Daniel Gros at WSJ asks the interesting question:

The real question is: Would a messy (and massive) default under which the country refuses to repay in full signify the end of the euro?

Yes and no.

A messy default would certainly end the ideal of the euro area as a club whose members are all equal and work toward a common goal, namely the stability of the common currency. Membership in such a club protects against financial problems, because members are supposed to behave well and help each other in case of unjustified speculative attacks. Although the EU Treaty says that members are not liable for each other’s public debt, there is an implicit political commitment, as we see right now, to provide emergency help.

The quid pro quo for this solidarity is of course the expectation that all members abide by certain standards, for example those embodied in the Stability and Growth Pact, that aim to limit budget deficits and debts. The continuing misreporting of fiscal data by Greece has already severely damaged this ideal. But the “club” could still be saved if Greece undertook a determined national effort to service its debt and avoid a messy default.

However, even a messy default by Greece alone would not necessarily mean the end of the euro area. The day after a formal default, Greek banks would no longer have access to the regular monetary policy operations of the European Central Bank. The ECB could no longer accept their collateral, Greek debt, which would immediately have less than junk status. The country would thus effectively cease to be part of the euro area. Its status would resemble that of Montenegro, which adopted the euro as legal tender without officially being a member of the single currency zone.

In Greece, following a messy default, euro notes and coins would still circulate in the economy, but one euro on a Greek bank account would no longer be automatically equivalent to one euro on a bank account elsewhere in the euro area, as Greek banks might immediately become insolvent and thus be shut out of the payment systems. Until Greek solvency has been re-established, the euro zone would thus de facto have lost one of its members—although the Greek Central Bank head would still sit on the Governing Council of the ECB, and the Greek finance minister would still be a member of the Euro Group, with his country’s normal voting powers intact.

The Greek economy would collapse, but the impact on the rest of the single currency zone should be minor, given that the country represents only about 2% of the euro area’s GDP and is not home to any systemically relevant financial institution.

In many ways, a Greek default would leave the euro zone in better shape. Its institutions would probably be strengthened, because it would have become clear that the framework is strong enough to withstand the failure of one of its members. Tolerance toward deficit violations and inaccurate reporting would be much reduced. The club would have been transformed into a federation whose peripheral components can be told to “get lost,” so to speak. As a result, majority voting would tend to replace consensus as the normal way of decision-making.

The potential monkey wrench is contagion. The main reason Germany is now agreeing to accelerate the Greek bailout package is that tension on Spanish financial markets has arisen over the past several days. In contrast to Greece and Portugal, Spain (and even more so Italy) are indeed “too big to fail.”

Will contagion prove fatal? The fundamentals of Spain and Italy, especially their self-financing capacities, are much stronger than in Greece and Portugal. Moreover, neither Spain nor Italy would gain much from a default, since most of their public debt is held by their own citizens. A default would thus not lower the foreign debt of the country. For Greece, by contrast, 90% of all public debt is held by foreigners, who could be expropriated by a default.

However, markets can at times be irrational. The real test of the euro area is thus not Greece, but whether it can protect members that do not have an insolvency problem from speculative attacks.

The signals are so far mixed. After an initial bout of generalized nervousness in February, when it first became clear that the second leg of the financial crisis could imply sovereign default, financial markets have increasingly differentiated among the weaker members of the euro area. Risk premia have tended to move together in the same direction, but with completely different orders of magnitude. The spreads on Spanish bonds have increased, but they remain less than one third of those of Greece, with Italy even lower.

The fate of euro is not being decided in Athens, but in Madrid and Rome.