On top of that, there is the exposure of the private sector. At the end of 2011 Greek companies and households owed international banks $69 billion. And, harder to quantify but just as real, there are losses from uncertainty and increased bond yields in other vulnerable countries that will follow from the demonstration that the euro really can be left.
What might this mean in numbers? Recent forecasts by the European Commission project the euro zone’s GDP declining by 0.3% this year, and then growing by 1% in 2013. Mr Cliffe estimates that following an orderly and well-managed Greek exit—one with very limited contagion and some continuing support to Greece from the euro zone and IMF—the euro area would suffer an extra first-year GDP loss of 1.6%, making a mild recession harsher. The other troubled peripheral economies would be hit hardest, though in this model they would increase their commitment to structural reform having seen the alternative. Germany would be least affected. Its economy is in any case forecast to do better than the euro area, expanding by 0.7% in 2012 and 1.7% in 2013; relative to this baseline it would incur a first-year output loss of 1%. America, he thinks, might be hit half that badly.
But could a Greek exit really be contained at its borders? European banks remain worryingly weak, not just in small economies like Cyprus—already in trouble, and very exposed to Greece—but also in large ones like Spain, the fourth biggest in the euro area. Bad loans in Spain have risen by a third over the past year, to €148 billion or 8.4% of outstanding loans, the highest since August 1994. Spanish banks are widely believed to require an injection of public capital of at least €30 billion (3% of GDP) and perhaps a lot more. Borrowing that much would be a hard task for the deficit-stricken Spanish government (which has yet again raised its estimate for last year’s deficit, to 8.9% of GDP).
With Spanish banking woes so prominent, there is a danger of bank runs as citizens of vulnerable economies fear ending up with devalued deposits. Such runs would become much more likely after a Greek exit, but it is possible that they could start before one, and indeed precipitate it—possibly the worst of all bad options. If confined to relatively small economies like already bailed-out Ireland and Portugal this might be manageable. In an economy the size of Spain’s or Italy’s they would be a terrible danger.
The “firewall” which is supposed to protect against contagion is neither designed for bank runs nor adequate to the needs of large economies. At present the EFSF, the temporary bail-out fund, has €250 billion of uncommitted funds which it could use to provide financing for governments that find themselves cut off from the markets or facing punitive rates as they try to save their banking systems. The permanent rescue facility, the European Stability Mechanism (ESM) is due to start in July, but has not yet been ratified by several countries, notably Germany. Even when it does get going, the new lending capacity available from the two funds will be capped at €500 billion, supplemented by possible support from the IMF of up to $430 billion.
Beyond the adequacy or otherwise of the funds’ size, there is the problem of what they can be spent on. If they were used to bail out commercial banks directly, they could break the pernicious circle in which unstable banks use the debt of barely solvent governments to shore themselves up. But as things stand neither the ESM nor the EFSF is allowed to do that. To free them in this way would require both agreements to be ratified again, a politically risky and time-consuming process.
That leaves the ECB as the last bulwark. It could buy bonds again, but this tactic would be less effective than before unless it dropped its insistence on being protected against any future haircut. If it does not, bond investors will regard every purchase it makes as pushing them down the pecking order, thus reducing any residual appetite they might have. It could also provide near unlimited liquidity through yet another huge long term refinancing operation. But this would involve loosening its collateral conditions and exposing the central banks to greater and greater risk.
If neither the rescue funds nor the ECB can do enough, a wider break-up might ensue, with huge costs all around. Mr Cliffe says that a disintegration of the euro would be catastrophic even for core Europe, with first-year output losses of 8.9% for the euro area (as was). This time Germany would not be spared, incurring a GDP loss of 8.2% as its exporters contended with the strength of a reborn D-mark. Across the former euro area, there would be a wave of bankruptcies as firms suddenly found themselves either owed money in a depreciating currency or owing money in an appreciating one.
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