Europe has reached the point where it must prepare for such an outcome.
Whether Greeks want it or not, circumstances could soon force their country to return to the drachma. Europe’s leaders, as Luxembourg Prime Minister Jean-Claude Juncker hinted, might extend Greece’s deadlines to meet the budget targets required for rescue money, but they won’t provide emergency financing to a government that refuses austerity measures. Without Europe’s help, Greece’s government (whoever ends up leading it) faces a dilemma: Cut spending even more than under the austerity program, or default on its debts and print a new currency to pay its bills.
A return to the drachma would be painful. The currency would immediately be worth a fraction of a euro, and would depreciate further if the government printed money to finance deficit spending. Bank depositors would get devalued drachmas, if they got anything at all. Businesses would be starved of credit. Prices and wages would probably rise to compensate for the currency’s loss of value, eroding the benefit of a cheap currency to Greek exporters.
The rest of Europe would face the daunting challenge of containing the fallout. To that end, as Bloomberg View columnist Clive Crook notes today, it must be prepared to do all the same fiscal reforms and take all the same emergency measures needed to keep the euro area intact, and more. Even then, a Greek exit would have unpredictable consequences.
First, Europe would have to absorb immediate losses on money lent to Greece. The country has about 400 billion euros in external debts, which its government, banks and companies would probably pay only in part or in drachmas. European taxpayers would suffer the lion’s share of the losses: Their exposure by way of the European Central Bank, national central banks and EU lending programs amounts to more than 300 billion euros. The rest would fall on private companies and banks, particularly in France, possibly requiring governments to step in and provide capital.
Second, European officials would need a plan to stop bank runs. As soon as Italian, Portuguese, Spanish and maybe even French depositors see footage of Greeks clamoring for their savings, they’ll want to get their euros out of local banks as quickly as possible. Bank holidays and bans on withdrawals would help only temporarily. To prevent a collapse of the banking system, Europe’s leaders would have to guarantee all deposits in euro-area banks, a move that would put Germany and other core countries on the hook for insuring more than 3 trillion euros in Italian and Spanish deposits. Common deposit insurance would also require euro-area governments to achieve in a matter of days a harmonization of banking regulation that has escaped them for more than a decade.
Third, Europe would have to calm market fears that other euro-area countries, such as Portugal and Spain, might follow Greece’s lead. Investors’ worries about such an outcome could become self-fulfilling if they pushed borrowing costs up to levels that the governments can’t bear -- a trend already evident in the yield on Spain’s 10-year bond, which stood at 6.3 percent Tuesday, up from less than 5 percent in early March. To keep interest rates down, the ECB could buy even more government bonds than it already has, or lend banks more money to do so. This could eventually leave the ECB holding or financing all the debt of the afflicted governments.
Alternatively, the ECB could try to restore market confidence with a show of overwhelming force, guaranteeing the repayment of all struggling euro-area governments’ debts for the foreseeable future. But even this course of action, which Bloomberg View has advocated as part of a plan to hold the euro together, might not have the desired healing effect after a Greek exit.
There would be political as well as economic costs. Greece is highly unlikely to leave the EU in a fit of nationalist pique -- it doesn’t want to face Turkey alone over Cyprus, or to see Balkan neighbors such as Albania, Macedonia and Serbia join the EU while it seethes outside. But for a European project that has been expanding and integrating ever more deeply since its formation as a six-nation coal and steel production union in 1951, a Greek exit from the euro -- especially if followed by other countries -- would mark a turning point. For example, if Greece can leave the euro, why not kick it out of the Schengen open-border zone? The majority of illegal immigrants to the EU come through Greece’s border with Turkey. It’s hard to predict what else might unravel.
Given the potential for unintended and unforeseen consequences, the least bad course for Greece and the EU remains, as Juncker hinted, for deadlines to be waived long enough for Greece to form a government that would recommit to a reform program. To make such an outcome possible, Europe’s leaders should move beyond self-defeating austerity and take immediate steps to support growth in Greece and other struggling countries. Failing that, Europe will have no choice but to prepare for the worst.
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