As we noted the other day, the quickly deteriorating situation in Greece has got people speculating that the Greek exit from the eurozone (“Grexit”) is just around the corner—perhaps coming as soon as September. And contagion is spreading past the troubled countries, maybe even infecting the otherwise-robust German economy.All this tumult has to have forced some serious contingency planning in Europe’s capitals. The Economist mapped out just what some of these plans might look like, using an imaginary memo to Angela Merkel from her staff as an expository device.The memo offers a menu of unappetizing options. Since an open-ended commitment to bailing out the delinquent states increasingly looks unsustainable both fiscally and politically, the first option is an orderly Grexit. Greece is forced off the Euro and it defaults on its obligations by redenominating them in newly devalued Drachmas. Even by writing off the entirety of Greece’s debts and providing a reasonable aid package to help in the transition, the total cost of this is estimated at around €320 billion, with Germany shouldering €110 billion of that.While this is superficially plausible and the least costly way forward, it contains within it the seeds of broader chaos.
If that was that, it would be a bargain compared with the likely present value of transfers from Germany to Greece over the next few years and maybe decades. But there is a sizeable risk that a Grexit could turn into a calamity, as markets reacted badly to the admission that euro membership was no longer irreversible. At worst there could be a market collapse to rival the one that took place after the Lehman bankruptcy in late 2008, which could in turn trigger a recession on the scale of the desperate downturn of 2008-09. In the panic, you would come under intense pressure (Barack Obama would be on the line immediately) to concede debt mutualisation without getting the quid pro quo of fiscal control at a European level that you have been demanding. After holding out for so long against demands that you write a blank cheque, that is what you might well end up having to do.
So what to do? Cut “well above the site of infection,” forcing Spain, Portugal, Cyprus, and Ireland off the Euro as well, and draw the line at France and Italy. The cost for this is exorbitant: €1.15 trillion, with Germany shouldering up to €500 billion, or almost 20 percent of its GDP. But with the costs of the chaos after a disorderly Grexit alone likely to exceed that, aggressive amputation might be the most reasonable way forward.That some variant of the above contingency plan exists on European leaders’ desks is quite likely. Whether there’s the political will to see it through is not.