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Germany may have just put the nail in Greece’s Euro zone coffin

February 19, 2015, 7:30 PM UTC

Germany’s rejection of Greece’s wilted olive branch on Thursday may mean that the Grexit—Greece’s exit from the Eurozone—is now inevitable.

German and European Central Bank officials have grown increasingly obstinate in recent months, showing little sympathy for Greece’s appeals for leniency connected with its bailout agreement. It is unclear what the fallout would be if Greece were to impose capital controls and leave the euro, but it seems that Germany and the ECB just don’t care anymore.

Greece’s new left-wing government blinked on Thursday morning in its month-long standoff with its eurozone partners, saying that it would agree to a six-month extension of the expiring bailout agreement at its current terms so that the two sides could have more time to negotiate. It was a typical “kick the can down the road” move we have come to expect from EU officials, something that Greece’s new government promised it wouldn’t do just a couple days earlier.

The markets rallied on the news, with Greek bank stocks shooting up 10% and Greek 10-year bonds yields falling back to the single digits. The so-called “radical” Greek government finally fell in line with the status quo, and that itself was enough for the market to chill out and hobble onward.

But in a shocking turn of events, Germany’s finance ministry rejected the Greek proposal, saying that it amounted to a bridge financing deal that didn’t propose any “substantial” solutions to the problem at hand.

So, what has changed? Did Germany truly expect a real solution to this issue? Or was the finance ministry just pretending to play hardball to save face with the German public? This wouldn’t be the first time for Germany to claim it was calling Greece’s bluff and then fall apart at the end of the day. It has happened pretty much every time Germany has negotiated a bailout deal since the eurozone debt crisis began in 2009.

But this time could be different. A report in German newspaper Frankfurter Allgemeine Zeitung quotes an unnamed central banker from the ECB who believes that the Grexit may now be inevitable. “One gets the impression that the Greeks want to get out [of the euro] and are just looking for a scapegoat,” at this point, the unnamed central banker told the paper.

This comes a couple weeks after the ECB abruptly stopped taking Greek sovereign bonds from Greek banks as collateral for low-cost loans to fund their operations. The ECB had been loaning the banks money and accepting the junk Greek debt at face value even though it was worth a fraction of that amount in the real world, something that, naturally, angered Germany.

The ECB pulled this cheap financing as Greeks were pulling money out of the their banks amid growing fear of a Grexit, when the Greek banks needed the money the most. The Greek banks were forced to turn to their own central bank for cash, which also borrows from the ECB, but at a higher interest rate.

All this has accelerated the run on the Greek banks, forcing the Greek Central Bank to borrow at a frenetic pace from the ECB to make sure they have enough cash on hand to meet demand. But there is a limit to how much the Greek Central Bank can borrow from the ECB, 65 billion euros, and it appears that they just hit the ceiling. The Greeks reportedly asked the ECB to increase their line of credit by 10 billion euros, but the ECB agreed in an emergency meeting overnight that it would only increase it by 3 billion euros.

The ECB knows very well that money buys the Greek banks a week, two weeks tops. The Greek banks won’t need the money if the panic stops, but that won’t happen unless Germany relents and agrees to Greece’s demand for leniency. With Germany saying Nein today just to extend talks without granting any concessions, it is now clear that the whole situation may actually blow up this time.

Greece will then have to make a tough choice. They will either need to accept total defeat and continue on with the terms of the bailout agreement, which would probably result in a Greek default in a few months time, or they can institute capital controls (which would restrict people’s ability to withdraw cash), default on the bailout now, and leave the euro.

Will the Grexit cause the euro to fall apart? Mario Draghi, the head of the ECB, famously promised that he would do “whatever it takes ” to save the euro, so a Grexit may not automatically mean the end of the currency union. He has been preparing for years to counter the backlash that would follow a Grexit, most recently by announcing a multi-billion euro quantitative easing program that could stabilize the bond yields of EU countries if they explode post-Grexit. Will it be enough? No one knows for sure.

For Greece, neither of its option seems acceptable at this point. For some reason, Greeks overwhelmingly want to stay in the euro, which is why the Greek government swallowed its pride and agreed to kick the can down the road. Jeroen Dijsselbloem, the current head of the Euro group negotiations with Greece, called for a fourth “extraordinary” meeting tomorrow of finance ministers to discuss the Greek plan. While Dijsselbloem is somewhat hopeful that a deal can be struck—he said at the last meeting that he wouldn’t call another unless he thought a deal was close—it will be impossible to strike an agreement without German backing, meaning a Grexit could be just around the corner.