How to protect euro from Greek exit

By Hugo Dixon
May 14, 2012

When euro zone policymakers are asked if there is a Plan B to cope with a Greek exit from the single currency, their typical answer goes something like this: “There’s no such plan. If there were, it would leak, investors would panic and the exit scenario would gather unstoppable momentum.”

Maybe there really is no plan. Or maybe policymakers are just doing a good job of keeping their mouths shut. Hopefully, it is the latter because, since Greece’s election, the chances of Athens quitting the euro have shot up. And unless the rest of the euro zone is well prepared, the knock-on effect will be devastating.

The Greeks have lost their stomach for austerity and the rest of the euro zone has lost its patience with Athens’ broken promises. But unless one side blinks, Greece will be out of the single currency and any deposits left in Greek banks will be converted from euros into cut-price drachmas.

People outside Greece may think this is simply a Greek problem. Would it really be much worse than Athens’ debt restructuring earlier this year which passed off with barely a murmur? But the process of bringing back the drachma is likely to involve temporarily shutting banks and imposing capital controls. That would set a frightening precedent.

Politicians and central bankers would, of course, argue that Greece was a not a precedent but a one-off. But why trust them? When Greece was first bailed out in 2010, policymakers said it was a special case. Then Ireland and Portugal required official bailouts while both Spain and Italy have had to be helped by the European Central Bank. If savers in Greece get hammered, depositors and investors in these other weak euro member would want to move their money to somewhere safer. Fears would rise of a complete break-up of the euro zone.

Indeed, there already has been significant capital flight from peripheral economies. The best way of seeing this is by looking at so-called Target 2 imbalances – the amount of money that national central banks in the euro zone owe to the ECB or are owed by it. These imbalances are a rough proxy for capital flight.

Four euro zone central banks – in Germany, the Netherlands, Luxembourg and Finland – have positive balances. At the end of April, the Bundesbank was owed 644 billion euros, according to data collected by Germany’s Ifo Institute. The sum has been rising by an average of 33 billion euros a month since the crisis took a turn for the worse at the end of July last year. Meanwhile, all the peripheral countries have big liabilities. Italy and Spain have the largest with 279 billion euros (as of April) and 276 billion euros (as of March) respectively.

A Greek exit from the euro would, at least temporarily, accelerate capital flight. Measures would need to be taken to counteract it – to protect both depositors and governments in vulnerable countries.

Fortunately, it’s not too difficult to construct a contingency plan. To protect depositors, the ECB would have to make clear that a limitless supply of liquidity with very few strings attached was available for banks across the euro zone. This would avoid the possibility that savers would find they couldn’t get money out of their accounts. After a while, calm might return.

To protect governments, the ECB would also need to wade into action. Although it cannot lend to states directly, it can buy their bonds on the secondary market. Indeed, it has already done so. It would, though, need to be prepared to buy bonds in limitless quantities. Otherwise, investors might just run anyway and take the ECB’s money while it lasted.

Although the ECB would have to play the main role in preventing a panic, the euro zone’s so-called firewall should play a subsidiary role. The region will soon have two main bailout funds – the existing European Financial Stability Facility and the European Stability Mechanism. These could be deployed in two ways.

First, they could provide a backstop to national deposit guarantee funds. That way, an Italian saver would know that, if Rome’s own guarantee scheme ran out of money, there were funds in another kitty to fill the hole. Second, the bailout funds could lend cash directly to governments that were no longer able to issue bonds in the markets.

However, the bailout funds are not large enough to stem a panic on their own. They only have 740 billion euros available. Even with help from the International Monetary Fund, they would not be able to douse the flames.

Although it is fairly easy to think of a plan B, that doesn’t mean it would be easy to get political agreement for it from Germany and the other creditor countries. One concern would be that the ECB would be taking huge financial risks by buying government bonds and lending to banks. Another is that such rescues, which would amount to a big step towards fiscal union, would take the pressure off the peripheral governments and their banks to reform themselves and improve their solvency.

On the other hand, failure to act as a lender of last resort in a Greek-exit panic could trigger a domino effect of bankruptcies – of banks and governments – throughout the periphery. The euro couldn’t survive that.

Germany may soon need to decide between going all-in to save the single currency or witnessing its destruction.

21 comments

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ESM ! you forgot to mention that with the coming of ESM, the ECB can ask, on short notice(7days), unlimited amounts of money from the EUro countries.

As a matter of fact, this means that the ECB can RUIN any country on short notice, without being held responsible and without the fear of litigation.

Say no more….

Posted by Willvp | Report as abusive

With the rejection of austerity, which has been nothing more than a reduction in the rate of deficit spending, the only weapon left to combat the worldwide financial crisis is massive quantitative easing. In the case of Europe it means a multi-trillion euro expansion of the ECB’s balance sheet. Among the world’s largest economies, central bank balance sheets have risen by over 2.5 times in the last 5 years to more than 15 trillion in US dollars. This rate of expansion will need to increase to ward off the pending sovereign debt crisis. The affect this will have on the world economy remains to be seen. If, as some have said, the world is marching toward a financial cliff, the EU will likely be the first over the edge.

Posted by gordo53 | Report as abusive

The only way to protect the Euro is for politicians to admit they were wrong to include so many countries into the Euro at inception. European politicians hubris needs to be addressed. The Euro should have been started with just 4 core participants, Germany,France, Benelux & Finland. (I treat Benelux as one entity for EU)

The solution:
1) Political Agreement in Europe
2) G8 Agreement to assist Euro unwind
3) Intervention to lower the value of the Euro (devaluation)to parity with the US$
4) Allow Club-Med & Ireland to step off the Euro train
5) Convert all debt, loans, commercial contracts to US
dollars
6) Establish domestic currencies in states that have left the Euro while creating a currency board and after a safe period of time introduce the new currency which is pegged to the US dollar at a small devaluation to par.
7) Permit the remaining Euro to rise back to 1.45-1.60 area.
8) This will boost Club Med countries and Ireland(if they leave) allowing them to reclaim competitiveness against core Euro states.
9) German, British, American, Chinese factories could move into the Club-Med / Ireland states at the devalued exchange rate to provide a manufacturing base, jobs for the locals.

10) After a period of 10-15 years these peripheral states could rejoin the Euro at a far more competitive rate with a refreshed economy.

Posted by GreatLakesForex | Report as abusive

The problem is that we are witnessing an uncontrolled crash. Better to have the EU man up and merely announce that Greece is out; that it is outside the reach of the fire hoses and that those are being deployed to prevent the fire spreading to other countries. They can’t save the occupants of this vehicle but maybe, just maybe, they can save those in the adjoining ones. The brakes are gone, the occupants are in panic and cannot control it, now it’s just damage control.

Posted by Gatortrapper | Report as abusive

It always seems to come down to Germany. Germany must do this, Germany must do that. If the euro is to be saved Germany must pony up ever more money to save the Mediterranean nations from their own failed policies. Would the Greeks have done half as much as the Germans already have to save the euro if the shoe was on the other foot? Doubtful. If the Greeks have no more stomach for forced austerity imposed on them by northern Europe, then they should go their own way. In the short run it will be painful, but these crises always pass. In twenty years people will wonder what the fuss was all about.

Posted by IntoTheTardis | Report as abusive

Nice analysis ..I would appreciate it more if you d give me any ideas what Greek citizens should do to protect their savings ( if any ) A real tragedy for million families is going to take place ..

Posted by Odyss | Report as abusive

The exit by Greece from the Euro is coming, soon. Time Euroland adjusted to this reality, and get the costs behind us. It means pain for everyone, most of all the people of Greece. The whole world is suffering because this small country. Enough already!

Posted by iceform | Report as abusive

How have the ‘chances shot up’? The chances are what they have always been. The results might end up being what we considered a long shot a year ago. But that doesn’t change what the odds have been all along.

Posted by SeaWa | Report as abusive

Germany crafted the Euro and now want the member states to dance to their music. The EU was supposed to be a Unified Europe, wasn’t it? Why do the EU citizens of Germany think they have more power than their fellow citizens. In the US, all states are not economically equal. But we all live within the same economy!

Posted by SeaWa | Report as abusive

It is only time before the euro ends. Since there is a limit to how much austerity a government can morally imposes to correct trade imbalances. The weak nations have to invest in under the table export subsides and worker education if they are compete with the trade winners (Germany et. all) in the zone. If not they will fail sooner or later or the winners like Germany has to agree to a single fiscal policy aimed at moving industries to the weak.

If official corruption is a national custom, the officials will not end it. Austerity on the lower classes alone has limits. At a point it will immoral for unemployed and others to allow themselves and others like them to be starved or uneducated, if did their what can.

Posted by SamuelReich | Report as abusive

If it is possible to protect part of the Eurozone from the exit of countries like Greece, then how does one justify the devastating expense of the recent bailouts and restructuring?

Why wouldn’t it have been better to send Greece back to the drachma before investing half a trillion Euros trying to keep them in the Euro?

Posted by breezinthru | Report as abusive

What people do not realize and thus assume too easily doomsday scenarios is that there is a difference between the Grefault /Greek default/ and Grexit /Greece euro exit/.

Greece may default and stay in euro, becoming effectively cash economy. Government would pay people as much as it collects and people would pay with available cash. This would automatically balance the economy and would obviously inflicted big pain. But it would be much less pain than exit and ensuing rampant inflation and chaos plus blockade of currency flows over the borders. It would also made pressure to import back the euros and capital send from Greece abroad.

Posted by Boomgloom | Report as abusive

@breezenthru:

easy answer: round tripping to the benefit (read: saving) the banks.

don’t be amazed next year when Greece is OUT and banks make big profits.

Posted by Willvp | Report as abusive

thank you for this and your previous article on the EURO.

Shorting the EURO worked perfectly since then… and will possibly last a bit longer.

Some, though, call for the EURO rising when Greece is out.

Posted by robb1 | Report as abusive

Greeks would be well advised to pull at least 90 percent of their accounts into cash (a mix of Euro and Dollars) and pay cash for their items, storing the remainder in a safe deposit box or good safe (burglars rarely search your attic behind a bunch of dusty furniture or under a pile of old clothes). I would not be surprised if on any given weekend (maybe this one!) the Greek banks mark the Euros they have with rubber stamps to temporarily mark them as “Greek Euros” in case they switch back to Drachma after the election. Get your clean, unmarked Euros and Dollars NOW.

Posted by mark_kaskin | Report as abusive

The far-left Greeks with their Mr. Tsirpas, who seems to be of an unstable mental condition, appear to become the winners of the coming elections. They are playing an extortion game like “You won’t dare to throw us out so we will do what we want, which certainly doesn’t include any austerity.”. As usual, the common man in Greece will be the main victim of this kind of immature posturing.

The eurozone then will pay a heavy price for its badly thought-through euro and for including failed states like Greece in its group.

Posted by Beethoven | Report as abusive

The far-left Greeks with their Mr. Tsirpas, who seems to be of an unstable mental condition, appear to become the winners of the coming elections. They are playing an extortion game like “You won’t dare to throw us out so we will do what we want, which certainly doesn’t include any austerity.”. As usual, the common man in Greece will be the main victim of this kind of immature posturing.

The eurozone then will pay a heavy price for its badly thought-through euro and for including failed states like Greece in its group.

Posted by Beethoven | Report as abusive

In the next one or two weeks, expect a run on Greek banks.

The Greek government and the Greek banks will go bankrupt.

Greece may not leave the Euro, in spite of this. I’m not sure what difference it would make which currency is used by a bankrupt state.

Posted by LoveJoyOne | Report as abusive

TIME FOR GERMANY TO LEAVE EURO CURRENCY

The crisis in euro zone will affect all countries in the world. Euro cannot be wished to die quickly and fast. The proposal to exit Greece out of Euro is very dangerous. It is like asking a citizen of a country to leave the country for not paying credit card bills. Which new country will take him? If you allow this idea then lender can force one by one outside the zone. The position of Spain, Portugal, Italy, Ireland, even France is more in line with Greece. Except Germany all European countries need a depreciated euro to rebuild business and jobs.

So the solution is for Germany to leave Euro now and immediately. The outcome is best for all concerned including Germany, in fact to the world. The sequence is as below.

1. Germany leaves Euro and issues Mark. The mark will settle at say one mark at 2 Euros.
2. With euro depreciated only against mark the European nations can start exporting bringing back the jobs and business.
3. The WORLD cannot complain since euro is existing and trading. If the market forces devalue euro no one is answerable / need not answer. Germany which is against inflation is out now.
4. The Tax on German exports to Europe will bring revenue to LOCAL Governments.
5. China cannot / need not complain since China will be better placed to trade against Germany. Euro reserves exist as a currency.
6. Germany will become like china a large holder of exchange reserves MAY BE A TRILLION EUROS..
7. Germany can restrain Mark from international trade like China Yuan / Indian Rupee and do external trade only in euro / US$.
8. France will emerge as European leader, which France never achieved till date.
9. USA should be happy Germany cannot raise now uncontrollably , and CAN concentrate on China / India
10. China can be happy Euro reserves will last as a currency and can be utilized. With Germany on par with China in legal terms for Euro trade China can do what it did to US. Koreans Can move in with their factories.

SO TIME TO ASK GERMANY TO LEAVE EURO NOW HAS ARRIVED

Posted by daffa | Report as abusive

Why couldn’t the Greeks at first peg a new drachma to the euro? At least initially that would help keep things calm as Greece exited the euro. Then they could gradually allow the new drachma to float against other currencies. Since the new drachma would most likely depreciate, that would make goods and services in Greece good bargains for foreigners which should then boost economic growth.

I do agree with daffa that Germany leaving the euro would be the best plan, though I don’t think Germany would agree to it.

Posted by xebob | Report as abusive

Its funny how you concentrate on a plan b without first clarifying plan a and assessing its initial potential. When will substantial reporting address what promises where broken and by whom? In my point of view the goals of all these intertwined institutions and organizations you’re referring to was to implement policies towards common progress of member states and facilitate/overview their execution instead of being overwhelmed by the risks involved. Was their work concentrated on safeguarding weaker economies susceptible to the crisis or the showcasing of Eurozone’s sense of awareness. Instead, as stated on a comment, the risk is basically overplayed proven by the fact that it has actually been subject to the same pressures all along. Now we find that the problem remains and strangely that the components have undergone a crisis of identity and orientation. Those who perceive the problems of weaker economies to be the threat for the stronger ones are first and foremost in denial and displaying behaviors opposing the very essence of union.

Posted by klodenberg | Report as abusive