The Costs of Grexit

Financial Mirror (Cyprus) - - FRONT PAGE -

Ear­lier last week, fol­low­ing days of tense dis­cus­sions, the new gov­ern­ment in Athens reached an agree­ment with its eu­ro­zone cred­i­tors that in­cludes a pack­age of im­me­di­ate re­forms and a four-month ex­ten­sion of the fi­nan­cial as­sis­tance pro­gramme. But, de­spite Europe’s col­lec­tive sigh of re­lief, the com­pro­mise does not pre­clude the need for fur­ther tough ne­go­ti­a­tions on a new fi­nan­cial-as­sis­tance pro­gram that should be in­tro­duced by the end of June.

In any ne­go­ti­a­tion, a key vari­able in­flu­enc­ing the pro­tag­o­nists’ be­hav­iour, hence the out­come, is what fail­ure to reach an agree­ment would cost each of them. In this case, the is­sue is the cost of Greece’s exit (“Grexit”) from the eu­ro­zone – a prospect that was widely dis­cussed in the me­dia through­out the re­cent ne­go­ti­a­tion, with con­sid­er­able spec­u­la­tion about the stance of the var­i­ous play­ers, es­pe­cially the Greek and Ger­man gov­ern­ments.

From Greece’s per­spec­tive, leav­ing the euro would be highly dis­rup­tive, which ex­plains why there is very lit­tle sup­port for it in the coun­try. But what about Grexit costs for the rest of the eu­ro­zone? Ever since the ques­tion was first raised in 20112012, there have been two op­pos­ing views.

One view – dubbed the domino the­ory – claims that if Greece ex­ited, mar­kets would im­me­di­ately start won­der­ing who is next. Other coun­tries’ fate would be called into ques­tion, as oc­curred dur­ing the Asian cur­rency crises of 1997-98 or the Euro­pean sovereign-debt cri­sis of 2010-2012. Dis­in­te­gra­tion of the eu­ro­zone could fol­low.

The other view – of­ten dubbed the bal­last the­ory – claims that the eu­ro­zone would ac­tu­ally be strength­ened by Greece’s with­drawal. The mon­e­tary union would be rid of a re­cur­ring prob­lem, and a eu­ro­zone de­ci­sion to al­low or in­vite Greece to leave would bol­ster the cred­i­bil­ity of its rules. No coun­try, it is claimed, could dare to black­mail its part­ners any­more.

Back in 2012, the domino the­ory looked re­al­is­tic enough that the cred­i­tor coun­tries ditched the Grexit op­tion. Hav­ing re­flected and pon­dered over the sum­mer, Ger­man Chan­cel­lor An­gela Merkel went to Athens and ex­pressed her “hopes and wishes” that Greece re­mains in.

But the sit­u­a­tion to­day is dif­fer­ent. Mar­ket ten­sion has eased con­sid­er­ably; Ire­land and Por­tu­gal are not un­der as­sis­tance pro­grammes any­more; the eu­ro­zone fi­nan­cial sys­tem has been strength­ened by the de­ci­sion to move to a bank­ing union; and cri­sis-man­age­ment in­stru­ments are in place. A Grexit-in­duced chain re­ac­tion would be sig­nif­i­cantly less likely.

But it does not fol­low that the loss would be harm­less. There are three rea­sons why Grexit could still se­ri­ously weaken Europe’s mon­e­tary union.

First and fore­most, a Greek exit would dis­prove the tacit as­sump­tion that par­tic­i­pa­tion in the euro is ir­rev­o­ca­ble. True, his­tory teaches that no com­mit­ment is ir­rev­o­ca­ble: ac­cord­ing to Jens Nord­vig of No­mura Se­cu­ri­ties, there have been 67 cur­rency-union breakups since the be­gin­ning of the nine­teenth cen­tury. Any exit from the eu­ro­zone would in­crease the per­ceived prob­a­bil­ity that other coun­tries may, sooner or later, fol­low suit.

Sec­ond, an exit would vin­di­cate those who do con­sider the euro merely a beefed-up fixed-ex­change-rate ar­range­ment, not a true cur­rency. Con­fi­dence in the US dollar re­lies on the fact that there is no dif­fer­ence be­tween a dollar held in a bank in Bos­ton and one held in San Fran­cisco. But since the 2010-2012 cri­sis, this is not en­tirely true of the euro any­more. Fi­nan­cial frag­men­ta­tion has re­ceded but not dis­ap­peared, mean­ing that a loan to a com­pany in Aus­tria does not carry ex­actly the same in­ter­est rate as a loan to the same com­pany on the other side of the Ital­ian bor­der. Crit­ics like the Ger­man econ­o­mist Han­sWerner Sinn have made a spe­cialty of track­ing ex­po­sure to the break-up risk.

None of this is cur­rently lethal, ow­ing to the ini­tia­tives taken in re­cent years; but it would be a mis­take to as­sume that full con­fi­dence has been re­stored. Euro­pean cit­i­zens would cer­tainly re­spond to a coun­try’s with­drawal (or ex­pul­sion) from the eu­ro­zone by start­ing to look at the cur­rency in a dif­fer­ent way. Where a euro is held would be­come a rel­e­vant ques­tion. Do­mes­tic and for­eign in­vestors would scru­ti­nise more closely whether an as­set’s value would be af­fected by a breakup of the mon­e­tary union. Gov­ern­ments would be­come more sus­pi­cious of the risks to which their part­ners po­ten­tially ex­pose them. In­deed, sus­pi­cion would be­come ir­re­versible, and it would re­place the be­lief in the ir­re­versibil­ity of the eu­ro­zone.

Fi­nally, an exit would force Euro­pean pol­i­cy­mak­ers to for­malise their so-far un­writ­ten and even un­spec­i­fied rules for di­vorce. Be­yond broad prin­ci­ples of in­ter­na­tional law – for ex­am­ple, that what mat­ters for de­cid­ing an as­set’s post-di­vorce cur­rency de­nom­i­na­tion are the law gov­ern­ing the un­der­ly­ing con­tract and the cor­re­spond­ing ju­ris­dic­tion – there are no agreed rules for de­cid­ing how con­ver­sion into a new cur­rency would be car­ried out. A Grexit would force th­ese rules to be de­fined, there­fore mak­ing it clear what a euro is worth, depend­ing on where it is held, by whom, and in what form. In­deed this would not only make the break-up risk more imag­in­able; it would also make it much more con­crete.

None of this means that eu­ro­zone mem­bers should be ready to pay what­ever cost is needed to keep Greece in­side the eu­ro­zone. This would ob­vi­ously amount to a sur­ren­der. But they should not har­bour any il­lu­sions, ei­ther: there can be no such thing as a happy Grexit.

Newspapers in English

Newspapers from Cyprus

© PressReader. All rights reserved.