CANNES—It may well be remembered as the day the euro zone began to break apart.
At a late night news conference in Cannes on Wednesday, German Chancellor Angela Merkel and French President Nicolas Sarkozy shattered the bloc’s most sacred taboo, conceding openly for the first time that Greece might end up having to leave the tight-knit currency club it joined a decade ago.
The admission, after an intense two-hour meeting with Greek Prime Minister George Papandreou on the eve of a G20 summit, sets the euro zone on a perilous course that could reverberate in Europe and beyond for decades.
Were Greece to leave the euro zone, a step that until now European officials have said is technically and legally impossible, the consequences would be devastating even though the country represents just 2.5 percent of the 17-nation currency area’s gross domestic product (GDP).
Just how devastating is difficult to say because the move would take Europe and the global financial system into uncharted territory.
But what does seem clear is that an exit would spark contagion to other peripheral countries as foreign investors pulled out en masse. This in turn would hammer financial institutions across the bloc, leading to bank runs and forcing the European Central Bank (ECB) to respond with massive liquidity provisions and government bond purchases.
The central bank and all private and official sector creditors would have to write off their claims on Greece in one fell swoop. The resulting credit crunch, economists say, would make the freeze-up that followed the 2008 bankruptcy of U.S. investment bank Lehman Brothers seem mild.
“If Greece left the euro, the market pressures on the countries perceived as the next most vulnerable would rapidly become overwhelming,” the Economist Intelligence Unit said in a recent report entitled “After Eurogeddon”.
“As the chain reaction spread across Europe, we think contagion would be rapid, dramatic and uncontrollable at times.”