Eurogroup may figure Grexit doesn’t have to be the end of the Euro

There has been a continual flow of text in the Eurozone crisis based on this idea:  if Greece goes, this is the end of the Euro.  Because of that, the Eurogroup will step back from the brink and make the necessary compromise, provide Syriza with the financing it needs with less or no conditionality, and Grexit will be avoided.  Robert Peston repeats this idea as a near certainty in his blog today on the BBC website.  He had a go repeating it on the Today program, but, mysteriously, the line was cut before he got going.  (Coincidence, or intervention by Schauble?  You decide).

This idea is greatly overplayed.

Greece is a very small country.  It’s too small and different to learn any kind of lessons about how the large, troubled countries would be dealt with.  Those being Spain, Italy, even France.  I’d say that the Germans would not be able or willing to finance any of those countries on their own, or together.  They are too large.  Greece staying or going does not change that calculus, because it doesn’t change the size of that potential bail-out.

What about the smaller countries:  Portugal, Ireland, Cyprus, Belgium…?  Would Eurogroup want to avoid suggesting that there could be exits of those countries?   Yes, but not at any cost:  the moral hazard argument weighs just as heavily.  The choice may between an exit, or [entering Eurogroup minds here] throwing good money after bad, and then exit.

And besides, the other small bail-out countries have been tamed, and the medicine can be argued to be working.  Regardless, with OMTs and QE, there are instruments already in place to fight a test of the exit domino theory.  Greece going would not alter the calculus that the others are too safe or easily protectable, to leave.  There is also, probably, not only an ability to protect those countries, but solidarity too, since they swallowed the pill and did what they were told.

The symbolic damage of Greece exiting is also not as project-destroying as Peston and others make out.  Notice that in the midst of all the chaos the Eurozone admitted a new member, Lithuania.

The calculus that the Euro is an idea – the current set of rules and regulations (discretionarily arrived at since 2010!) – may be as powerful in Eurogroup minds as the statement that it is a particular geographic construct.  If you follow that through, better to let Greece go, leaving the ‘idea’ intact, and maybe one day come back if it chooses.

Pissarides’ Euro apocalypse was different.  He asserted that markets everywhere would run looking for a safe-haven (outside the Euro).  They may.  But he didn’t put any weight on the observation that they haven’t so far run from anywhere except Greek banks.  And there has been  no response but this each time Eurogroup has turned the screw.

My tweets about this generated the response ‘they didn’t run before the Lehman’s run either’.  [eg from Jo Michell at UWE].

That’s a good point.  However, three responses.

First, Lehman’s is fresh in the mind.  That would tell me we would be more likely to experience a pre-Grexit run than otherwise.  [‘I didn’t make it out the door fast enough last time, so this time I’m not going to make that mistake’].

Second, 80% of the exposure to Greek sovereign debt is to other governments.  And there has been lots of time for the private sector to arrange their affairs to cope with the rest.

Third, markets have not been thrown any Bear Sterns-like dummy by Eurogroup to precipitate a repeat of the Lehman’s surprise.  If anything, Eurogroup [is it Eurogroup, or ‘the Eurogroup’?] have erred on the side of tough-talking.  ‘Get out while you can because we are not giving in’.

[HT Robin Wigglesworth for reminding me of the cold war domino analogy.]