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What's the danger for a country leaving the Eurozone?

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(Read caption) The European Union flag flutters in the wind with the ancient Parthenon temple, right, and the Propylaea, left, at the Acropolis Hill, in Athens in this file photo. Bernstein argues that if a country like Greece were to drop out of the Eurozone, it could be financially devastating for the dropout country.

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The more we learn about this one, the better.  No one knows the likelihood of say, Greece, to pull an example out of the air, pulling out of the Eurozone and reverting to the drachma.  I’d guess not, but the potential is obviously real and growing.

What would happen if a country broke away?  Well, the problem is all in the transition.  Contracts between creditors (lenders) and debtors (borrowers), including everything from bonds to cheese deliveries, have to be renegotiated, and done so at the value the world decides to assign to the new currency, e.g., the ND (“new drachma”).  And one can imagine that assignment will not be flattering to the dropout country.

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Bank runs are a worry—those holding euros in Greek banks will be assigned the new value in “NDs,” and account holders will want to avoid that devaluation.

As weaker economies dropout, their currencies will fall relative to those of stronger ones, like the US dollar or the euro, as currency markets once again can vote on an individual country’s currency, as opposed to that of a currency block.  This could help them adjust through exports, but we’re probably not talking about gentle devaluation here; we’re talking systemic shock.

Basically, the transition is by definition a huge devaluation event.  You leave the currency union because you can’t achieve solvency within it, and once you’re free, the world casts judgment by revaluing your currency in ways that reflect the conditions of your exit.  Any support you enjoyed from being a weaker player of a stronger team vanishes.

These realities are why I suspect the Eurozone remains intact.  But I wouldn’t bet more than an ND or two on it.

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