #i(ure is !ess than @4 percent>$

Third and most important!y' this critica!ity and po!iticization means that in Europe a so"erei(n de+t crisis immediate!y +ecomes a +an in( crisis and a +an in( crisis immediate!y +ecomes a so"erei(n de+t crisis$ ,2re!and is a case in point http://www$strat#or$com/ana!ysis/D4%4%%-4Gire!andsG!on(GroadG+ac GeconomicGhea!th. $ 2rish state de+t was actua!!y extreme!y !ow (oin( into the D44B #inancia! crisis' +ut the +an s5 o"erindu!(ence !e#t the 2rish (o"ernment with !itt!e choice +ut to !aunch a +an +ai!out 88 the cost o# which in turn reEuired 9u+!in to see a eurozone rescue pac a(e$ And since European +an s are deep!y enmeshed into each others5 +usiness "ia a we+ o# cross8stoc and +ond ho!din(s and the inter+an mar et' trou+!e in one country5s +an in( sector Euic !y !eads to cross8+order conta(ion in +oth +an s and so"erei(ns$ The DB4 +i!!ion euros in Gree so"erei(n de+t he!d outside the country is most!y he!d within the +an in( sectors o# <ortu(a!' 2re!and' Spain and 2ta!y 88 a!! o# whose state and pri"ate +an in( sectors a!ready #ace considera+!e strain$ A Gree de#au!t wou!d Euic !y cascade into +an #ai!ures across these states that wou!d +e uncontaina+!e =German and particu!ar!y French +an s are hea"i!y exposed to Spain and 2ta!y>$ E"en this scenario is somewhat optimistic' since it assumes a Gree eurozone e*ection wou!d not dama(e the 344 +i!!ion euros in assets he!d +y the Gree +an in( sector =which is o# course the sin(!e !ar(est ho!der o# Gree (o"ernment de+t>$ ,h-.7a in( Europe 0or 0ithout Greece,/h-. The tric is to ma e a #ire+rea around Greece so that its #ai!ure wi!! not co!!apse the European #inancia! and monetary structure$ SeEuesterin( a!! #orei(n8he!d Gree so"erei(n de+t wou!d cost a+out DB4 +i!!ion euros' +ut there is more exposure than simp!y that o# (o"ernment +onds$ Greece has +een in the European 1nion since %&B%$ 2ts companies and +an s are inte(rated into the European who!e' and since *oinin( the eurozone in D44% that inte(ration has +een denominated who!!y in euros$ 0hen Greece is e*ected that wi!! a!! unwind$ Add the cost o# miti(atin( that unwindin( to the so"erei(n de+t stac and 88 conser"ati"e!y 88 the cost o# a Gree #ire+rea rises to @44 +i!!ion euros$ That' howe"er' on!y dea!s with the immediate crisis o# the Gree de#au!t and e*ection$ The !on(8term unwindin( o# Europe5s economic and #inancia! inte(ration with Greece =there wi!! +e #ew Gree +an s wi!!in( to !end to European entities' and #ewer European entities wi!!in( to !end to Greece> wi!! tri((er a series o# on(oin( #inancia! mini8crises$ Additiona!!y' the e*ection o# a eurozone mem+er state 88 e"en one such as Greece' which !ied a+out its statistics in order to Eua!i#y #or eurozone mem+ership 88 is sure to ratt!e European mar ets to the core$ 2n Au(ust' 2nternationa! 7onetary Fund =27F> chie# Christine ?a(arde recommended an immediate D44 +i!!ion euro e##ort to recapita!ize European +an s so that they cou!d +etter dea! with the next phase o# the European crisis$ 0hi!e o##icia!s across the E1 immediate!y decried her ad"ice' ?a(arde is in a position to now: 1nti! Hu!y 3' she was France's #inance minister =:ot sure what her position as French Fin7in has to do with it>$ ?a(arde5s D44 +i!!ion euro #i(ure assumes that the recapita!ization occurs +e#ore any

de#au!ts and +e#ore any mar et panic$ 1nder such circumstances prices tend to +a!!oon6 usin( the D44B American #inancia! crisis as a (uide' the cost o# recapita!ization durin( an actua! panic wou!d pro+a+!y +e in the ran(e o# B44 +i!!ion euro$ 2t must a!so +e assumed that the mar ets wi!! not on!y +e e"a!uatin( the +an s$ Go"ernments wi!! come under harsher scrutiny as we!!$ :umerous eurozone states !oo !ess than hea!thy' +ut 2ta!y rises to the top as concerns hi(h de+t =(ross percent o# G9<> and !ac o# po!itica! wi!! to tac !e it$ 2ta!y5s outstandin( (o"ernment de+t is approximate!y %$& tri!!ion euros$ The #ormu!a the Europeans ha"e used to date to determine +ai!out "o!umes has assumed that it wou!d +e necessary to co"er a!! expected +ond issuances #or three years$ For 2ta!y' that comes out to a+out A44 +i!!ion euros usin( o##icia! 2ta!ian (o"ernment statistics =and c!oser to &44 +i!!ion usin( third8party estimates>$ =2t's ind o# hard #or me to understand where this para(raph comes #rom 88 2'm assumin( we're sayin( that i# Greece were e*ected' 2ta!y wou!d co!!apse in the ensuin( panicI> A!! to!d' STRATFOR estimates that a +ai!out #und that can mana(e the #a!!out #rom a Gree e*ection wou!d need to +e rou(h!y D tri!!ion euros$ ,h-.Raisin( D Tri!!ion Euros,/h-. The European 1nion a!ready has a +ai!out mechanism' the European Financia! Sta+i!ity Faci!ity =EFSF>' so the Europeans are not startin( #rom scratch$ Additiona!!y' the Europeans wou!d not ha"e to ha"e D tri!!ion euros a"ai!a+!e the day Greece is e*ected6 e"en in the worst8case scenario 2ta!y wou!d not crash within D@ hours =and e"en i# it did' it wou!d need &44 +i!!ion euros o"er three years' not a!! in one day>$ 2# Greece were e*ected #rom the eurozone' on that day Europe wou!d need pro+a+!y a+out A44 +i!!ion euros =@44 +i!!ion to com+at Gree conta(ion and another -44 +i!!ion #or the +an s>$ The 27F cou!d pro"ide at !east some o# that' thou(h pro+a+!y no more than %34 +i!!ion euros$ The rest comes #rom the pri"ate +ond mar et$ The EFSF is not a traditiona! +ai!out #und that ho!ds masses o# cash and acti"e!y restructures entities it assists$ 2nstead it is a trans#er #aci!ity: 2t has (uarantees #rom the eurozone mem+er states to +ac a certain "o!ume o# de+t issuance$ 2t then uses those (uarantees to raise money on the +ond mar et' su+seEuent!y passin( those #unds a!on( to +ai!out tar(ets$ To prepare #or Greece's e*ection' two chan(es must +e made to the EFSF$ First' there are some !e(a! issues to reso!"e$ 2n its ori(ina! incarnation #rom D4%4' the EFSF cou!d on!y carry out state +ai!outs and it cou!d on!y do so a#ter European institutions appro"ed them$ This resu!ted in !en(thy de+ates a+out the merits o# +ai!out candidates' pu+!ic airin(s o# disa(reements amon( eurozone states and more mar et an(st than was necessary$ A Hu!y DD eurozone summit stren(thened the EFSF' stream!inin( the appro"a! process' !owerin( the interest rates o# the +ai!out !oans and' most important!y' a!!owin( the EFSF to en(a(e in +an +ai!outs$ These impro"ements ha"e a!! +een a(reed to' +ut they must +e rati#ied to ta e e##ect' and rati#ication #aces two o+stac!es$

,Germany's (o"ernin( coa!ition is not united on whether German resources 88 e"en i# !imited to state (uarantees 88 shou!d +e made a"ai!a+!e to +ai! out other E1 states http://www$strat#or$com/ana!ysis/D4%%4&4D8a(enda8(ermany8prepares8crucia!8+ai!out8 "ote.$ The #ina! "ote in the )undesta( is supposed to occur Sept$ D&$ 0hi!e STRATFOR #inds it hi(h!y un!i e!y that this "ote wi!! #ai!' the #act that a de+ate is e"en occurrin( is #ar more than a worryin( #ootnote$ A#ter a!!' the German (o"ernment wrote +oth the ori(ina! EFSF a(reement and its Hu!y DD addendum$ The other sna( re(ards sma!!er' so!"ent' eurozone states that are concerned a+out states5 a+i!ity to repay any +ai!out #unds$ ?ed +y Fin!and and supported +y the :ether!ands' these states are demandin( ,co!!atera! http://www$strat#or$com/ana!ysis/D4%%4B%&8 o+*ections8(ree 8+ai!out8create8pro+!ems8e#s#. #or any (uarantees$ STRATFOR +e!ie"es +oth o# these issues are so!"a+!e$ Shou!d the Free 9emocrats 88 the *unior coa!ition partner in the German (o"ernment 88 "ote down the EFSF chan(es' they si(n their party5s death warrant$ At present the Free 9emocrats are so unpopu!ar that they mi(ht not e"en ma e it into par!iament in new e!ections$ And whi!e Germany wou!d pre#er that Fin!and pro"e more p!ia+!e' the co!!atera! issue wi!! at most reEuire a s!i(ht!y !ar(er German #inancia! commitment to the +ai!out pro(ram$ The second EFSF pro+!em is its size$ The current #aci!ity has on!y @@4 +i!!ion euros 88 a #ar cry #rom the D tri!!ion euros reEuired to hand!e a Gree e*ection$ 0hich means that once e"eryone rati#ies the Hu!y DD a(reement' the %A eurozone states ha"e to (et to(ether =a(ain> and modi#y the EFSF =a(ain> to Euintup!e the size o# its #und8raisin( capacity$ Anythin( !ess ends with 88 at a minimum 88 the !ar(est +an in( crisis in European history and most !i e!y the euro5s disso!ution$ )ut e"en this is #ar #rom certain' as numerous e"ents cou!d (o wron( +e#ore a Gree e*ection: ,u!.,!i.Su##icient states 88 up to and inc!udin( Germany 88 cou!d +a! at the potentia! cost to pre"ent the EFSF's expansion$ 2ts easy to see why: 2ncreasin( the EFSF to D tri!!ion euros represents a potentia! increase o# each contri+utin( state5s tota! de+t !oad +y D3 o# G9<' a num+er that wi!! rise to -4 o# G9< shou!d 2ta!y need a rescue =states recei"in( +ai!outs are remo"ed #rom the #undin( !ist #or the EFSF>$ That wou!d push the nationa! de+ts o# Germany and France 88 the eurozone hea"ywei(hts 88 to near!y %%4 percent o# G9<' in re!ati"e size more than e"en the 1nited States5 current +!oated "o!ume$ The comp!ications o# a(reein( to this at the intra8(o"ernmenta! !e"e!' much !ess se!!in( it to s eptica! and +ai!out8weary par!iaments and pu+!ics' cannot +e o"erstated$ ,/!i. ,!i.2# Gree authorities rea!ize that Greece wi!! +e e*ected #rom the eurozone anyway' they cou!d preempti"e!y !ea"e the eurozone' de#au!t or +oth$ That wou!d tri((er an immediate so"erei(n and +an in( me!tdown +e#ore the remediation system cou!d +e esta+!ished$ ,/!i. ,!i.An unexpected (o"ernment #ai!ure cou!d premature!y tri((er a (enera! European de+t me!tdown$ There are two !eadin( candidates$ 2ta!y' with a nationa! de+t o# %D4 percent G9<' has the hi(hest nationa! de+t in the eurozone outside Greece' and since <rime 7inister Si!"io )er!usconi has consistent!y (utted his own ru!in( coa!ition o#

potentia! successors his po!itica! !e(acy appears to +e comin( to an end$ <rosecutors ha"e +ecome so em+o!dened that now )er!usconi is schedu!in( meetin(s with top E1 o##icia!s to dod(e them$ )e!(ium is a!so hi(h on the dan(er !ist$ )e!(ium has not had a (o"ernment #or %A months' and its ,careta er prime minister announced his intention to Euit his *o+ Sept$ %- http://www$strat#or$com/ana!ysis/D4%%4&%@8trou+!ed8+e!(ium8 threatens8eurozone8sta+i!ity.$ 2t is hard to imp!ement austerity 88 much !ess ne(otiate a +ai!out pac a(e 88 without a (o"ernment$ ,/!i. ,!i.The European +an in( system 88 a!ready the most dama(ed in the de"e!oped wor!d 88 cou!d pro"e to +e in #ar worse shape than is a!ready +e!ie"ed$ A care!ess word #rom a (o"ernment o##icia!' a misp!aced austerity cut or an in"estor scare cou!d tri((er a cascade o# +an co!!apses$,/!i. ,/u!. E"en i# Europe is a+!e to a"oid these pit#a!!s' none o# this so!"es the eurozone's structura!' #inancia! or or(anizationa! pro+!ems$ This p!an mere!y patches up the current crisis #or a coup!e o# years$ The next cha!!en(e wi!! +e a German e##ort to (et a!! the eurozone states to inc!ude de+t !imitations and German8run +ai!out pro"isions in their constitutions$