Running through unilateral Greek exit scenarios
I wrote this outline for Italy in November before the ECB’s Italian job. I didn’t and still don’t see an Italian exit or default as a baseline. However, a Greek exit for the eurozone has been my baseline for a number of months. Citigroup’s Willem Buiter has talked a lot about this recently. He and his colleagues call it "Grexit". Business Insider’s Simone Foxman has a good synopsis of that view.
Here’s how I see it happening, based on my Italian default post.
- Plan. The Greek government can plan for a redenomination into New Drachma in secret that takes advantage of the Greek law jurisdiction over their sovereign debt obligations.
- Law. “Euroization” would remain in place and the euro would continue as the currency of physical payment. However, New Drachma would become the national currency, pegged at 340.75, exactly the same rate as the Drachma was fixed on 19 June 2000 and converted into euros on 1 January 2002. All debt under Greek law would be redenominated into New Drachma at the 340.75 New Drachma exchange rate peg. This would effectively bring us back to 31 December 2001 for Greece.
- Taxes. The government would announce that henceforth it will tax exclusively in New Drachma. All municipal governments would be required by law to tax in New Drachma.
- Banks. Like the Argentines before them, the Greek government would convert all euro bank accounts legally into New Drachma. The systems would process as if it were euros because of the fixed peg, but legally the money would be New Drachma. This would make the Greek economy “euroized” but make the banking system redenominated into New Drachma.
- Retail. Retailers, all sellers of Greek goods, would then be forced to return to the double accounting treatment of pre-2002 whereby they denominate all transactions in both Drachma and Euros. Again, the paper money would be euros and each euro would initially be worth 340.75 New Drachma. The electronic money would legally be New Drachma, even while the systems said euro.
- Float. On day one, immediately after redominating, the Greek government would drop the 340.75 New Drachma exchange rate peg and float the new Drachma as a freely floating currency. From that day forward, foreign currency adjustments would need to be made between euro and New Drachma.
- Physical currency. New Drachma would be printed by the Bank of Greece and introduced to replace euros.
When the present government loses re-election in a few months, the new government will have difficult decisions to make. One of these will be whether to rescind the austerity deal now being hammered out. If they do not accept the deal, Greece must then exit the euro zone.
Not one single Greek would offer his/her Euros for New Drachmas in the certain knowledge of devaluation.
So, tell us a more realistic scenario.
Sorry to say this but the Greek’s would love and welcome the Drachma back, they never wanted the Euro in the first place.
The fact that the so many have transferred so much out of Greece already means that they will not be happy with exiting the Eurozone. I do not see exiting the Eurozone as inevitable. There could simply be a change in the rules to keep Greece in. Eventually that will result in a return of Greek held euro balances.
Hi Ed:
Just a random thought.
I think there is a mentality in America that does not agree with debt forgiveness for borrowers that may not be worthy of debt forgiveness when a current mortgage payee has made all the right moves. I think this is either an understated or an overlooked aspect of blog generality of housing problems. I know it’s there, but I’m just saying int the aggregate circles no one touches it outside of “strategic default”.
Despite that fact, I think this plays a major role in our political process. I think the people “playing by the rules” are a concern in the final agreements we see.
My random thought, is that given how great our fiscal nation is and how we can use fiscal policy as a means to an end because we’re in a fiscal union, is there not an underlying similarity to Europe. America my handle it’s difference better because there is financial and legal infrastructure, but are the conflicts that different? Do we not still suffer from the same human tendencies of I don’t want to pay for you and you don’t want to pay for me?
Politically, a home buyer bailout is a hot potato because some home buyers are current and some are not. Add to that some people don’t own homes and even some not chose to buy for all the right reasons and you get the EU minus the currency.
Sorry to add this one, as this has dragged on, but I have read so many comments about how the Euro has prevented the currency to adjust, but no one presents that old adjustment mechanism of gold leaving the country as an “automatic stabilizer”. It’s not like a floating currency is the only mechanism. The reason a floating currency worked is the same reason a gold standard worked. Only when the standard was pegged was when it went wrong.
Scott
I agree with you that the concept of debt forgiveness is abhorrent to many in the US. And I would venture to say the same is true in Europe and other contract-dominated societies.
In western society, contracts are considered sacred and the violator of the contract is considered to be the wrongful party. In cases of default, therefore, the defaulter is always seen as someone who has failed to live up to her contractual obligation. In times past, the defaulter’s moral character was in question. So the concept of letting these people off the hook in some way when they have been ‘defective’ in some way in conduct strikes a lot of people as unfair, undermining the entire ethos of a contract law based society. This whole law and attendant psychological apparatus of where moral obligations lie is well-entrenched in our society and a big reason to doubt that debt forgiveness can happen unless we are deep in a Depression.
I started to do a proposal myself of a possible process which grew to about six pages long in outline and yet is clearly incomplete. Every time I look at it I see more problems. Increasingly I have begun to wonder if it is legislatively and economically possible.
One cannot successfully introduce a weaker currency over a stronger one, without very heavy policing, and enforcement. No-one would willingly accept it. Commerce would be paralyzed. So it is a practical necessity to introduce a stronger (strong enough) currency.
But what Greek currency would be stronger than the Euro? Logic demands therefore that the process of devaluation and adjustment must precede the new currencies introduction.
So the process of devaluation and adjustment must be inside the introducing legislation. Bear with me here…
If the process of devaluation and readjustment could possibly be inside the enabling legislation – there would be no further need to change the currency. There would be no problem left for that currency to solve.
Having caged the tiger there is no longer any need to shoot it.
It is not only impractical to leave the Euro it is is unnecessary. If you could do it, you wouldn’t.
Up until 2 days ago I would have agreed with you 100%. However, after reading “Boomerang”,Michael Lewis’ book about the financial crisis and the incredible state of affairs in Greece my opinion of the Greek tragedy and the German response has done a 180 degree turn.
It is now clear to me that the breathtaking incompetence and the disastrous state of affairs in Greece is solely of Greece’s doing. And that the political elites in Greece that are shepherding the country through this very difficult time realizes that Greece has no choice but to rebuild its system from the ground up. Even if Greece defaulted, exited the Eurozone, and resorted to the Drachma it would, in fact, be back to square one, except this time without the advantage of being part of the Eurozone.
Any Greek politician with any intelligence is using this crisis in Greece to impose wide ranging reforms that are desperately needed to turn it into a viable and functioning economy. If Greece takes the least path of resistance and exit’s the Eurozone it will turn the country into a third world country with absolutely no prospects for pulling itself out of the mire of their own making.
Any Greek sensible enough to realize this will realize that the savage reforms that they are going through are absolutely necessary and will take a decade or more to achieve. They will also realize that Greece has no other alternatives. For this reason alone I believe the Greeks will stay in the Eurozone. To leave is slow motion suicide.