There's talk of an exit – but default would have catastrophic consequences

 

Heather Stewart The Observer, Sunday 12 February 2012

The prospect of a eurozone without Greece is now openly discussed, even though break-up would bring banking chaos

Dutch prime minister Mark Rutte has said: 'We are currently so strong in the rest of the eurozone… that we can handle an exit of Greece.' Photograph: Evert-Jan Daniels/EPA

Greece's finance minister, Evangelos Venizelos, believes his country's dilemma about whether to pay the price and stay in the euro is a moment of destiny; but a Greek exit – "Grexit", as it is being called – would send shockwaves throughout the world economy.

In theory, Greece could default on its debts and remain within the single currency: the bailout now on the table already involves a partial default to private sector creditors such as banks. But resentment against Greece has been growing in Brussels, where it is seen as tarnishing the euro project. If politicians in Athens cannot reach agreement on the latest cutbacks – or if they sign up and then fail to deliver – their eurozone partners may take that as a decision to leave the club.

As the talks rolled on last week, a growing number of voices in the single currency's more stable "core" countries suggested they could manage without Greece. Dutch prime minister Mark Rutte said: "We are currently so strong in the rest of the eurozone… that we can handle an exit of Greece."

Some investors, too, argue that, because a default has been a possibility for many months, financial markets would take it in their stride.

But default and "re-drachmatisation" would be a costly and chaotic process. In the long term the euro might be strengthened if some of its weaker members headed for the door. But in the short term banks across the eurozone might have to be closed to prevent a run on the single currency as investors speculated about which country might be next. A new wave of bank nationalisations would be likely to follow as lenders counted their losses on now worthless Greek debt.

Capital controls would have to be imposed and borders shut to stop money flooding out of Greece. Portugal, Italy and Spain would come under intense pressure from investors wary about the risk of another victim. Banks everywhere, already reluctant to lend, would cut back hard, nervous about their exposure to the bonds of all Europe's crisis-hit states.

For Greece, a drastic devaluation – the markets would be likely to value any new drachma at less than half the value of the euro – could at least provide the hope of an export-led recovery. But unlike Argentina, which defaulted on its debts in 2001 after a wrenching political and economic crisis, Greece has neither the advantage of plentiful natural resources nor a boom in the world economy to ride. There's no easy way out: but as the economist Nouriel Roubini points out, even with this second bailout Greece will be left with debts worth 120% of GDP by 2020 – which he says still amounts to insolvency.

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