Greece takes the eurozone's future to the brink

By Russell Hotten
Business reporter, BBC News

  • Published
rioters in Athens
Image caption,
Some economists believe withdrawing from the euro would cause Greece no more pain than staying in

Is this the endgame for the euro?

Some economists and politicians have forecast the euro's demise for years. The game, they argue, is just taking longer than expected to reach its denouement.

But there is no doubt that the issue is moving centre stage. The crisis in Greece has exposed the biggest fault lines in the single currency project since the euro was introduced in 1999.

On Monday former Foreign Secretary Jack Straw said the euro is facing a "slow death".

The Labour MP said the eurozone "cannot last" in its current form, and the UK government should prepare for its potential collapse.

On Tuesday, Prime Minister David Cameron insisted that the euro would not collapse, because member states "will not let it".

But Mr Cameron is no doubt more than relieved that Britain is not a member of the single currency.

The financial markets do not seem to be as confident as European politicians that the eurozone will hold together.

"All economists would agree that the debt dynamics of Greece are unsustainable," said Neil MacKinnon, global strategist VTB Capital told the BBC.

"A scenario in which Greece at some stage decides that an exit from monetary union is much more preferable to a diet of economic contraction and fiscal austerity can't be rule out," he said.

The Centre for Economics and Business Research (CEBR) goes further, predicting that the eurozone is "almost certain" to break up within five years and "probably" by 2013.

And with a eurozone break-up, what becomes of the euro and its status as the second largest reserve currency, as well as the second most traded currency in the world after the dollar?

Investor confidence in the euro would most likely collapse.

In May, when Germany's Der Spiegel magazine reported that Greece was threatening a euro withdrawal (which Athens denied) the currency had its worse two-day fall since December 2008.

According to the CEBR, several forces make a eurozone break up inevitable: slow economic recovery in Greece, Portugal, Spain and Italy; tough austerity packages; lacklustre export growth; an eventual unwillingness of countries and institutions to keep funding bail-outs.

Without a break-up of the eurozone, the CEBR argues, economic growth in southern Europe will be below 1.5% in every year to 2015.

Moment will come

Only by exiting the bloc might the economies be able to re-adjust through currency devaluation and usher in growth that would allow them to pay off their debts.

CEBR chief executive Douglas McWilliams says: "Sooner or later both the Greek population and international creditors will tire of fighting a losing battle, leading to a break-up of the currency union as Greece pulls out, probably followed by other countries.

"A series of bail-out packages and eventual debt restructuring will delay this moment, but it will come," he said.

At the moment, the eurozone's 'core' - specifically, Germany - has much to gain from a stable euro. But eventually, the cost of bail-outs will become too great, he said.

Greece's exit from the euro would be disastrous for French and German banks, which are heavily exposed to the Mediterranean country.

Mr McWilliams adds: "The danger of knock-on effects means that a [banking sector] bail-out like that which followed Lehman's collapse will be required."

For many people, however, this is precisely why an orderly bail-out and/or restructuring of the eurozone's weaker members must continue.

The one thing worse than staying in the euro at this moment would be to exit it, they say.

On Monday a group of business leaders from France and Germany sent open letters to the media in their respective countries warning that "a failure of the euro would be a fatal blow to Europe".

No country has left the euro. It would be a big leap into the unknown, and one of the financial markets' greatest worries is the "law of unintended consequences".

Indeed, there are no exit clauses in the treaties that brought the eurozone together.

The European Central Bank (ECB) has spoken of the "considerable risks and difficulties and... substantial legal complications" should a eurozone member try to restore its old currency.

If Greece, say, exited the eurozone, euro notes would be taken out of circulation and exchanged for new drachmas, a process which the ECB would have to supervise.

Even basic financial transactions like simple loans and mortgages would have to be re-organised, never mind multi-billion-euro international business deals.

It could become an international legal minefield, taking years if not decades to resolve in the courts.

The drachma would no doubt plunge in value against the euro and other currencies. That in itself could have positive benefits - for example, in exporting goods and promoting tourism.

Competitive devaluation

But as a Greek exit would probably happen only after it had defaulted on its debts, the financial markets would take a dim view and refuse to lend to Athens for years.

In any case, a Greek withdrawal might encourage others to do the same, sparking competitive devaluation and wiping out any first-mover advantage.

For economist Mark Weisbrot, director of Washington-based Center for Economic and Policy Research, Greece has little to lose from leaving the euro.

He compares the Greek crisis to Argentina's financial nightmare in the early 2000s, when the country defaulted on its debts and unpegged its currency from the dollar.

Most economists predicted disaster for Argentina, but in fact the economy grew rapidly, he said.

"The main reason for Argentina's rapid recovery was that it was finally freed from adhering to fiscal and monetary policies that stifled growth," he wrote in the New York Times. "The same would be true for Greece if it were to drop the euro."

Nobel-prize winning economist Paul Krugman has said that comparing Greece to Argentina is "an imperfect parallel".

In particular, the South American country still had the peso and so the mechanics of de-pegging were easier.

Mr Krugman did not completely rule out a euro exit for Greece, but said he was not yet "ready to counsel" such a move - preferring a debt restructuring as the best way forward.

Even so, some serious thinkers are starting to think the unthinkable.