09 August 2012

Karl Whelan: Would a Greek exit really be manageable?

A Greek exit would forever shatter the illusion that the euro is a fixed and irrevocable union. European politicians will claim that Greece is a unique case but they have made far too many false claims in the past to be considered credible.

A Greek exit would likely trigger a massive flight of bank deposits from the periphery as the current “bank jog”—largely driven by large corporate accounts and non-residents—turns into a full retail bank run. If default on deposits is to be avoided, this would require a massive injection of central bank funding by the Eurosystem into these countries.  This would raise severe tensions: Will Germans be willing to allow the Banca d’Italia to print enormous amounts of euros to facilitate Italians to move their money to Germany and have their deposits stand on an equal footing with German resident deposits after a euro break-up?

Another possible response to a bank run would be the introduction of euro-wide deposit insurance. However, this plan would only work provided it guaranteed that people retained the original value of their euro deposits even after they had been re-donominated into pesetas or lira. Otherwise, people will still have an incentive to move their money. But re-denomination insurance provides a huge incentive for countries to leave. People can have their debts re-denominated into a weaker currency and the EU will kindly pick up the tab in relation to the money people lose on their deposits. This proposal would not be acceptable to the core eurozone countries.

A Greek exit would trigger a broad range of different legal problems as various parties sue each other to claim they are owed euros, not drachmas. The resolution of these problems would illustrate which kinds of parties are at risk when a country exits the euro and their Spanish and Italian counterparts would come under severe pressure.

A Greek exit would place pressure under peripheral eurozone economies no matter what the outcome is. A disastrous post-euro outcome in Greece will convince many investors that any economy in the euro area at risk of leaving should be avoided.  Alternatively, a healthy Greek rebound after the initial chaos would place pressure on governments in countries suffering inside the eurozone that Greece is an example to be followed.

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