Germany’s handling of the Euro crisis has been anything but stellar. It all begins in October 2009, when the newly elected Greek government reveals the 2009 budget deficit to be 12.5% of GDP, far above the 3.7% predicted only 5 months earlier. Markets barely notice. On December 8, rating agency Fitch strips Greece off its A-rating. The 10-year Greek government bond yield, at 5% – nothing compared to the high drama unfolding a few months later.

In January of 2010 the IMF sends a “technical mission” to Athens to advise on tax collection and budgetary controls, while an embarrassed European Commission condemns Greece for falsifying data on its public finances.

The 10-year yield rises to 5.5%. Greece duly unveils a plan to cut its budget deficit from 12.7% to 2.8% of GDP by the end of 2012. The first bond auction of the year (January 25th) goes reasonably well, with orders of EUR 20bn for the 5 year paper, four times the amount issued. But it comes at a price – the 10-year yield rises above 6%.

However, towards the end of January, yields reach almost 7% after rumors China was not interested in buying Greek government debt.

On February 11, Euro-zone leaders promise financial help if Greece cuts its budget deficit. Yields fall back to 6%. On February 25, S&P and Moody’s warn of possible rating downgrades by two notches. Undeterred, investors pile into a EUR 5bn 10-year bond offering, with a bid-to-cover ratio of 3, hungrily mopping up yields of 6%.

Mrs. Merkel, facing important local elections in North Rhine-Westphalia on May 9th, shows little appetite in actually sending taxpayer’s money towards Greece, since this would be highly unpopular in Germany, and possibly be challenged by the Constitutional Court in Karlsruhe.

The game of words continues. Greece has the backing of Euro-zone countries, that, in case of need, there would be help coming. Greece has not officially asked for help, so no need to do so.

Bond markets are not impressed. The crisis does not go away, and threatens to infect other countries. Finally, on April 12, Euro-zone countries commit to provide EUR 30bn in 3-year loans to Greece. The IMF chips in an additional 15bn. Interest rates are rumored to be around five per cent. Of course, the Greek Finance Minister makes clear Greece has not yet asked for any money.

Greek government bond yield continue to rise and reach 8.65%. On April 23, Greece officially asks for activation of financial help. Euro-zone countries promise to decide at a meeting on May 10. Help is on the way – but so are German elections. Despite multiple promises for help, Greece is left hanging. On  April 27, S&P downgrades Greece to “junk”; the 10 year bond yield reaches 9.5%. Suddenly, German and French banks are at risk of losing billions of Euros. The next  day, markets are ablaze with rumors; Greece might need EUR 100-120bn over the next 3 years instead of 45bn. The 10 year reaches 12.5%, a level Greece had to pay before joining  the Euro.

May 2, one week to go until German election. The crisis is out of control. EU finance ministers approve EUR 110bn emergency loans (thereof 30bn from the IMF). Even if everything goes according to plan, Greece’s  debt-to-GDP ratio is expected to reach 150%. Assuming a (very benign) interest rate of 5%, Greece will have to pay 7.5% of GDP annually. With 75% of debt owned by foreign institutions most of that interest will leave the country.

On May 3 the ECB suspends its minimum rating requirements for collateral since otherwise Greek banks would be forced to buy back Greek government bonds, possibly taking down the Greek banking system.

On May 6, the Down Jones Industrials Index suffers a 1,000-point intra-day drop as three people are killed in an Athens bank after protestors set it on fire. The Greek 10-year trades above 12%.

Sunday, May 9. Europe’s finance ministers meet in Brussels to negotiate a last-minute attempt to save the Euro. Where is the German chancellor? She flies to Moscow to celebrate V-day with Putin; born in East Germany she is fluent in Russian. Sarkozy and Berlusconi cancel their participation out of concern for the Euro crisis.

Meanwhile, German finance minister Schaeuble is hospitalized with an “adverse reaction to a new prescription”. Interior minister De Maiziere has to be flown in. The meeting of finance ministers can resume only at 8:30pm. As Asian markets open at midnight, a press release should be ready by then. But discussions drags on. The French want the ECB to support free-falling Euro-zone government bonds. Their idea is to create a stabilization fund financed by collective EU commission bonds. For approval of such measures a majority vote should suffice. Germany wants to preserve the independence of the ECB, no common EU bonds, unanimous approval, any rescue fund to be temporary and involvement of the IMF.

Finally, at 3am, “shock-and-awe”: a EUR 750bn rescue package (on top of 110bn for Greece). 440bn government-backed loan guarantees and bilateral loans, 60bn expansion of existing payments facility, 250bn from IMF. The ECB steps into the market and buys more than EUR 60bn of government bonds – a hard-to-swallow pill for the inflation-averse Germans.

Greek 10-year yields recede to 7.5%, and the bond-buying tapers off by early July. Going forward, the ECB only steps in with token amounts on days where yields spike up massively.

So far, no country has asked the European Financial Stability Fund (EFSF) for help. With 10-year yields at roughly 9%, Ireland would be a candidate to trigger help. But is seems that the EUR 750bn fund was never meant to be used. Like earlier promises, a fata morgana (mirage) seen by a thirsty desert hiker, only to turn into sand once he reaches the assumed oasis.

The EFSF is a Luxembourg-based bank, administered by the German debt management office and run by a German (Klaus Regling). When called upon, the EFSF will have to issue bonds in its own name. Guaranteed by individual Euro-zone countries and 20% over-funded the bonds will carry AAA-ratings. But the loans will not come cheap: swap rates plus 3%-points (4% for maturities of more than 3 years) plus a 0.5% one-time service fee. This, apart from unavoidable humiliation, will deter countries from accessing the EFSF’s help.

Having lived through a terrible hyper-inflation in the 1920’s Germans have a natural aversion to anything akin to tinkering with monetary stability. Bailing out entire countries goes against the treaty of Maastricht, and does not make for happy voters domestically. Hence Mrs. Merkel’s recent coup: in exchange for giving up automatic sanctions for deficit sinners France agreed to replacing the EFSF in 2013 by a “resolution mechanism” including the possibility of default. She explicitly warned bond holders to be prepared to suffer losses. Suddenly, investors who had banked on “moral hazard” and hoped to earn high yields without the risk of default had a rude awakening. Countries will be allowed to go bankrupt!

This of course was a game changer, and recent developments in Irish and, to a lesser extent, Portuguese government bonds mirror the panic in the days before the May 10-bailout announcement.

It is disheartening to look back on 12 months of Euro crisis: first ignorance, followed by complacency, denial, dithering, then – finally – sheer panic. Half-baked solutions, which, in case of Greece, are mathematically impossible to work.

Rising unit labor costs, trade and budget deficits as well as insolvent banking systems have lead to unsustainable situations for many countries of the Euro zone. More debt will merely postpone the inevitable.

So far politicians have resisted the possibility of Euro member defaulting on their debt, partially out of fear for their own banks (holding large amounts of foreign government debt). It seems this valve has now been opened.

A government default will reduce debt and interest burden, but provide no relief in terms of trade imbalances and competitiveness. Only an exit from the Euro zone would help. But it seems that the latter option is politically not acceptable yet. That is unfortunate. An exit from the Euro zone would provide a fresh start. Iceland’s trade balance has turned positive while unemployment has declined to below 8%.

A Euro exit usually means default, since the economy (measured in a new, weaker, currency) cannot support the existing debt (remains denominated in Euro) as the debt service costs in local currency increases.

If a country defaults anyway, it might as well exit the Euro. The punishment by the bond market will be similar, but the rewards for the economy will be greater.

The Euro was supposed to be the crowning moment of European unity – and now becomes the wedge prying everything apart.