Why would Greece's leaving the EMU result in "incalculable" damage?

That’s a quote from Angela Merkel, specifically

My question: Why.

I follow the financial markets pretty closely. I read a variety of publications and spend at least 3 or 4 hours per day watching the financial news and occasionally trading. Even so, I don’t really see why this would be so devastating.

The obvious question being … who’s next? How bad does it have to be before someone is kicked out of the Euro? How much effort will be put into saving the next country, once the precedent has been set? What value is there to a euro where half the countries that used it don’t use it any more…? A currency for almost all of Europe is great. A currency for some of the North Sea countries is not as impressive - certainly not a rival to the US dollar.

Politicians for the troubled countries will think - it’s simpler to separate out now, than to wait until they’ve racked up so much euro-denominated debt that a devaluation won’t work (the cae with Greece).

The problem is that all the obligations - salaries, pensions, etc. - are denominated in euros. It’s easier if they are in the local currency, so instead of having to say “we cut your pension in half” they simply allow the local currency value to slide. So instead of spending the last 10 years borrowing in euros to pay high slaaries and pensions, they could have borrowed a lot less (much debt would still be in an extenal currency) to pay a lot smaller pensions and wages.

As soon as Ireland, Italy, Spain, Portugal, etc. realize this is a quick way to get a debt under control, there goes a lot of the Euro. That just leaves the Germans as the major controllers of the euro-mark, and the French as the main country riding their coat-tails. How long will the French do that?

Aside from the immediate damage to Greece, which would have to switch to a new currency, it would ruin market confidence in the Euro as a whole. It would set a precedent that if a Euro state takes on too much debt, it can simply leave the Eurozone and no longer be subject to the oversight of the European Central Bank and not benefit from the stability of a large unified currency. Bondholders of Euro-denominated debt might find themselves wondering if they’ll have to accept payment in some new fly-by-night currency if things get a little wobbly.

Now maybe there’s merit in that calculation: if Eurozone members are that unstable then perhaps confidence in the Euro shouldn’t be as high as it is, anyway. But if there is a Greek default, that will prove to the market that all their worst fears are coming true.

The moment it was confirmed that Greece was leaving, all Greek holders of euro accounts would try to get their money out and into foreign euro accounts to avoid their funds being devalued into new drachmas, or whatever the hell it gets called. In fact it’s happening already, Greek money is buying up real estate in central London as a hedge.

The bigger worry is that as soon as it was confirmed Greece was leaving, people would try and get their money out of banks in other Eurozone countries that looked like they might also be driven out by similar circumstances, causing a widening bank run in Portugal, Ireland, etc.

The point of the Euro is that a Euro in a Portugese bank is supposed to be worth the same as one in an a German bank. But if there’s some meaningful chance that these countries might all of a sudden seize all your Euros and replace them with other (presumably less valuable) currencies, then that risk means even if the countries don’t end up pulling out, your Portugese-Euro has become worth something different then your German banked Euro, and people will start shuffling their money around to find a place where its worth the most.