Cannes - It may well be remembered as the day the eurozone
began to break apart.
At a late night news conference in Cannes on Wednesday,
German Chancellor Angela Merkel and French President Nicolas Sarkozy shattered
the bloc's most sacred taboo, conceding openly for the first time that Greece
might end up having to leave the tight-knit currency club it joined a decade
ago.
The admission, after an intense two-hour meeting with Greek
Prime Minister George Papandreou on the eve of a G20 summit, sets the eurozone
on a perilous course that could reverberate in Europe and beyond for decades.
Were Greece to leave the eurozone, a step that until now
European officials have said is technically and legally impossible, the
consequences would be devastating even though the country represents just 2.5%
of the 17-nation currency area's gross domestic product (GDP).
Just how devastating is difficult to say because the move
would take Europe and the global financial system into uncharted territory.
But what does seem clear is that an exit would spark
contagion to other peripheral countries as foreign investors pulled out en
masse. This in turn would hammer financial institutions across the bloc,
leading to bank runs and forcing the European Central Bank (ECB) to respond
with massive liquidity provisions and government bond purchases.
The central bank and all private and official sector creditors would have to write off their claims on Greece in one fell swoop.
The
resulting credit crunch, economists say, would make the freeze-up that followed
the 2008 bankruptcy of US investment bank Lehman Brothers seem mild.
"If Greece left the euro, the market pressures on the
countries perceived as the next most vulnerable would rapidly become
overwhelming," the Economist Intelligence Unit said in a recent report
entitled "After Eurogeddon."
"As the chain reaction spread across Europe, we think
contagion would be rapid, dramatic and uncontrollable at times."
Beyond the harrowing financial consequences, the move would
also be a crushing symbolic setback for Europe.
After more than half a century of closer integration, it
would open the door to a new era of disintegration.
Merkel herself has said an exit would lead to a devastating
"domino effect" across the eurozone.
"Not a single person would put their money in Europe
anymore," she said in late September.
Frustration at breaking point
This is what makes her and Sarkozy's about-face in Cannes so significant.
German officials said Papandreou's surprise call for a
referendum on the latest EU/IMF rescue package for Greece - a move that sparked
widespread panic in global financial markets - was the final straw for the
German and French leaders.
Frustration with Papandreou's government has been building
steadily since the bloc first bailed out Greece in May 2010. Since then Athens
has failed repeatedly to meet the fiscal targets set for it by its
international lenders.
Against hopes, its economy has also nose-dived. It is
expected to contract by over 5% this year and by 3% next year in what would be
its fourth straight year of recession. Unemployment has skyrocketed.
It is this economic collapse that has sapped popular support for Papandreou's government and the austerity-for-aid rescues from the EU and IMF.
Papandreou's referendum call reinforced the idea in major
European capitals that Greece may be too far gone to save and its political
leadership not credible enough to back up with billions more euros in taxpayer
money.
On Thursday, the Greek government appeared to be on the
brink of collapse. Sources in Papandreou's Socialist party told Reuters that
lawmakers were forging a proposal for a new coalition government headed by
former ECB vice president Lucas Papademos. The prime minister's chief of staff
said he had not resigned and had no plans to.
Regardless what happens, political and social turmoil in Greece looks sure to continue unabated. The resulting uncertainty will undermine confidence in the eurozone's ability to get a grip on the crisis.
The costs of keeping Greece in the euro, some European
officials now believe, may outweigh allowing it to leave.
"The euro as a whole must remain stable," Merkel
said on Wednesday night. "We would prefer to ensure this with Greece
rather than without it. But the top priority is stability."
Aid would not end with exit
An ECB working paper published in December 2009, just as
Greece's dire fiscal problems were coming to light, concluded that withdrawal
from the monetary union without a parallel withdrawal from the broader EU would
be legally impossible - a view that was backed up by the European Commission on
Thursday.
But even the Germans admit that Europe's obligations to
Greece would not end if it were to leave the currency bloc.
One senior official told Reuters on condition of anonymity
that the disorderly default that would result if Europe refused to give Athens
more aid would lead to a bank run within 48 hours, a mass flight of capital and
Greek citizens abroad, and instantly halt all money transactions by the Greek
government.
That could force Europe to fund core services such as
healthcare and water. A eurozone exit would make things even worse.
"You would have to ship truckloads of euros to Greece
on the sly" to prevent social implosion, the German official said, noting
the EU had been forced to take similar steps in Bosnia and Montenegro, and the
United States in Panama.
All this means that Europe is likely to do everything in its
power to avoid a Greek exit, even if it has now come around to the idea that it
could happen.
"As far as we're concerned this is the only option that is on the table," a European Commission spokesperson said on Thursday.
But ultimately it will be up to the Greeks, as Merkel and
Sarkozy made clear in Cannes.