There are lots of things to worry about in the face of an ever more likely Grexit, but the future of the euro isn’t one of them.
The credibility of the euro depends on the credibility of the rules, the institutions and the political will behind it. A Grexit won’t affect that much; indeed, a Greek exit may end up strengthening the credibility of the euro by removing the one member that all agree should never have been allowed to join in the first place.
The euro has never been ‘irreversible’ the way the dollar is or the Deutsche Mark was irreversible. Bavaria was not going to drop out of the DM and Oregon isn’t going to drop out of the dollar. The euro is clearly a multinational project, and there are always risks and uncertainties when different sovereign nation-states cooperate on a project. That was true five years ago and it remains true today.
The deeper question for the future of the euro is whether countries like Italy, Spain and even France are ready, willing and able to do what it takes to prosper in a currency union dominated by Germany and including ‘hard money’ partners like the Netherlands, Finland and Austria.
At the same time, the question is whether the hard currency countries are prepared to compromise their principles to hold the monetary union together as the soft money countries slowly move toward reform.
Those were open questions five years ago and they are still open today. However, we have learned some important lessons about political will in the north and the south. On the whole, the news is good. The northern countries, reluctantly, have been willing to allow the ECB to provide substantial relief to the southern countries. The southern countries, reluctantly, have continued their efforts at reform.
The political will to maintain the euro remains strong, and investors and currency speculators are likely to take note of this in the future.
From the beginning, Greece has been in a different category from countries like Italy and Spain. It was a terrible candidate for the common currency, and only ‘met’ the targets by cooking its books. Greece’s inability to meet the targets legitimately and the moral and political bankruptcy revealed by the willingness of its political class to cook the books on a matter this grave should have disqualified Greece from the beginning. This kid wasn’t ready for college and shouldn’t have been accepted.
Putting Greece in the euro weakened the credibility of the currency right from the start. The willingness of European authorities to turn a blind eye to the wholesale chicanery in Athens weakened the common currency and undercut the currency’s credibility among financial market participants from the start. The bad decision on Greece was a sign that the Europeans weren’t taking the task of building the euro seriously enough, and that they were letting political and even populist considerations distract them from the extremely serious business at hand.
So forcing Greece out could end up being good for the eurozone. The message would be clear: the rules are real and the Europeans are committed to managing their common currency in a serious way even when there is a political price to be paid. A Grexit at this point will probably reassure investors and savers around the world in the medium term, even if it unnerves them short term. The exit under duress of a member that can’t or won’t play by the rules shows that the euro is a solid currency that can be trusted, and will bolster its reputation as a store of value.
Those who fear the consequences of Grexit for the euro look at how the Grexit might affect countries like Italy and Spain? Will the spectacle of a Grexit lead speculators to attack Italian and Spanish bonds and banks stocks at any sign of economic difficulty? There would be huge amounts of money to be made for investors who short Spanish or Italian assets if those countries should be driven from the euro in a new crisis. If the sharks scent blood in the water, will a feeding frenzy begin?
We’ll see what happens to Spanish and Italian bond yields this week, but in the medium to long term, Grexit might not change the rules of the game very much. As long as Spain and Italy want to remain in the euro and are willing to play by the rules, markets are likely to think that the rest of the zone will work to keep them on board. That would change if another European country started speaking in Greek. If, for example, Podemos won the next election, formed a new government in Spain, and launched a confrontational bargaining strategy with the rest of the eurozone, many investors would head for the hills. But that would happen whether or not Greece leaves the euro. It would happen in Italy if an anti-euro party won the election. It would happen in France if the National Front came to power.
Overall, however, the biggest factor in the confidence markets have in the euro going forward will be their assessment of the wisdom and sustainability of the policies that back it. If reforms in Spain and Italy bear fruit (and there are signs this is happening, though painfully slowly and the progress could come apart very quickly) or, better yet, a virtuous circle sets in—reforms lead to better performance, better performance creates the political support for more reform—then both Southern Europe and the euro would have a bright future, whatever does or doesn’t happen in Greece. The markets already understand that the euro is in trouble; a Grexit won’t tell them anything they don’t know and the fortunes of European bond and stock markets are likely to continue to reflect fundamental assessments of the health of currency union and the prospects for growth.
There is one way a Grexit could introduce more instability into European financial markets over time: what if the exit has a happy ending for Greece? If it exits the euro and after a wrenching adjustment things start going fairly well fairly quickly, the EU’s laggards will take notice and their anti-euro parties would grow stronger. Greek success outside the euro could weaken the political consensus inside Italy, Spain and France behind the common currency. That could start to have an impact on investors, who might start to wonder whether those countries are really committed to the project with all its difficulties.
There are many good reasons even at this very late date to try to find a way to keep Greece in the euro. But these reasons are more political than economic. There has never been a good economic case for Greek euro membership; there has always been a good political case. That remains true today.
What the Europeans need to do now is to stop letting Greece suck all the oxygen out of the room. Big questions about the future of the common currency remain. These questions need sustained attention and perhaps policy changes in both the north and the south of Europe. The Greek drama has cost months of time as European leaders and policymakers have engaged with the grandstanding Syriza politicians. Time to move on, one way or another.