Greek deal or not, the euro is now a different beast

By invoking a Greek euro exit as a possible outcome of failed bailout negotiations, European governments have effectively rewritten a key tenet of the shared currency – and maybe even for the better.

Deal or no deal on staving off Greek default or ‘Grexit’, euro governments have talked openly for the first time of how Greece could slide uncontrollably out of the currency bloc if it failed to agree bailout terms and meet debt payments.

Of course, all insisted that keeping Greece in the bloc was still ‘Plan A’ at least. But the signaling was clear for all who wanted to hear: failure to reach a deal could reverse the “irrevocably fixed exchange rates” of European Union Treaties into something that was, after all, revocable.

The message was certainly clear to Greek depositors, who have withdrawn tens of billions of euros from banks this year and more than 4 billion euros last week alone.

And while German Chancellor Angela Merkel has studiously avoided talking of a Greek exit, her hawkish finance minister Wolfgang Schaueble made clear on a number of occasions that this was still a potential, if undesirable, outcome.

“We can’t rule it out,” he said in March, when asked if Greece could accidentally slide out of the euro.

Closer to the EU centreground, European Commission President Jean-Claude Juncker, a founding father of the euro, said Grexit was not on the table but that he couldn’t “pull a rabbit out of a hat” to prevent it.

Smaller countries bailed out along with Greece five years ago spoke likewise. Irish finance minister Michael Noonan said euro leaders had gone as far as they could to prevent Grexit. “The option now is to prepare for Plan B.”

While talk of an accidental Greek exit may have been a negotiating bluff never truly contemplated by European Union leaders, others claim powerful voices argued that a euro without Greece may be better off and that the rest of the zone could survive the divorce.

Either way, the message from European capitals was a far cry from European Central Bank chief Mario Draghi’s defiant 2012 speech on doing “whatever it takes” to safeguard the euro.

And the change of tone is important way beyond the Greek brinkmanship.

If it’s now conceivable that Greece could leave the bloc when push comes to shove, then it has to be at least theoretically possible for any euro member to go – however low the chances or unlikely the circumstances.

And this matters because of the way investors behaved in decade leading up to 2008, where the seeds of the crisis were sown in the huge buildup of banking, household, corporate and public debts across the currency zone when benchmark borrowing rates collapsed to Germany’s “risk free” rate.

In effect, private creditors saw no difference in risk between sovereign credits and were lending to all countries at ludicrously low rates regardless of government balances, default possibilities, political or redenomination risks.

Once the Lehman crisis hit and later when Greece revealed its public accounts hole in 2010, investors raced to the other extreme, ballooning bond spreads, forcing serial bailouts and threatening the collapse of the whole bloc.

If neither peak nor trough seemed was terribly well thought through, there are reasonable questions over political messages that bordered on guarantees and unreasonable “certainties.”

The ECB’s interventions since 2012, its backstops, liquidity injections and this year’s quantitative easing program, have helped to collapse spreads once again in recent years.

Yet few think a return to pre-2008 spreads makes any more sense than it did back then.

“There are a lot of idiots in financial markets: I don’t believe in rational markets. The idea that people were lending money on that scale to Greeks at German interest rates – they wanted their heads examined,” former UK finance minister and pro-EU Conservative Ken Clarke told the BBC on Monday.

Investors counter that they were simply taking the irreversibility of euro membership on the word of its designers and assumed, as proved at least partly correct over 2010-13, that bailouts would prevent sovereign default within the bloc.

University College Dublin professor Karl Whelan argues there was never a strict “no bailout” clause in euro treaties to begin with and, despite all the political rhetoric, financial rescues were always possible in extremis.

Markets opted to believe politicians about “no exit” but saw through the “no bailout” line and assumed the sheer political will behind the euro would trump all. Given the disastrous consequences, the political message needs a rewrite.

And if these Greek talks have ushered in a new world where exit and default are no longer unthinkable, bond investors will simply have to work harder on risk assessment.

Whether the cost of that is bearable by the euro economy is a more existential question for the currency. But somewhere between the bond extremes of 2006 and 2012, maybe where we are now with the help of the ECB, would be bearable and sensible.

The euro may already be a different beast as a result. [Reuters]