As euro area finance ministers hold an emergency meeting to address the Greek debt crisis, many questions loom about what a “Grexit” would mean for the weakened nation.
But what would the first exit from the monetary union mean for the future of the entire eurozone?
Steven Englander, Citi’s Global Head of G10 FX Strategy estimates that around 40% of the clients he meets with believe that a Grexit “would irrevocably lead to a breakup of the eurozone down the road.”
In a note to clients, however, Englander rejected this assertion, explaining that it was based off of the incorrect idea that a monetary union is a fixed exchange regime.
“The basic argument is that once it becomes clear that euro zone membership is not a one way street, risk premia will be priced into other countries that are viewed as potential leavers,” he wrote of those who think an exit could lead to the end of the eurozone. “For weaker euro members currency risk would be priced into fixed income markets, effectively permanently tightening monetary policy.”
In this train of thought, countries with the highest risk premium would find it necessary to exit and move their currency to a more sustainable level.
But Englander says this theory excludes an important distinction that would lead to more than just a slow exchange rate mechanism.
“This misses the major difference between a monetary union and fixed exchange rates — a central bank in a currency union can intervene credibly to stabilise internal asset markets in a way that central banks with pegs and ERM arrangements could not,” Englander wrote. “In the case of the euro, the ECB could extend its QE buying to offset the panic selling by the private sector. It has deeper pockets than the private sector, and if the contagion is unjustified, it will likely profit from fighting off the contagion.”
Still, Englander believes that a Grexit would be a “lose-lose” for the euro.
If there is fear of additional exits, investors will price subsequent exits and depreciations into EUR assets, including the EUR. Economic, political and financial pressure will probably add further downward pressure… Right now I don’t see an EUR-positive outcome in the event of Grexit, but it is possible that I am missing something.
On Monday, the euro was bouncing around, but ultimately little changed, against the US dollar right near $US1.14.