Greek euro exit would hit at home, but fallout could be global

Spiralling inflation. A collapsed banking system. Hundreds of billions of dollars in unpayable debts and likely isolation from the world financial community.

That much Greece can count on — at least initially — if its political paralysis continues and it leaves the euro.

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Patrick Legland, head of research at Societe Generale SA, discusses the U.S. economy and possible implications of Greece leaving the euro. He speaks with Maryam Nemazee on Bloomberg Television's “The Pulse.” (Source: Bloomberg)

But the fallout would extend well beyond Greece’s borders, and analysts have been struggling to grasp whether it would upend markets as the collapse of Lehman Brothers did in 2008 or — if Europe’s financial systems prove durable and its politicians adept in response — simply pass with a shrug.

There could be immediate risks to the Spanish and Italian economies: Tens of billions of dollars have left those nations in recent months as investors doubt their ability to both control rising public debt and boost their economies from recession. A Greek departure from the euro would, officials and analysts fear, push the lack of confidence in the euro zone to another level, accelerate that capital flight and leave one or both nations close to economic collapse.

It is a pattern reminiscent of what happened in Latin America and Asia in the 1990s, and it is the most likely way that a Greek exit from the euro could ignite a global round of financial contagion. The risks were highlighted Thursday when the Moody’s rating agency cut its assessment of Spanish banks, saying it had less confidence in the ability of the Spanish government to support the country’s financial system.

If the crisis “turns to bigger players like Spain and Italy, through so many channels — trade, capital flows — it becomes global pretty quickly,” said Rebecca Patterson, chief market strategist with JPMorgan Asset Management. “If you own a Spanish bond what would you do? Even if in the long term it works out, there are other things to do with your portfolio ... What are we advising? We are staying away.”

That strategy of euro avoidance is one reason the interest rates Spain must pay to borrow money have risen to levels that officials in Madrid acknowledge they cannot sustain for long. Interest rates on some shorter term bonds have nearly doubled this year; longer term Spanish bonds are now being resold on secondary markets at rates equivalent to five percentage points a year more than Germany pays — a disturbing “spread” for a nation that just a few years ago was working hard to have its economy converge toward a German ideal.

Most analysts and officials agree it will only get worse if Greece drops the euro — an event for which there is no procedure, guidebook or precedent.

There are potential benefits to an exit, although they would take time to become clear. By controlling its own money supply and exchange rates, the country could make its exports more competitive and help set the stage for recovery. Officials in Athens could also count on help from their central bank in financing government deficits — rather than being dependent on the stricter rules of the European Central Bank in Frankfurt, which prohibit financing of government debts.