Planning for 'Grexit'

An orderly Greek exit from the euro has its benefits

Observers of Europe's markets are preparing for a roller-coaster ride. The new anti-austerity government in Greece is settling down to a game of hardball, first with the European Central Bank (ECB) and then with its various creditors in northern Europe. Irrational optimism over a possible rescue plan caused the Athens stock market to rise by over 11 per cent on Tuesday and sent government bond yields down by a percentage point; but those gains could likely prove completely illusory as and when the plan is comprehensively rejected by the ECB. Such volatility is likely to be par for the course. The Greek government has reportedly already retreated from its pre-election stand of a big haircut for all creditors on Greek debt; the haggling at the moment is over bridge financing until a restructuring of existing loans can be worked out. This is a reminder that Greece itself is very short of options. The new government must deal with its people who are strongly anti-Germany but pro-euro. The ECB and northern European creditors will no doubt see the contradiction in the Greek electorate's stand and take full advantage of it.

The odd thing, however, is that beyond the Greek volatility, matters are not as dark for Europe as they could be. Several points should suggest that a structural recovery might be on the horizon. First, there is the secular decline in energy prices. As Europe is a net energy importer, there will no doubt be a boost to its manufacturing as and when its famously inflexible markets can adjust. Then there is the quantitative easing (QE) plan announced by the ECB, in a major victory for the bank's governor, Mario Draghi. If production is poised for a revival, the QE programme could well provide the liquidity needed to finance it. Finally, the effect of large-scale QE will be, inevitably, a downward pressure on the value of the euro. This will make Europe's exports more competitive - and perhaps kick-start export growth even in relatively high-cost economies like France and Italy.

Many commentators have correctly viewed the recent Greek election as making a forced exit from the euro zone more likely. There remains strong political resistance to this eventuality, however - at least in public. The opinion is gaining ground, however, that a Greek exit - or "Grexit" - would, if planned, be the best thing all round. It would allow the Greeks to inflate their way out of immediate trouble and reform at their own pace. Countries such as Spain would escape the political turmoil that the example of successful Greek brinkmanship would bring. And investors, including those in northern Europe, would benefit from the end of Greece-induced volatility, which would allow Europe to take advantage of structural tailwinds. Hopefully, behind closed doors, plans for an orderly "Grexit" are being formulated as well.