Greece, responsible for 0.4 percent of the world economy, nowposes a threat to international prosperity as investors raise betsits days using the euro are numbered.

A Greek departure from the currency would inflict “collateraldamage,” says Pacific Investment Management Co.'s Richard Clarida,a view echoed by economists from Bank of America Merrill Lynch andJPMorgan Chase & Co. At worst, it could spur sovereign defaultsin Europe as well as bank runs, credit crunches and recessions thatmay spark more euro exits.

Global trade and financial ties mean the pain wouldn't beconfined to the euro area. JPMorgan Chase estimates a 1 percentagepoint slump in the euro countries' economy drags down growthelsewhere by 0.7 percentage point. Exporting nations from the U.K.to China would suffer and commodity producer Russia would facefalling oil prices. While the U.S. may fare better, even it wouldfeel echoes similar to the financial infection following thebankruptcy of Lehman Brothers Holdings Inc.

“An awful lot depends on what is done to limit the contagionwithin Europe,” said Barry Eichengreen, a professor at theUniversity of California, Berkeley, and author of a 2006 history ofthe European economy, in a telephone interview. “If too little isdone then, to use a financial term, all hell breaks loose. I canimagine things playing out that way.”

Citigroup Inc. economists, who earlier forecast departurechances at as much as 75 percent, now are assuming as a “base case”that Greece will leave on Jan. 1, 2013. BofA Merrill Lynchstrategists estimate the euro-region's gross domestic product wouldcontract at least 4 percent in the recession that follows, similarto the decline after Lehman's 2008 collapse.

The euro would slide through $1.20 and Europe's Stoxx 600 BanksIndex would tumble below 110 points, from 123 yesterday, accordingto BofA Merrill Lynch's May 17 report.

Other crisis-torn countries, such as Portugal and Spain, wouldincur higher borrowing costs. In Germany, perceived by investors asa safe haven because of its stronger economy and lower debt,10-year bund yields could fall to 1 percent, the report said.

'Disaster' for Some

“If you let Greece go you would be sending the message thatbeing a member of the euro zone is not necessarily permanent, whichcould be a disaster for some countries,” said Laurence Boone, chiefEuropean economist at BofA Merrill Lynch in London. Her primaryscenario is that Greece remains within the euro because of the highcost of the alternative.

The creditworthiness of governments and banks in Italy andSpain, the euro area's third- and fourth-largest economies, wouldbe thrown into fresh doubt as traders shun their sovereign bondsand pore over their financial institutions' balance sheets, saidYiannis Koutelidakis, an economist at Fathom Financial Consultingin London.

Investors are signaling increased concern. The euro has droppedabout 5 percent in the past month against the dollar, while thecost of insuring Spanish government and financial debt reached arecord this month. Germany, by contrast, last week sold 5 billioneuros ($6.3 billion) of two-year notes with a zero-percent couponfor the first time.

Beyond the euro area, major trading partners such as the U.K.,Switzerland and nearby emerging economies including Romania's couldbe hurt as demand slows. Their currencies probably would riseagainst the euro, making exports less competitive. China's biggestinvestment bank says that nation could see its weakest growth inmore than two decades.

Even if the dollar surges, the U.S. may be more insulated givensigns of a rebound in its domestic economy — at 8.1 percent inApril, the jobless rate is down from a peak of 10 percent inOctober 2009 — and the fact that just 13 percent of its exportshead to the euro area. Capital flooding into a perceived safe havenmay also hold down interest rates.

Still, BofA Merrill Lynch estimates U.S. bond and stock marketseach account for a third of global capitalization, leaving themprone to a European shock. Greek elections helped wipe almost $3trillion from worldwide equities this month.

If the U.S. economy is pulled down it may complicate PresidentBarack Obama's re-election bid, said Eichengreen. Obama said May 21that what happens in Greece has an impact in the U.S. and calledfor “greater urgency” from European leaders.

Volatility Effect

“The election will turn on the economy and the economy issignificantly affected by Europe,” Eichengreen said. “The longer itremains unresolved and the more volatility it creates the worse itis for Obama.”

A splintering of the 13-year-old currency bloc might not come topass even if Greece next month elects parties campaigning to rejectthe terms of the bailouts needed to pay its bills, said JacobKirkegaard, a fellow at the Peterson Institute for InternationalEconomics in Washington.

Such an event would probably cut the nation off from outsideaid, tipping Greece's economy and financial system into such chaosthat the new government would fall within weeks, he predicted.Credit Suisse Group AG analysts say a majority of Greeks backstaying in the euro, the costs of leaving for the country and therest of the euro region would be considerable and the singlecurrency is a political project.

“I will attach less than a 5 percent probability for an actualGreek exit,” said Kirkegaard.

Continued membership may still cause headaches for the worldeconomy as Greece suffers political paralysis, a fifth year ofrecession, the need to repay what it owes and the burden ofausterity goals. “Our best guess is they're not leaving yet andthat this will be a story that will be discussed repeatedly formore than another year,” said Jim O'Neill, chairman of GoldmanSachs Asset Management in London.

Still, some companies are bracing themselves. Jan du Plessis,chairman of London-based Rio Tinto Group, the world's third-biggestmining company, said May 10 that any exit by Greece “woulddestabilize the European economy to a significant extent.” Withsales to Europe accounting for 12 percent of revenue last year, theregion is “one of the many reasons why our posture has to becautious,” he told reporters in Brisbane.

If Greece does depart, the pressure would be on central bankersand governments to quarantine it, said Lucrezia Reichlin, theEuropean Central Bank's former chief economist, now a professor atLondon Business School. Governments would quickly need torecapitalize weak banks and guarantee deposits as the ECB providedemergency aid, she said in an interview.

New Resources?

Global central banks may also help out by pumping dollars aroundthe world and pursuing easier policies where they can, said NarimanBehravesh, chief economist at Englewood, Colorado-based forecastersIHS Inc. The International Monetary Fund has already won pledges ofnew resources to help fight crises.

The cost of Greece exiting the euro would probably exceed the 1trillion euros previously estimated by the Institute ofInternational Finance, Managing Director Charles Dallara said in aMay 25 interview. That bill includes direct projected losses fromGreece's debt and the need to protect Portugal, Ireland, Spain andItaly, as well as money for reinforcing banks.

The channels of trade, confidence and finance would spread theimpact beyond Europe, according to Joseph Lupton, an economist atJPMorgan Chase in New York.

Euro-area imports account for 5 percent of global GDP, Luptonestimates, so a 15 percent decline would drag down the worldeconomy by 0.5 percentage point.

Euro-area nation economies would be first to feel thereverberations if Greece quits, given that about half their exportsgo to each other. Already, data last week showed declines in Germanbusiness confidence as well as European manufacturing and servicesoutput.

Mark Cliffe, the London-based global head of financial marketsresearch at ING Bank NV, calculates a Greek departure would leaveoutput in the rest of the euro region about 2 percentage pointslower than otherwise, with Spain and Italy suffering the most. Acomplete breakup of the euro would provoke a cumulative GDP loss ofmore than 12 percentage points over two years, he estimates.

Financial contagion is another damaging route, said Fathom'sKoutelidakis. Investors could dump the bonds of cash-strappedeconomies and pull money out of banks, tightening credit.

Greece defaulting would raise the odds of Portugal following, inturn setting off a domino chain that could leave a total eurobreakup “very much on the cards,” he said: “It is foolhardy toassume a Greek exodus would be manageable.”

Peripheral Debt

Greece's exit could also spur bank runs and capital flight inEurope's peripheral countries as investors flee corporatebankruptcies or try to escape redenomination of their accounts.European banks alone hold $1.2 trillion of debt issued by Spain,Portugal, Italy and Ireland, according to the Bank forInternational Settlements in Basel.

Another financial threat, says Lupton at JPMorgan Chase, isEuropean banks pulling back some of the 5 trillion euros they haveoverseas.

Beyond the euro area, Bulgaria and Romania are “first in thefiring line,” according to Neil Shearing, chief emerging marketseconomist at Capital Economics Ltd. in London. Romanian exportsworth 3.5 percent of GDP head to Greece and Greek banks have alarge presence in both nations. Hungary and the Czech Republic eachsend shipments equivalent to more than 40 percent of their GDP tothe wider euro area.

Eastern European banks are also dependent on euro-countryparents for funding. Short-term credit lines are equivalent to over10 percent of GDP in Hungary, Croatia and Bulgaria.

Oil-producer Russia could suffer: Capital Economics estimatesBrent crude would fall to $95 a barrel as global growth declined.OAO Sberbank, the country's biggest lender, estimates Russia'seconomy would contract 2.1 percent and banks may lose $95 billionin capital in a worst-case scenario, while the Center for StrategicStudies in Moscow says President Vladimir Putin would riskincreased political instability.

Greece quitting the euro could reduce China's expansion to 6.4percent this year, from 9.2 percent last year, if internationalgrowth is dragged down by half as much as during the 2008-2009financial crisis and policy makers don't offset the pain,economists at China International Capital Corp. said in a reportlast week.

Hit to China

Chinese exports, 19 percent of which go to the European Union,slowed unexpectedly in April. They may fall 3.9 percent this yearif Greece leaves, compared with a 10 percent gain without an exit,CICC projected.

A euro-region crisis would also mean a “renewed, deep recessionwould be highly likely in Hong Kong, Singapore, Malaysia, Taiwanand Korea,” Robert Prior-Wandesforde, Singapore-based director ofAsian economics at Credit Suisse, said in a report today.

Such economies are key to the global supply chain and often relyon trade for growth. Prior-Wandesforde calculated that exports tothe euro zone account for more than 5 percent of total GDP in HongKong, Singapore, Malaysia, Thailand and Taiwan. More than sixpercent of total domestic bank lending in Singapore, Hong Kong,India and the Philippines was from the euro area last year, hesaid.

As for the U.S., the hit to its economy from turmoil in Europemay be 0.5 percentage point at the very most, said Behravesh atIHS. In a sign that economy is on firmer footing, data last weeksuggested the housing market is stabilizing.

Financial ties have diminished as the Greek travails havelasted. Fitch Ratings says estimates U.S. money market funds haveabout 15 percent of their assets there.

For Clarida, a former U.S. Treasury official and now a globalstrategic adviser at Pimco, Greece leaving the euro may be too muchof a risk for Europe to take. In an interview on BloombergTelevision's “In the Loop” with Betty Liu, he said a common view inmid-2008 was that a Lehman failure could be managed.

“We saw how that turned out,” Clarida said. “The one thingmarkets hate is making it up as you go along, and that's what we'dhave with a Greek exit.”

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