Mutually assured destruction in the eurozone
Jean Pisani-Ferry

The relationship between Greece and the rest of the eurozone is increasingly reminiscent of the cold war’s balance of terror. We are of course speaking only of financial terror and Greece is not the Soviet Union, but the mechanics are strikingly similar.

Start with the options for Athens. It is important to distinguish between budgetary and external aspects. Greece is forecast to record a slight primary budget deficit in 2012, so should it default, forcing European partners to unplug assistance, it would have to tighten more, but only marginally. However the current account deficit is still expected to be close to 8 per cent of gross domestic product. Without assistance and in the absence of significant private capital inflows, the European Central Bank would have to increase its exposure even further. Should it refuse, as likely, Greece would be forced into an exit and it would have to close its external deficit precipitously. What remains of the economy would fall into chaos. Financial disruption would be massive, resulting in a chain of bankruptcies. Currency depreciation would substantially overshoot, making foreign goods unaffordable, especially as policy institutions have no credibility. Eventually, depreciation would help rebuild competitiveness, but in the meantime the damage would be severe.
A unilateral Greek default would undoubtedly be costly to its partners. Official exposure to Greece through assistance loans, ECB claims on the national central bank and ECB holdings of government bonds amount to more than