Talk of Greek Expulsion Is Mostly Just Talk

Greece’s exit would cost the eurozone more than further accommodation.

Milton EzratiGerman politicians seem to have lost patience with Athens. Blustering about throwing good money after bad, they have shown a new eagerness to throw Greece out of the currency union, at least rhetorically. They are not alone. Similar sentiments have surfaced in Austria, Finland, the Netherlands and even Estonia. Understandable as such talk is, an expulsion of Greece is not as easy as these naysayers seem to believe and would almost surely cost the eurozone more than further accommodation, a lot more. On the assumption that politics will follow at least vague cost-benefit calculations, the likelihood then is that Europe, for all the tough talk, will find a way to keep Greece in the currency union.

The rhetoric certainly has intensified. Though German Chancellor Angela Merkel has remained circumspect, her own economy minister, Philip Rösler, stated bluntly that “a Greek exit has long since lost its horrors.” In only slightly less blunt language, her finance minister, Wolfgang Schäuble, said: “It is not responsible to throw money into a bottomless pit.” Volker Kauder, who heads the conservatives in Merkel’s own party, the Christian Democratic Union, declared that Greece has run out of “wiggle room” and there is “little chance of a third aid package.” Stefan Müller, parliamentary secretary of a coalition partner, the Bavarian Christian Social Union, believes any concession would send “the wrong message entirely.” Bavarian finance minister Markus Söder openly called for expelling Greece from the currency union, while Austria’s finance minister sought ways to add language on expulsion to the union’s governing documents.

Just the talk of a Greek departure has engendered signs of such strains. To be sure, Spanish bonds have sold well recently, pushing their yields down enough to offer Madrid some relief. But that improvement hinges entirely on European Central Bank President Mario Draghi’s promise to buy large volumes of Spanish debt if necessary. Otherwise, concerns for the future of the euro have driven funds away from Europe’s troubled periphery into Germany and other stronger economies, so thoroughly, in fact, that German interest rates have at times dropped into negative territory. The fears have reduced cross-border interbank transactions so that in June, the most recent month for which data are available, they ran at their lowest level since the 2008-2009 financial crisis. Several European banks have loosened their ties to their own subsidiaries in periphery countries. Germany’s Commerzbank and Deutsche Bank have ordered their Spanish and Italian branches to borrow from the ECB rather than rely on funds from headquarters. European oil giant Shell has stated bluntly that it hesitates to invest funds in Europe in any way.

Should such fears spread, as they almost certainly would after a Greek expulsion, Europe could expect to face economic and financial pains comparable to those suffered in the United States during the subprime crisis. Though fear of currency depreciation was not a factor in the American experience, default was, along with concerns about whether counterparties could meet their obligations. The reluctance of financial institutions to advance credit in such an uncertain environment, even to each other, caused interbank lending rates to soar, despite the Federal Reserve’s commitment to keep its benchmark federal funds rate near zero. The ensuing loss of liquidity widened credit spreads and forced asset prices to fall faster and farther than they otherwise would have, deepening and prolonging the recession and significantly slowing the pace of the subsequent recovery.

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