"Let me illustrate what bond spreads are doing."

Photographer: Kostas Tsironis/Bloomberg

Greece's Tremors Felt in Italy and Spain

Mark Gilbert is a Bloomberg View columnist and writes editorials on economics, finance and politics. He was London bureau chief for Bloomberg News and is the author of “Complicit: How Greed and Collusion Made the Credit Crisis Unstoppable.”
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One reason European Union officials are allowing Greece to toddle dangerously close to the cliff top of exiting the euro is their oft-asserted belief that the situation is ring-fenced. A Greek default or departure from the single currency would be its own affair, the argument goes, without spillover effects. But that's turning out to be not quite as true as Europe's leaders would like to have us all believe.

With the European Commission discussing what Valdis Dombrovskis, vice president for euro policy, euphemistically calls "less favorable scenarios," investors are betting on contagion. And by driving Spanish and Italian yields higher, at the same time as U.S. and German levels decline, they're suggesting that complacency over Greece's exit may be misplaced at best:

Source: Bloomberg

It's not just financial markets that are taking fright at the brinksmanship between Greece and its lenders. With the common-currency project at risk of unravelling, the real economy is also having a conniption. Figures today show German confidence slumped for a third month in June to its lowest level since November, and was significantly weaker than economists had forecast.

It's possible the current contagion could reverse no matter which way the Greek crisis gets resolved. It may turn out that it’s the uncertainty that's rattling investors, and that they're indifferent to whether Greece stays in the euro or goes, so long as there's some finality to the outcome. "We are pretty much waiting for almost any outcome to buy," Luca Paolini, who helps oversee about $460 billion as chief strategist at Pictet Asset Management, told Bloomberg reporters Inyoung Hwang and Sofia Horta e Costa. "If there is a Grexit or a default, there will be a final selloff, which will be a good entry point for us. The fundamentals of QE and earnings growth would then reassert themselves."

Greece contributes less than 2 percent of the euro region's gross domestic product, and European banks have slashed their exposures to Greek assets in recent years -- hence the argument that a car crash involving Athens might leave bystanders unscathed.

That's dangerous thinking, though, since its departure would pose an existential threat to the euro. European Union Economic and Monetary Commissioner Pierre Moscovici obliquely characterized the risk that dare not speak its name, when he said on Tuesday that:

I’m attached to two characteristics of the euro. The first one is integrity and the second one is irreversibility. To me, the euro is more than a fixed-rate zone. It’s more than that; it’s really a single currency.

By abandoning the currency, Greece would disprove the "irreversibility" part of the equation, which would fatally wound the "single-currency-not-just-currency-pegs" conclusion. And that, in turn, could induce traders to try to force more euro members to quit the club the next time there's a whiff of economic trouble on the periphery of the continent. That's the risk that the euro's guardians are taking as they flirt with Greece's exit. 

This column does not necessarily reflect the opinion of Bloomberg View's editorial board or Bloomberg LP, its owners and investors.

To contact the author on this story:
Mark Gilbert at magilbert@bloomberg.net

To contact the editor on this story:
Cameron Abadi at cabadi2@bloomberg.net