By Michael Grogan, First Class Analytics, 
  • A temporary Greek exit from the Eurozone would significantly undermine confidence in the euro currency.
  • In this instance, contagion would not be contained and could possibly spread to other European countries.
  • With a default looking more likely, an outright exit could possibly allow for a more self-contained management of the crisis.
With Greece remaining under pressure to meet its last debt obligations, confusion remains as to the best course of action for the country. Various measures have been proposed thus far; the most obvious being for Greece to abandon the euro currency and return to the drachma. However, other potential solutions have been in the grapevine over the past month including Greece defaulting without leaving the euro, and most recently a potential exit with a view to Greece rejoining the euro at a later date.

I had previously stated that Greece should either meet its debt obligations and remain in the euro, or default and leave the eurozone. A Greek default while retaining the euro currency would not relieve potential contagion in Greece as a result of failure to meet debt obligations. However, I would argue that a temporary exit from the euro is simply overstepping the mark at this point.

Hans-Warner Sinn, President of the Ifo Institute for Economic Research was quoted as saying:

Isn’t it better to have a more flexible euro where someone can leave temporarily and return later with a devalued currency, rather than trying to impose the devaluation internally? This is a recipe for maximizing unemployment and turmoil.

I remain highly unconvinced by this argument, which appears to suggest that Greece should exit temporarily, allowing the euro to weaken and then rejoining with a devalued currency. The Eurozone would effectively absorb the contagion that would be more self-contained should Greece decide to part ways. However, the euro would not only trade lower as a result of contagion, but also due to a potentially undermined confidence in the currency. Should Greece be able to exit and enter at will, who is to say that other indebted countries such as Spain or Italy could not attempt the same?

I see the Greek crisis as being a critical test for the Eurozone’s reputation at this point in time. By allowing Greece a temporary exit, the Eurozone will have demonstrated that the guidelines regarding entry and exit are not being strictly enforced, and this could lead to lower confidence in the euro on the part of international investors.

The strength of the euro (or any currency, for that matter) is largely based on the premise that the nation(s) using that currency are able to meet the associated debt obligations. Failure to do so will either be reflected in a weaker currency – or in the case of Europe the country in question should no longer hold the right to that currency as doing so would undermine investor confidence.

Ultimately, default is looking increasingly likely for Greece. While there will be a degree of volatility across both Greece and the Eurozone given a Greek exit, an outright exit would allow a more self-contained management of the crisis. Simply allowing for a temporary exit would undermine the reputation of the Eurozone, and in my view this is too big a risk to justify keeping Greece in the euro by any means possible.