I read time and again, for instance here, that Greece’s debt crisis “threatens the euro”. Indeed, there are lots of right-minded people around Europe who worry deeply about this threat and have determined that a Greek default has to be avoided to save the euro. I’m having trouble, however, figuring out what that this is supposed to mean.
There seem to be different interpretations of what the “threat to the euro” is. The more dramatic interpretations invoke the idea of an existential threat. Others view it as involving reputational harm. I’ll take each of these ideas in turn.
The Existential Threat
Some people apparently think that a Greek fiscal default will, inexorably, lead to Greece leaving the euro. I don’t see why this is the case.
One narrow interpretation of this idea was provided on Morning Ireland today by Daniel Gros. He noted that if Greek government bonds could not be use in ECB repo operations than this would shut Greek banks out from part of the operation of the Eurosystem. But this is indeed a very partial shut out from the EMU, since the euro would still be legal tender in Greece and, indeed, there is no legal reason why Greek banks have to use Greek government bonds as their principal collateral for ECB operations.
Some people think that Greece’s problems stem from a recession due to an over-valued exchange rate and that the Greek government may decide to leave the euro to devalue their currency and thus promote growth. This is one potential interpretation of the “threat to the euro”. However, as best we can tell (insert mandatory caveat about Greek economic statistics) Greece’s recession has been milder than the rest of Euro zone’s. According to the Autumn 2009 release of the excellent Statistical Annex to European Economy, Greek GDP is estimated to have declined 1.1 percent in 2009 compared with 4 percent for the Eurozone as a whole.
Even if an over-valued exchange rate – rather than fiscal mis-management – was Greece’s key problem, it is incredibly unlikely that alleviating this particular problem via exiting the euro would offset the other problems that this would impose such as the return of exchange rate premia on sovereign debt and the host of legal and contractual problems associated with re-introducing a new currency. Nor, as best as I can tell, has anyone explained why the Greek government would choose the moment of a technical default on its debt (failing to roll over its debt as the EU cavalry chooses not to arrive) as the moment to induce further mayhem by leaving the euro.
I suspect some people have in mind that a Greek default would lead somehow to them being expelled from the Eurozone, perhaps because they have brought shame upon the noble euro project. However, this idea of expulsion – lurking in the background of the Gros\Mayer EMF proposal – is not in any way realistic. A recent ECB legal working paper states that “a Member State’s expulsion from the EU or EMU would be legally next to impossible.”
It’s also worth remembering that EMU survived for a number of years without Greece (and for longer without Slovenia et al) and that it would carry on even in the unlikely scenario of Greece leaving.
A final possibility is that, out of disgust at sharing a currency union with defaulting nations such as Greece, core euro nations such as Germany decide to re-establish their own currency. I don’t know if anyone has ever suggested this as something that could happen but it doesn’t sound in any way plausible.
I conclude from all this that the existential threat is overstated.
The Reputational Threat
So the euro would carry on even if Greece defaulted. What’s the big issue then?
Well, it is possible that if Greece defaults, that bond markets will perhaps lose faith in Irish, Italian or Spanish sovereign bonds and there will be a wave of distruptive fiscal crises across Europe. The idea of a European backstop can prevent such an outcome, though it does raise questions: Aren’t Spain and Italy too big to save from default? Doesn’t the existence of the implicit European safety net make it harder politically, rather than easier, for governments to impose the necessary fiscal adjustments?
These are valid points for discussion but they don’t have anything, per se, to do with the euro. They would apply just as validly if the UK was on the verge of fiscal crisis, even though they are not in the euro.
The issue for the euro appears to be that it would “damage the image” of the euro. You might read this kind of thing a lot but it’s worth keeping in mind that about 90 percent of what’s written in newspaper articles about currency movements is complete claptrap – today’s award for currency claptrap goes to this Irish Times article for its mentioning of the “psychological key level of $1.35”!
In practice, the vast majority of demand for euros will be unchanged by a Greek default. It is possible that such a default would reduce global portfolio demand for euros to be used to purchase various types of financial assets because of a perceived increase in risk. And it is possible that this could, at least temporarily, reduce the value of the euro.
But who says this is a bad thing? The Eurozone economy is still in pretty bad shape and could well use the boost to net exports that is coming from the current round of currency depreciation.
The bottom line here is that despite the widespread agreement of the great and the good that Greece’s problems are “a threat to the euro” and so it must be rescued to save the currency, it just ain’t necessarily so. There may be good arguments for bailing out Greece, but the threat to the euro is not one of them.