ABOUT two months ago, we wrote a commentary headlined "Five scenarios for EMU denouement". The subtitles were "Greeks will leave, but only after a fight" and "Don’t presume that the Germans will always give in".
In the rapidly evolving euro crisis, this analysis still stands. Below, we review the five scenarios, with an updated commentary.
Forecasts that European Monetary Union (EMU) will survive and prosper, or at least muddle through, depend on the assumption that, as the crisis deteriorates, Germany will relent on previous hardline undertakings, decide an all-encompassing bail-out and forestall a breakup.
However, German creditor fatigue has accelerated and the idea that Germany can always be relied on to save the euro no longer holds. The financial markets got carried away by expectations that the Germans would agree to major European Central Bank (ECB) bond purchases at last Thursday’s ECB council meeting.
As the crisis worsens, the costs for Germany of a rescue will exceed the costs of breakup. Policy makers and investors face a wide combination of permutations. We outline our five possible scenarios for the coming months, with appropriate updating.
One: Greece says Yes to the euro, but leaves after a protracted legal and political wrangle — still likely.
This was based on New Democracy winning the election, as did indeed happen. But although, in theory, the Greeks voted for euro membership with the accompanying pain of structural reform, they have tried to change the rules and sought easier terms since the election.
However, it is clear from the general debate that — whatever is done with other countries — Greece is now the sacrificial lamb, the country to be sacrificed to encourage others.
In the collision between a Greek desire for easier terms and an absolute German refusal to consider it, Grexit (a Greek exit) is still on the agenda, perhaps in the next few weeks, as Greece runs out of money and the Germans push the ECB to cut off the Bank of Greece’s emergency lending support for Greek banks. Greece could be suspended in a half-in, half-out limbo, introducing exchange controls and a dual currency for domestic (drachma) and foreign (euro) payments, before implementing the decision to leave.
Two: Greece makes a clean exit, leading to further pressure on the periphery — and potential EMU unravelling — overtaken by events.
This was based on a victory by Alexis Tsipras and his Syriza party and had thus been overtaken by events. Moreover, it seemed beliefs that secret working parties had been drawing up guidelines for a clean Greek exit were exaggerated.
Three: Greece remains in EMU after concessions from Germany.
This is now extremely unlikely, partly because of the hardening of German attitudes towards the periphery in general and Greece in particular. But also because these attitudes are spreading elsewhere, including to France. Recent surveys show French voters-taxpayers increasingly unwilling to fund Greece remaining in the euro. This can only strengthen German reluctance to countenance any easing of terms for the country widely seen to have lied its way into the euro and precipitated the crisis in 2010.
Four: Greece remains in the EMU with no change in policies — just about possible.
This scenario is still possible, but only assuming what our original commentary referred to as a heroic combination of positive circumstances. With euro-area growth weakening, this is looking less likely, but it could ensue as the result of signs of a progressive rebalancing of the pan-European economy, as current account deficits improve in the peripheral countries and Germany’s economy remains robust.
The difficulty with such prognoses is that they rely on far more time given for adjustment of Europe’s imbalanced economies than is likely to be available from sceptical financial markets.
Five: Germany and others leave EMU — less unlikely.
This scenario was based on anti-euro opposition gaining ground in Germany, support for the fiscal pact and other EMU remedies ebbing away in the German parliament — and Germany (probably accompanied by other creditor countries such as the Netherlands, Finland and Austria) leaving the euro and possibly inaugurating a new currency grouping.
This development is indeed what we have seen in Germany, with employers groups joining trade unions in opposition to further bail-outs.
Meanwhile, the Bundesbank is fighting an increasingly lonely rearguard action against an ECB and eurozone governments seemingly determined to press on with the "European project". But in this case it is the central bankers who are speaking for the people.
Nobody thinks that a German exit could solve Europe’s challenges — but a development that only a short while ago seemed fairly unlikely, is no longer so far-fetched.
A Grexit is likely, but Gexit is now a real possibility, too.
• David Marsh and Gabriel Stein write on behalf of the Official Monetary and Financial Institutions Forum
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