The relationship between Greece and the rest of the eurozone is increasingly reminiscent of the cold war’s balance of terror. We are of course speaking only of financial terror and Greece is not the Soviet Union, but the mechanics are strikingly similar.
Start with the options for Athens. It is important to distinguish between budgetary and external aspects. Greece is forecast to record a slight primary budget deficit in 2012, so should it default, forcing European partners to unplug assistance, it would have to tighten more, but only marginally. However the current account deficit is still expected to be close to 8 per cent of gross domestic product. Without assistance and in the absence of significant private capital inflows, the European Central Bank would have to increase its exposure even further. Should it refuse, as likely, Greece would be forced into an exit and it would have to close its external deficit precipitously. What remains of the economy would fall into chaos. Financial disruption would be massive, resulting in a chain of bankruptcies. Currency depreciation would substantially overshoot, making foreign goods unaffordable, especially as policy institutions have no credibility. Eventually, depreciation would help rebuild competitiveness, but in the meantime the damage would be severe.
A unilateral Greek default would undoubtedly be costly to its partners. Official exposure to Greece through assistance loans, ECB claims on the national central bank and ECB holdings of government bonds amount to more than €250bn. To this sum must be added private sector exposure through bank loans and equity, roughly another €100bn.
Additionally, a Greek exit would signal that there is nothing irrevocable with participation in the euro, turning the European currency into a sort of magnified fixed exchange-rates system; equally importantly, it would force to set rules for converting euro-denominated claims into the new currency, thereby indicating to every business or household what assets and liabilities would become in the case of a euro break-up. No doubt this would trigger massive precautionary moves and undermine the rest of the eurozone.
What this suggests is that a Greek threat to default within the euro is not be credible if the ECB is ready to stop extending liquidity. The next government could wish to renegotiate some aspects of the programme but it will still need it, until it completes the largest part of its adjustment.
The EU official line – no renegotiation of the programme, no exit at any price – is however not credible either. For if the price it puts on exit is infinite, the EU cannot deter Greece from making use of its leverage. To strengthen its hand, it has to be ready to contemplate a forced exit. But it can only do that if equipping itself to limit potential damages. This means beefing-up firewalls and speeding-up preparations for banking union and the issuance of common bonds. Here, it is Berlin that lacks consistency. Signals that it is not ready to pay any price to keep Greece within the euro are only credible if accompanied by willingness to consider bold moves to preserve the common currency.
A lesson from the Cold War is that ultimately, rational behaviour proved to be the best insurance against disaster. Today also, both partners have a common interest in behaving in cool blood. They have to set red lines credibly and unambiguously, as well as to indicate where there is room for discussion. This can only happen after June 17, when a new coalition emerges from the election and forms a government in Athens. In the meantime, we are bound to live dangerously.