Pricing the Cost of a Greek Euro Exit

Wall Street Journal

As Greece girds for elections next month that could lead to its exit from the euro zone, economists are acknowledging an unsettling reality: No one knows what the bill will be.

A wide range of potential price tags has been reported, anywhere from €150 billion to €1 trillion euros ($1.27 trillion). But none of these are comprehensive, nor are they meant to be—they don't, for instance, weigh the cost of an exit against the cost of avoiding one. By comparison, the 2008 Troubled Asset Relief Program, known as TARP, was a $700 billion program initiated in response to the U.S. financial crisis.

The amounts could vary sharply depending on how Greece walks away, with each scenario introducing its own set of uncertainties. There is no real precedent for economists to analyze, as prior defaults or devaluations are very different. And any signals from investors are ambiguous: It's impossible to isolate Greece's contribution to stock-market gyrations this week from other factors.

Any number "for the costs would involve a huge amount of error," says Dean Baker, co-director of the Center for Economic and Policy Research, a left-leaning Washington, D.C., think tank. "There is such a wide range of uncertainty around the exact course of events." More important, he adds, a Greek exit from the euro would spur policies in response, from the European Union and from member states. Predicting those is more a matter of politics than economics.

"It goes beyond our rationality and touches on our behavioral and psychological aspects," says Constantin Gurdgiev, professor of finance at Trinity College, Dublin.

The most straightforward cost calculations are narrow, focused on impacts to lenders to Greece if the country defaults on much or all of its debt. That kind of cost appears to be what departing French finance minister François Baroin had in mind when he said this week a Greek exit would cost France €50 billion. Mr. Baroin is leaving his post as Socialist François Hollande brings in a new French government.

Eric Dor, director of research at the IESEG School of Management in Lille, France, puts potential losses to France at €66.4 billion, and to Germany at €89.8 billion—calling those upper bounds, since Greece could pay back some of that debt, albeit with a new currency widely expected to plummet relative to the euro right after it is introduced.

Those are just the direct costs, Dr. Dor says. "There would be a lot of indirect costs because the event could trigger an even deeper recession in Europe, lowering tax receipts."

The Institute of International Finance, a global association of banks that has represented private lenders to Greece in negotiations with the country, took a broader view. In a February report that leaked in March, it put the total cost at a minimum of €1 trillion, including over €700 billion that could be needed to prop up other troubled European economies, including Portugal and Italy.

An IIF spokesman declined to comment on the report, because it hasn't been released officially. "I don't want to even calculate the total cost to Europe of trying to stabilize the euro zone in the case of a Greek exit," IIF managing director Charles Dallara said in a speech in Dublin this week, according to an IIF transcript, "but I can tell you it would be huge."

The IIF isn't a disinterested party, economists say: It negotiated the Greek debt exchange in March, in which its members got new Greek bonds that would plummet in value in an exit.

"The IIF went for a trillion because, why not?" says Gary Jenkins, founder of Swordfish Research, a U.K. bond-analysis firm. "It's a great figure, sounds fantastic." However, Mr. Jenkins adds, "I don't think anyone can work out a precise figure. The uncertainties are just absolutely huge."

For costs further from the center of the crisis, those uncertainties grow. Economists say the pain from a Greek exit likely would spread to the U.S. economy as banks world-wide face a slowdown in fund flow and panicked depositors. However, none contacted for this column hazarded a guess as to how that might affect the U.S. economy.

Alan J. Auerbach, an economist at the University of California, Berkeley, cautioned that the IIF estimate is incomplete. It looks at gross costs, "not netting them against what it would cost to keep Greece going within the euro."

Just what would those costs be? Andreas Koutras, a partner of training for the London financial, advisory and training company In Touch Capital Markets, responds by asking, "You mean, what is the cost of throwing good money after bad? I don't know."

One potentially large cost to heading off a Greek exit from the euro zone could be borne by Greece itself. The country's economy has contracted under austerity measures designed to narrow the public debt. "Whatever the cost, growth will be faster afterwards than it would be if an attempt is made to keep the weaker currencies in the euro through continued austerity," Douglas McWilliams, founder and chief executive of the London-based Centre for Economics and Business Research, wrote on the company's website this week.

That growth case is bolstered by a comparison to Argentina's experience after defaulting on its debt in 2001. Its economy grew rapidly afterward. So did Russia's after devaluing the ruble in 1998 and defaulting on its debt. But neither case is close to a perfect analogue for Greece, economists say. Neither Argentina nor Russia was withdrawing from a currency union. And Greece is unlikely to be bolstered by rising oil prices, as was Russia. "Greece is very unlikely to find commodities" like Russia did, Mr. Jenkins says.

The Greek finance ministry declined to comment, citing the changeover this week to a caretaker government.

Economists might also turn to the stock market as a proxy. Perhaps the loss of market capitalization in the European markets this week—the Stoxx Europe 600 index fell 5.2% this week—is an indicator of how much a Greek exit might cost. But any signal from stocks is hazy, researchers say—and not just because other factors could be tugging on prices.

"Stock markets are notoriously unreliable in estimating anything of that order of magnitude," says Thomas Risse, director of the Center for Transnational Relations in Berlin. "These and other financial markets are currently driven by what one calls the 'herd effect.' "

And the herd is as confused as everyone else, Mr. Jenkins says. "This is such an extraordinarily difficult event to analyze and to quantify that in many ways I can understand stock markets to some degree not reacting to it totally. What possible value could you put on things if you think there's a chance the entire system could melt down?"