Don’t panic: The sky won’t fall in if Greece decides to leave the euro

There will be no global rout nor all-out crash if Greece leaves the euro - it is too small to matter

A European Union flag is flying over the temple of Parthenon on Acropolis hill in Athens
Greece is the one country that the eurozone can afford to lose Credit: Photo: EPA

Slowly but surely, we are moving to a denouement in this latest incarnation of the eurozone crisis. Nobody knows for sure what is going to happen – but there is a greater chance than ever before that Greece will eventually quit the eurozone and default on its debts. Greeks and Germans are refusing to move back from the brink, which means that a complete breakdown now looks eerily possible.

Many investors and analysts will be tempted to panic at the thought of a possible Grexit. They certainly should be very concerned. But the slightly boring reality is that the world won’t end if the Greeks decide to quit the single currency. The financial markets will experience extreme volatility in the short term, of course, and anybody with exposure to Greek markets and Greek debt will lose heavily. But there will be no global rout, no all-out crash. Greece is too small to matter, and 77pc of Greek government debt is owned by official bodies or governments. There will be huge problems, and a major row over Greece’s Target 2 liabilities to the European Central Bank. But the sky won’t fall in.

Until now, the yields of the other troubled eurozone economies haven’t reacted to the Greek negotiations, probably because the markets believe that some sort of deal will eventually be reached. That, after all, is always the City’s default position: bankers inevitably think that a compromise is better than nothing, and that political actors are “rational”, as defined by the received wisdom of the day. The reality is very different. Countries do default and they do quit currency unions. Monetary textbooks are replete with such cases; and this is not the end of history. The euro is not “irreversible” – nothing is.

I’m more sanguine than some observers such as Capital Economics, which believes that a Grexit will trigger “a seismic reaction across global markets”. Greece’s economy will face short-term devastation, to be sure. But the global effect will be modest.

Any major sell-off will be limited in scope and duration. Investors will assume that a Grexit was a one-off, a warning to others to get their act together. Greece is the one country that the eurozone can afford to lose. In fact, there are at least some in the chancelleries of Europe who believe that the chaos that Greece would face in the event of a precipitated departure from the euro would serve as a warning to others. A Grexit, the argument goes, would reduce the chances of any further break-up, and nip populist uprisings in the bud in Spain and elsewhere.

The German public agrees: an N24/Emnid poll shows that 47pc of German voters believe that a Greek departure would be a one-off; just 39pc say that it would threaten the existence of the entire eurozone.

There are two other reasons why investors will be more relaxed: the ECB’s quantitative easing programme ought to keep bond yields low and the Outright Monetary Transactions programme ensure the survival of the euro.

It is true that the latter can only be activated for economies that are enrolled in and abiding by the terms of a troika programme. But the markets will expect this to be a bluff: with Greece gone, they will assume that the eurozone and the EU will do all in their power to keep countries in the single currency at any cost. There is another reason why yields will stay low: the spectre of low growth and deflation in some parts of the eurozone will continue to cancel out an increased default risk premium.

What of the foreign exchange markets? Paradoxically, and here I agree with Capital Economics, the euro is unlikely to fall much overall. It could even rise. Finally, we would expect safe-haven currencies to do well, partly at the expense of the euro. The prospect of QE has already pushed down the value of the single currency; meanwhile, CFTC numbers reveal that net short positions for the euro – in other words, bets that it will drop in value – are already near a record high.

A Grexit would be a major event, a defining moment for the global economy. But it will not by itself prove catastrophic to the rest of us.

allister.heath@telegraph.co.uk