Leaving the euro would be devilishly difficult

ONE BIG QUESTION has lurked throughout the euro crisis: should one or more members quit? The most obvious candidate is Greece, the country where the trouble began. It never met the criteria for joining, but its deficit and debt figures were misrepresented. And the crisis has inflicted agonies on the Greeks. Pierre Moscovici, the EU’s economic- and monetary-affairs commissioner, notes that Greece’s GDP per person has fallen by 45% since late 2009 and unemployment is nearly 50%. This is the worst performance ever by any advanced country.

Now a further row looms, over funds needed for Greece’s third bail-out this summer. The IMF reckons that Greece will never repay its debts, which currently amount to 180% of GDP and rising. Yet euro-zone creditors refuse to accept any debt relief, preferring variants of “extend and pretend” to avoid owning up to fiscal transfers. Meanwhile Greece’s government rejects more austerity, just as Greek voters did in a referendum in July 2015, only for it to be forced on them all the same. Even so, Greeks do not want to leave the euro—perhaps because for them it has become like Alcatraz: a prison that keeps people in mainly by making escape too risky. If an orderly procedure for leaving the euro were available, a Greek departure might become more attractive.

Officials say it cannot be done. Yet at least twice in 2012, and again in 2015, the German finance ministry spoke in favour of it. The technicalities of returning to the drachma could surely be managed. Existing euro notes might continue to be used, perhaps overstamped, as in the Czech-Slovak currency split in 1993; in any case, ever more payments are made electronically or by card. Most Greek banks would go bust, but stringent capital controls could be imposed, just as they were during the banking crisis in Cyprus in 2013. The ECB could provide the Bank of Greece with plenty of liquidity. The Greek economy, especially the tourist industry, would quickly reap large benefits from a substantial devaluation.

It was two other considerations that tipped the scales against Grexit. The first was the threat of contagion. If Greece left, the myth that there is no way out of the euro would be instantly exploded, bringing the single currency closer to a fixed exchange-rate regime. The markets might fret that Portugal or even Italy could follow, presaging the currency’s eventual collapse. Yet Greece accounts for only 2% of the EU’s total GDP, so if the EU fears that the departure of such an economic tiddler could destroy the euro, it has alarmingly low confidence in its own creation. Besides, institutional changes have provided the euro with far stronger defences than it had before.

The second objection is the potential cost of Grexit, not only in support for Greece’s banks and people but through “TARGET” balances at the ECB. These reflect inflows and outflows of euros in national banking systems, which usually attract little attention. But the numbers have recently risen, a sign of renewed market nerves. Greece and Italy at the end of January had negative balances of over €70bn and over €360bn respectively, whereas Germany had a positive one of almost €800bn, its all-time high (see chart). Were a country to leave or the euro to break up, these balances would probably crystallise into genuine (and surely unpayable) claims.

Some economists have suggested that Germany, not Greece, should temporarily leave the euro, and rejoin later at a higher rate. The argument is that the underlying causes of the euro’s problems are Germany’s strong competitiveness and its huge current-account surplus. Yet a German exit seems politically implausible: the issue for markets is Greece’s membership, not Germany’s. Political or economic events could restart talk about Grexit at any time. It would be prudent to prepare for the worst—and seek to minimise the collateral damage.