A Greece Exit Would Cost A Fortune -- That Doesn't Mean It's Impossible

There’s an argument that because a Greek exit of the Euro area is going to be very messy and very costly, not only for the Greeks, but literally the whole of Europe, that there is enough incentive for everyone in their power to avoid this scenario playing out.  The latest making this argument appears to be Joe Weisenthal, who just argued with Felix Salmon on this issue.

Indeed, the cost of a Greek exit will be painfully high not only to Greeks, but the whole of Europe, and even the whole world.  Greek’s euro redenomination will likely cause massive devaluation of the new currencies.  Banks’ and private sectors’ claims on Greek entities would be very hard to be collected.  Banks outside Greece will suffer yet more losses, compromising their already-weak capital position.  Bank runs could happen to at least most of periphery and capital would flow to Germany, thus causing great stress in the banking system.  Trade would collapse.  Everything would collapse. 

But is this a sufficient threat for the European politicians so that they have enough incentive to make sure that a Grexit can never happen?

Greek people do like to stay in the Eurozone, and European politicians appear to be trying to avoid a Grexit.  But I have some doubt as to whether this can be a sufficient justification to believe that a Grexit can’t happen.

In the early 20th century, when the globalisation of that time was at its height, a British journalist Sir Norman Angell, then the reporter of the Daily Mail French edition in Paris, wrote a little book called “Europe’s optical illusion“.  In it, he argued that modern warfare cannot possibly be a profitable endeavour even for the victor because of the increasingly integrated economy and interlinked financial system, which guaranteed that even the winning side will end up being a loser.

How have conditions so changed that terms which were applicable to the ancient world; in one sense at least to the mediaeval world, and, in another sense still to the world of that political renaissance which gave to Great Britain its Empire, are no longer applicable in any sense to the conditions of the world as we find them to-day? How has it become impossible for one nation to take by conquest the wealth of another for the benefit of the people of the conqueror ? How is it that we are confronted by the absurdity (which the facts of our own Empire go to prove) of the conquering people being able to exact from conquered territory rather less than more advantage than it was able to do before the conquest took place?

The cause of this profound change, largely the work of the last 30 years, is due mainly to the complex financial interdependence of the capitals of the world, a condition in which disturbance in New York involves financial and commercial disturbance in London, and, if sufficiently grave, compels financiers of London to co-operate with those of New York to put an end to the crisis, not as a matter of altruism, but as a matter of commercial self-protection. The complexity of modern finance makes New York dependent on London, London upon Paris, Paris upon Berlin, to a greater degree
than has ever yet been the case in history.

This interdependence is the result of the daily use of those contrivances of civilisation which date from yesterday—the rapid post, the instantaneous dissemination of financial and commercial information by means of telegraphy, and generally the incredible progress of rapidity in communication which has put the hall-dozen chief capitals of Christendom in closer contact financially, and has rendered them more dependent the one upon the other than were the chief cities of Great Britain less than a hundred years ago.

(pp. 43 – 45)

He also outlined a scenario where (God forbid) that if German’s Army were too loot the Bank of England, what would then happen:

What would be the result of such an action on the part of a German Army in London? The first effect, of course, would be that, as the Bank of England is the banker of all other banks, there would be a run on every bank in England, and all would suspend payment. But, simultaneously, German bankers, many with credit in London, would feel the effect; merchants the world over threatened with ruin by the effect of the collapse in London would immediately call in all their credits in Germany, and German finance would present a condition of chaos hardly less terrible than that in England. The German generalissimo in London might be no more civilised than Attila himself, but he would soon find the difference between himself and Attila. Attila, luckily for him, did not have to worry about a bank rate and such like complications ; but the German general, while trying to sack the Bank of England, would find that his own balance (did he possess one) in the Bank of Berlin would have vanished into thin air, and the value of even the best of his investments dwindled as though by a miracle; and that for the sake of loot, amounting to a few sovereigns apiece among his soldiery, he would have sacrificed the greater part of his own personal fortune. It is as certain as anything can be that were the German Army guilty of such economic vandalism there is no considerable institution in Germany that would escape grave damage; a damage in credit and security serious as to constitute a loss immensely greater * than the value of the loot obtained. It is not putting the case too strongly to say that tor every pound taken from the Bank of England German trade would suffer a thousand. The influence of the whole finance of Germany would be brought to bear on the German Government to put an end to a situation ruinous to German trade, and German finance would only be saved from utter collapse by the undertaking on the part of the German Government scrupulously to respect private property, and especially bank reserves. It is true the German Jingoes might wonder what they had made war for, and an elementary lesson in international finance which the occasion afforded would do more to cool their blood than the greatness of the British Navy. For it is a fact in human nature that men will fight more readily than they will pay, and that they will take personal risks much more readily than they will disgorge money, or for that matter earn it. ” Man/’ in the language of Bacon, ” loves danger better than travail.”

Events which are still fresh in the memory of business men show the extraordinary interdependence of the modern financial world. A financial crisis in New York sends up the English bank rate to 7 per cent., thus involving the ruin of many English businesses which might otherwise have weathered a difficult period. It thus happens that one section of the financial world is against its will compelled to come to the rescue of any other considerable section which may be in distress.

(pp. 46 – 49)

The possible consequence of a run in one banking system and its effect on other banking system is not so much different in those days from today.  Earlier, I wrote briefly about the failure of an Austrian Bank Credit-Anstalt and its consequence on the whole of European banking system.  And should Grexit happen, the worst case scenario, I suspect that it is not going to be all that different either.

Now, German Army did not ever have a chance to loot Bank of England in both world wars, but Sir Norman Angell is right about the fact that wars are very costly, and that both the victors and the losers will be very much harmed, of which John Maynard Keynes has predicted in The Economic Consequences of the Peace.  Yes, wars were so ruinous, and yet they fought it.

Greek exit of the Euro zone will be ruinous, financially.  It appears, however, to be just too early to say “no, that will not happen”.

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