Is everybody overstating the consequences of a Greek default and/or devaluation? The Economist points out that Europe has seen quite a few defaults in recent decades (Russia, Poland) and also break-ups of currency unions (Czechoslovakia, Yugoslavia) — and that none of these events caused a lot of lasting damage.

I’m not convinced, if only because the Russia default caused the collapse of LTCM and a serious crisis; if it weren’t for tough arm-twisting by the Fed and billions of private-sector dollars from America’s biggest banks, it could have been much worse. And the end of the koruna and the dinar also meant the end of the Czechoslovakia and Yugoslavia, and the worry is very much that if Greece or anybody else were to exit the euro, then the whole currency union could fall apart, endangering the EU itself.

More generally, financial markets are good at taking the collapse of risky assets in their stride: what they’re bad at is dealing with the collapse of assets they thought were safe. And until very recently, Greek bonds were considered to be an interest-rate play, not a credit play. As a result, the institutions owning them can ill afford to see big losses on them.

The euro was designed to be a super-safe currency; as such, the repercussions of it falling apart would surely be many orders of magnitude greater than anything we saw in the wake of the collapse of the unlamented Yugoslav dinar. Read the rest of this entry »