Insight - 'Grexit' struggle tests Germany's power duo

By Noah Barkin BERLIN (Reuters) - On July 17th, her 61st birthday, Angela Merkel stepped to the podium in the Bundestag and urged German lawmakers to approve a new round of bailout negotiations with Greece, warning of "chaos and violence" if Athens were pushed out of the euro zone. The chancellor had worked tirelessly to negotiate the blueprint of a deal with Greek Prime Minister Alexis Tsipras, forcing him to make major reform concessions at a marathon summit in Brussels days earlier. On the face of it, the deal looked like a victory for Merkel. Yet the only enthusiastic applause she heard during her 18-minute speech came halfway through when she paused to thank her finance minister, Wolfgang Schaeuble, for his role in the talks. The ovation from conservative parliamentarians thundered through the glass-domed chamber for nearly a full minute. Schaeuble, sitting on the coalition benches to the right of Merkel, stared straight ahead with a frown on his face. The scene was telling. Schaeuble had made it abundantly clear over the previous week that his preferred solution was the very one Merkel had worked so hard to prevent -- namely a Greek exit from the single currency bloc. By applauding Schaeuble, lawmakers were sending a message to Merkel: their appetite to help Greece had reached its limits. Schaeuble's frown was a signal that he was less than pleased with the outcome he was forced to defend in parliament. The Bundestag gave a green light for the talks, but 65 of Merkel's conservative allies broke ranks and refused to back her. Over the past five years, as the euro zone crisis raged, ebbed and then raged again, Merkel has shown herself to be a master of political acrobatics. Time and again she has struck a delicate balance between European and German interests, ensuring the fragile currency bloc was held together with a series of rescues while keeping on board an ever-more sceptical home audience. In the past week, Merkel came closer than ever to falling off her tightrope. And the unfinished drama over a third Greek bailout, with Schaeuble in the starring role, suggests her real troubles may have only just begun. "Until now Merkel and Schaeuble were seen as a good cop, bad cop act that worked together to get the most favourable deal for Germany," said a senior official who has worked closely with both. "But that was always premised on the idea that they had the same goal. This time on Greece they didn't. We got the result that the bad cop didn't want." Schaeuble may not have got his "Grexit", but the 72-year-old doyen of German politics, has emerged strengthened and unbowed. If Greece slips again, his Plan B is on the table. TEMPORARY EXIT? Gruff and irascible, Schaeuble is the longest-serving member of the German parliament. He led the negotiations on German reunification in 1990 only to be shot and crippled by a deranged man a week after the merger of East and West was completed. He has soldiered on in a wheelchair ever since, driven by a passion for politics and for European integration. In recent weeks he has surged past Merkel in popularity polls and solidified his cult status in the conservative wing of her Christian Democratic Union (CDU). Some German media are calling Schaeuble the "shadow chancellor". Merkel looks more vulnerable than at perhaps any time in her 10-year reign. She is more dependent on Schaeuble than ever to hold the party together. At the same time, the past weeks have shown that she has very little control over her minister. Days after Merkel clinched the deal with Tsipras in Brussels and before the crucial vote in the German parliament, Schaeuble told German radio that a temporary exit of Greece from the euro zone might still be the best solution. After the vote he issued a thinly-veiled threat to Merkel, telling Der Spiegel magazine that he would sooner resign than carry out policies he did not believe in. "On a tactical level, Schaeuble has won out over Merkel – 100 percent," said Gero Neugebauer, a political scientist at Berlin's Free University. "She has a wait-and-see approach, breaking down complicated issues into smaller problems that are tackled step by step. Schaeuble is just pressing ahead. He has the advantage because he is acting, not hesitating." People in Merkel's entourage play down the differences and the risks of Schaeuble undermining the chancellor on Greece, noting that he has always been a difficult but loyal partner. "She knows that he likes to play games, to send out the signal that he's free and independent," one aide said. "There would come a point if he pushed it too far, if he kept saying in public that Grexit was a good option, that she might have to intervene. But we're not there yet." Still, Schaeuble's stance raises uncomfortable questions for Merkel, who has talked tough in public, but shown a preference for compromise with Greece behind closed doors in Brussels, according to people who have witnessed her at recent summits. Can Schaeuble be counted on to negotiate in good faith with the Greeks on a third bailout? And will he be ready to swallow his pride and back her again in parliament when German lawmakers are asked to approve a final deal, next month or in September? TANGLED HISTORY To answer these questions it's important to understand the tangled history between Merkel and Schaeuble, who have known each other for a quarter century and been cabinet colleagues for a decade -- but still address each other with the formal "Sie". Both were proteges of Helmut Kohl, Germany's longest-serving post-war leader, but it was Schaeuble, not Merkel, who was long seen as heir apparent. He might have become chancellor himself had Kohl not decided to run for an unprecedented fifth term in 1998 instead of passing the baton to his loyal number two. Kohl lost and Schaeuble became head of the CDU, with Merkel as his deputy. A little over a year later he was forced out when he stumbled over a party funding scandal centred on Kohl. Merkel had an indirect role in his fall and years later, having taken his place atop the party, refused to support his bid to become German president. "It's wrong to think that between Schaeuble and Merkel there is a friendship," Schaeuble biographer Hans-Peter Schuetz said. "He can't forget that she outmanoeuvred him in the battle for the CDU nor her behaviour when he was a candidate for the presidency." One senior German official who has witnessed the two over the years and described their relationship as "the most complex" in Berlin, went further. "If he could kill her politically without leaving his fingerprints on the gun, he would do it," the official said. But others close to Merkel and Schaeuble believe he will remain loyal to the last, "You can't just see the negative," the aide said, noting that Merkel had supported Schaeuble when he had serious health problems in 2010, giving him time off to recover when he was prepared to resign. "Over the course of their political lives the two haven't always done each other favours. But the good and the bad balance out. They've been through a lot and know they can rely on each other." The differences over Greece are not the first between the two since the euro crisis erupted. Back in 2010, Schaeuble was dead-set against giving the International Monetary Fund (IMF) a role in euro zone bailouts and was overruled by Merkel. He now acknowledges that she was right to involve the global lender. But the "Grexit" conflict is potentially far more explosive. HIGH RISK Like Schaeuble, Merkel does not believe Athens should be kept in the euro zone at any price. Her aides signed off on a controversial finance ministry paper Schaeuble took to the crucial Brussels summit which raised the idea of a five-year euro zone "time-out" for Greece. So she is prepared to go down that route as a last resort. But for the chancellor, the risks associated with a Grexit -- for Europe and her own reputation -- are high. A Greek exit could spark a humanitarian crisis on Europe's southern rim, for which Merkel could be blamed. Her aides acknowledge it might also lead to a damaging clash with France, which has taken a more conciliatory approach towards Greece and expressed exasperation with Berlin's hard line. This could be devastating for Europe at a time when Britain is debating whether to stay in the EU, a standoff with Russia over Ukraine remains unresolved and the continent is struggling with a migration crisis and threats from Islamist militants. Schaeuble sees it differently. He is passionate about European integration but has come to see Greece as an impediment to closer cooperation and a distraction for the bloc. A trained lawyer, he also believes the euro zone can only survive if its fiscal and debt rules are strictly followed. Schaeuble was already flirting with the idea of a Greek exit back in 2012, former U.S. Treasury Secretary Timothy Geithner wrote in his 2014 memoir "Stress Test". But his stance has hardened, officials close to him say, since the left-wing Tsipras government came to power in January, flouting rules that Schaeuble holds so dear, threatening not to pay Greece's debts and making bold promises they couldn't keep. "If the Greeks were serious Schaeuble would have no problem with them," said his biographer Schuetz. "But their behaviour over the past months has convinced him that they are not an asset to Europe, that they are damaging the very values on which the European idea is based, that they just want to poker and bluff. And this is the ultimate sin for him." A majority of Germans seem to agree. An INSA poll for Focus magazine this week showed 56 percent disapproved of parliament's decision to authorise talks on a new bailout for Athens. What does this mean for Greece's future in the euro? In the Bundestag debate on July 17th, Schaeuble described the bailout talks as a "last chance" for Greece. That too was a message to Merkel. "This is a crusade for him," said a cabinet colleague who requested anonymity. "He is an unguided missile." (Additional reporting by Gernot Heller, Andreas Rinke, Paul Carrel and Michael Nienaber; Writing by Noah Barkin; Editing by Paul Taylor)