How will Grexit affect euro zone? No one knows

The escalation of the Greek debt debacle has altered the dimensions of the crisis. Athens is veering towards an exit from the single currency, something which still seemed unlikely just days ago. At issue now is containment of the fallout for the euro zone at large.

This is a nightmare scenario. Almost six years have passed since Greece set off Europe’s sovereign debt crisis by admitting its official financial statistics were falsified. Everything done in the consequent turmoil was cast to hold the euro zone together, stretching the currency system to its very limit as Ireland and a line of other crisis-struck countries came under speculative attack. The zone remained whole when the disruption was at its very worst but the assumption that it will always be so – no matter what – is now under grave threat.

It was only when European Central Bank chief Mario Draghi pledged in 2012 to do “whatever it takes” to keep the euro together that the crisis abated, not least because a battery of firewalls and rescue funds had been put in place to prevent the weakest of the weak from falling out of the currency. The most potent weaponry was not used, meaning Draghi’s pledge to buy unlimited quantities of sovereign bonds to keep a country in the euro has never been put to the test.

Weakened countries

If the “Grexit” actually happened, however, it would bring with it the immediate threat of contagion to other weakened countries. Yes, emollient political messaging suggests Europe is better placed these days to withstand a departure from the currency. But no one can accurately predict that the rest of the euro zone would sail on smoothly. Spain’s borrowing costs were quick to come under pressure as the talks with Greece soured in recent weeks – and that was when markets still believed a funding agreement would be reached. If recent volatility on markets was always predicated on an eventual settlement, the absence of settlement in the coming days will only worsen the volatility.

After a chaotic weekend of rancour, rhetoric and recrimination in Athens and Brussels, the prospects of a deal have receded appreciably. The talk now in the euro zone is of a “strong possibility” of Greece leaving, something which would demonstrate that a supposedly permanent currency union is reversible.

This is to say nothing of the hardship this would create for millions of Greeks, who should not have to pay for the titanic errors of their elected leaders. This is to say nothing either of the political and psychological consequences for the EU’s peace project and the clear potential for geopolitical upset of a post-euro Greece aligned with an increasingly belligerent Russia.

Practical questions abound. There is, of course, no legal mechanism to leave the euro. In theory at least the only available exit mechanism is via a departure from the EU itself. While that presents all kinds of complexity – not to mention political and economic risk – these are the very issues which would have to be confronted very soon if the deadlock is not broken.

There’s no sign of it either. At this sorry point there seems little prospect Greece will repay a €1.6 billion IMF debt tomorrow, the day its current EU-IMF rescue programme expires. That snap referendum takes place next Sunday on a funding proposition already scrapped by euro zone finance ministers, a proposal the Greek government has promised to oppose in the plebiscite.

Meltdown

It’s not looking good at all, but it’s not over yet either. The ECB kept the ball in play yesterday by maintaining special support for Greece’s crippled banks at the level it reached last Friday, a little below €90 billion. Yet as depositors pull billions of euro from their accounts, the banks can’t continue to meet their demands without additional ECB aid. The immediate impact is that the banks won’t open today – nor will the Greek stock exchange – and there is doubt as to when the banks, in particular, might be able to reopen. While the ECB manoeuvre prevents an immediate meltdown of the banks, it raises the stakes appreciably in the political process within Greece and in the country’s on/off negotiation with international creditors.

Something has to give. If the three-year debt crisis was the biggest moment in European politics since the fall of the Berlin wall, then another such moment could now be upon us. Greece has been cast as the laggard outlier from start of the debt crisis, the country with the deepest economic problems, biggest debt and most unpredictable politics. An abiding lesson of the crisis is that the weakness of one country in a currency union is the weakness of all. It is not too great a stretch to say that the weakness of a country ejected from a currency union presents weakness for all as well.