German 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.
If the problem were just Greece, Europe would have little difficulty acting on such tough talk. Merkel, no doubt, would join in, and Europe would have banished Greece from the euro months ago. The Greek economy, after all, is less than 2% of Europe’s gross domestic product, and its outstanding government debt amounts to less than 1% of all European bank assets. The problem is that Greece’s fate casts a shadow over all the countries in Europe’s beleaguered periphery, including the significant economies of Spain and Italy. Even while Greece remains in the union, the continent faces a profound risk that a contagion of fear that could bring down the finances of Portugal, Spain, Italy and others. The expulsion of Greece significantly raises the probability of such a panic.
It is easy to understand the fear investors and bankers have about countries exiting the eurozone. They anticipate forcible currency conversions from euros into newly revived national currencies that would surely depreciate and cut deeply into the real value of their assets. They also expect expelled governments to repudiate their euro debts and counterparties in the troubled economies to have difficulties meeting their obligations. Such prospects would prompt bankers and investors, on the least hint of expulsion, to remove their deposits and assets to safer locations. The whole pattern, by decreasing financial liquidity and driving up interest rates for all borrowers in such questionable countries, would compound their financial difficulties, deepen their economic troubles, and, in a pattern of self-fulfilling prophesy so familiar in finance, significantly raise the probability that they will in fact have to depart the currency union.
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.
If Europe, which is already in recession, wants to avoid such a fate, then one way or another it must convince investors and bankers that the euro is not in jeopardy. Finding a way to keep Greece in the currency union is the easiest way to do that, which, no doubt, is why all have worked so hard to support Greece during these last two-plus years of crisis and why expulsion, for all the tough talk, is less likely than accommodation and compromise. To be sure, Berlin will try to get the best deal it can. It will continue to insist on safeguards and to demand that Athens correct its budget problems at the same time it retools its economy. Athens may choose to go its own way. Politics, never wholly rational, may yet force the eurozone into draconian, if self-destructive, action. But if the politicians pause for even the most cursory review of costs and benefits, an expulsion of Greece looks a lot less likely than compromise.
For more articles by Milton Ezrati about Europe’s debt crisis, see Berlin’s Limited Options and Where Is Blücher? For recent news coverage, see Merkel, Monti Lead Diplomatic Push and Weidmann Resignation Report Fuels Tension.