By Ambrose Evans-Pritchard

LONDON, England - September 11, 2011 - Bild Zeitung populism has prevailed. Germany is pushing Greece towards a hard default, risking the uncontrollable chain reaction so long feared by markets.

First we learn from planted leaks that Germany is activating "Plan B", telling banks and insurance companies to prepare for 50% haircuts on Greek debt; and then that Germany is “studying” options that include Greece's return to the drachma.

German finance minister Wolfgang Schauble has chosen to do this at a moment when the global economy is already flirting with double-dip recession, bank shares are crashing, and global credit strains are testing Lehman levels. The recklessness is breathtaking.

If it is a pressure tactic to force Greece to submit to EU-IMF demands of yet further austerity, it may instead bring mutual assured destruction.

"Whoever thinks that Greece is an easy scapegoat, will find that this eventually turns against them, against the hard core of the eurozone," said Greek finance minister Evangelos Venizelos.

Greece can, if provoked, pull the pin on the European banking system and inflict huge damage on Germany itself, and Greece has certainly been provoked. Germany’s EU commissioner, Günther Oettinger, said Europe should send blue helmets to take control of Greek tax collection and liquidate state assets. They had better be well armed. The headlines in the Greek press have been "Unconditional Capitulation", and "Terrorization of Greeks", and even “Fourth Reich”.

Mr. Schauble said there would be no more money for Athens under the EU-IMF rescue package until the Greeks "do what they agreed to do" and comply with every demand of “Troika” inspectors.

Yet, to push Greece over the edge risks instant contagion to Portugal, which has higher levels of total debt, and an equally bad current account deficit near 9% of GDP, and is just as unable to comply with Germany's austerity dictates in the long run. From there, the chain reaction into EMU's soft-core would be fast and furious.

Let us be clear, the chief reason why Greece cannot meet its deficit targets is because the EU has imposed the most violent fiscal deflation ever inflicted on a modern developed economy – 16% of GDP of net tightening in three years - without offsetting monetary stimulus, debt relief, or devaluation.

This has sent the economy into a self-feeding downward spiral, crushing tax revenues. The policy is obscurantist, a replay of the Gold Standard in 1931. It has self-evidently failed. As the Greek Parliament said, the debt dynamic is "out of control".