A Greek exit from the euro area would inflict heavy damage in Greece and throughout Europe. It could also be one of the best things that ever happened to the currency union.
Greece’s repeat parliamentary election next month will serve as a referendum on whether the country should end its 12- year membership in the common currency. An affirmative answer would trigger a cardiac arrest of the Greek economy, as the banking system collapsed and foreign suppliers refused payment in drachmas. The financial system of the euro area, by far Greece’s biggest international creditor, would suffer hundreds of billions of euros in losses.
For the European economy as a whole, the primary danger would be the reintroduction of currency risk into what has been billed as an irrevocable monetary union. When Greek banks collapse, or have to be closed for a prolonged holiday to facilitate a forced conversion of deposits into new drachmas, one cannot predict whether citizens and firms across the periphery of Europe will pull their money out of their banks just in case. The result could be financially disastrous.
The potentially dire repercussions have led many to assume that no responsible European policy maker would allow a Greek exit to take place. By this view, all the talk about letting Greece leave is merely a scare tactic. Europe’s leaders will blink first in their game of chicken with Greece and ease the terms of the country’s austerity program. Moral Hazard
This logic underestimates a crucial element of the euro area’s political economy: In a union of partially sovereign members without a supranational authority, concerns about moral hazard -- the possibility that lenience toward Greece will encourage other countries to misbehave -- still carry a lot of weight. Euro-area leaders are not bluffing when they threaten to cut off support from the European Central Bank and let the Greek government run out of money, leaving it to decide whether to dump the euro or remain as merely a euro-ized country such as Montenegro.
What Europe’s leaders will not countenance is a breakup of the euro. Therein lies the silver lining of a Greek exit. To protect the currency union from the fallout, the remaining members will have to move very quickly toward the economic and financial integration that has always been necessary for the euro’s long-term survival.
Such is the nature of the European Union and the history of regional integration: It is propelled by bouts of acute crisis. Make-or-break moments are what shape the boundaries of the politically possible and inspire leaders to do whatever it takes to save the euro.
Consider, for example, how Europe might respond to the threat of bank runs. Only some kind of pan-euro deposit- guarantee program would be authoritative enough to persuade people to keep their money in the banks of peripheral countries such as Portugal, Spain and Italy. Initially, German Chancellor Angela Merkel and ECB President Mario Draghi could make the commitment orally. Putting the program in place, though, would require a quantum leap in the integration of euro-area banking supervision and regulation. Control over banks in the area would have to be transferred to the supranational level. In other words, a euro-area banking union could emerge as the direct result of a Greek exit.
Euro falls vs dollar on fears debt crisis may spread * Spain's Catalonia asks for help, raises contagion fears * Uncertainty in Greece keeps sentiment bearish US dollar
NEW YORK, May 25 (Reuters) - The euro slipped to near two-year lows against the dollar on Friday, rattled by fears of a possible Greek exit from the euro zone and the risk other debt-plagued countries could also leave the bloc. A plea from Spain's wealthiest autonomous region, Catalonia, for help from the central government to refinance its debt this year was the latest news to hit the euro, which was on track for its worst weekly showing in five months.. Catalonia's appeal reverberated across financial markets. Spanish and Italian bonds sold off, equities fell, and U.S. crude oil futures turned negative. "The Catalonia news was a big deal because it implies that the Spanish government may have to take on more debt and it cannot afford to do so," said Richard Franulovich, senior currency strategist at Westpac Securities in New York. "It looks like all the euros that were bought need to be resold. For now, it's all about contagion," he added. In mid-afternoon New York trading, the euro slipped 0.2 percent to $1.2511, after earlier falling to a nearly two-year low of $1.2495, using Reuters data, taking out a key options barrier at $1.25. The common currency has lost 5.5 percent against the dollar so far this month and is facing its fourth straight week of losses, raising the possibility of a test of the 2010 low of $1.1875. It has dropped 2.1 percent this week, placing the euro on pace for its worst weekly performance since mid December.
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