A Greek Exit?

A Greek Exit? Euro Zone May Be Ready

5/18/2012

By BINYAMIN APPELBAUM | New York Times

WASHINGTON — It is increasingly conceivable that Greece may leave the euro zone, not just because of its own political dysfunction but also because the consequences of such an exit for the rest of the Europe and the global economy no longer seem quite so scary.

The foot-dragging and brinkmanship of the last few years have won the other members of the currency

union valuable time to prepare for life without Greece. Banks have recorded losses on Greek investments, companies are making contingency plans and Europe has bolstered rescue funds for other vulnerable nations like Portugal, Ireland and Spain.

Those measures also have reduced the risks for the United States, making it less likely that a “Lehman moment” will spread panic through global financial markets. American investment funds and banks have also sharply reduced their investments in Europe.

But some experts say Europe’s preparations remain incomplete and the potential costs of a Greek exit are highly uncertain and potentially substantial. That reality helps to explain why Germany continues to profess its determination to keep Greece in the currency union if at all possible.

Still, European leaders are increasingly willing — even eager — to comment publicly on the possibility that Greece will leave, something they long refused to countenance, not just because relations with Greece continue to deteriorate but also as a result of their own preparations.

“We’ve worked hard to mitigate against such a scenario,” the Dutch finance minister, Jan Kees de Jager, told reporters after a meeting of European finance ministers early this week. “That’s why the contagion risk would be far, far smaller than one and a half years ago.”

What once seemed unthinkable is being reduced to a budget line. Economists at a German bank recently estimated that a Greek exit would cost the German government about 100 billion euros ($127 billion), or about 3 percent of the nation’s annual economic output.

François Baroin, the departing French finance minister, said this week that a Greek exit would cost France up to 50 billion euros — a similar share of its economic output.

“Greece is not a big deal in itself. It’s not a major risk and our banks and insurance companies certainly would be able to absorb it,” Mr. Baroin told Europe 1, a French radio station on Tuesday.

The more pressing question, as Mr. Baroin went on to say, regards the consequences for the other struggling nations at the bottom end of Europe. He warned that the departure of any member could spread “doubt and distrust” in the minds of foreign investors over the health of the euro. Stock markets have declined worldwide on fears that Europe will unravel.

The first job of a finance minister is to convince the markets that everything is under control, and in recent days, European officials have lined up to insist that the euro would survive.

“They seem fairly at ease, fairly resigned to the fact that they would be able to deal with it, which I think is a result of the months that they have had to prepare,” said Jacob Funk Kirkegaard, a fellow at the Peterson Institute for International Economics here.

He said the current round of talks was intended primarily to influence the outcome of the Greek elections next month, but he added that he thought Europe was legitimately in a better position to handle a worst case.

But Kenneth S. Rogoff, a professor at Harvard and former chief economist of the International Monetary Fund, said Europe had made progress but still was not adequately prepared to control the fallout. He said Europe lacked sufficient mechanisms to ensure that loans remained available to other troubled countries, like Spain and Italy. Furthermore, there is no political consensus about support for borrowing by local governments and private companies. And, he said, there is no credible long-term plan to ensure the viability of the euro.

“These are difficult political decisions that they just aren’t ready for,” he said. “They should be. They’ve had two years to think about it. But they’re not ready.”

Uri Dadush, director of the international economics program at the Carnegie Endowment for World Peace here, and formerly director of economic policy at the World Bank, said Europe had made significant strides. An agreement this year reduced the value of outstanding Greek government debt by roughly 90 percent, limiting the potential for further losses. A range of corporations have acknowledged that they are preparing for the possible return of a Greek currency. Europe has significantly expanded the scale of its various emergency lending programs.

Still, he said, “the bottom line is that it remains a risky proposition.”

If a Greek departure is interpreted as a sign that the euro zone is crumbling, depositors in other troubled countries could start to withdraw their money from the local banks, and interest rates could continue to rise. Italian companies are already struggling to compete against rivals in other countries because of the higher interest rates that they are forced to pay.

“How do you prevent the disease from spreading?” Mr. Dadush asked. “That’s the big question for the Europeans if the Greeks go out.”

The United States mostly is watching from the sidelines.

The Federal Reserve chairman, Ben S. Bernanke, has said repeatedly that problems in Greece would have little direct impact on the American financial system. Domestic banks have eliminated more than two-thirds of their investment in Greece over the last two years, paring their exposure to $5.8 billion at the end of 2011 from $18 billion at the end of 2009, according to the most recent available data from federal financial regulators. The banks have also reduced their exposure to other troubled countries, including Spain (down 21 percent), Ireland (16 percent) and Italy (14 percent).

Money market funds have also backed away from Europe. The funds held $205 billion in debt issued by euro zone banks in April, down 62 percent from the previous April, according to research by JPMorgan Chase. Investment has actually increased during the early months of the year, but most of the new investment is in the banks of France and Germany, which are regarded as relatively safe.

But the domestic economy remains vulnerable to disruptions in Europe. Roughly one-quarter of American exports go to Europe, and Americans held $1.4 trillion in the securities of euro zone companies and countries at the end of 2010, according to the most recent available federal data.

“If there is a major financial problem in Europe,” Mr. Bernanke told Congress in February, “there will be so many different channels on which that will affect our financial system that I would not want to take too much comfort from” the fact that the financial system has little direct exposure to Greece.