What would a Greek exit from the eurozone look like?
Rumors are rife of a Greek exit from the eurozone. While no country has yet dropped the common currency, there are some indications of what will transpire if Greece does.
Odysseus, hero of Greek mythology, once had to navigate his ship between two horrible monsters. Rather than risking the loss of his the entire vessel to Charybdis, he sailed past Scylla and sacrificed part of his crew.
Modern-day Greeks face a similar dilemma. Should they endure the austerity measures demanded by the European Union and the International Monetary Fund (IMF) in exchange for bailout funds that will be used to pay bank debts and allow the country to stay in the eurozone? Or should they reject the spending cuts and lose the bailout, requiring that they leave the currency union and return to the drachma they so happily abandoned in 2001 (at an exchange of 340.75 drachmas for each euro).
With a re-do of national elections scheduled for June, and anti-bailout parties enjoying substantial popular support, thereâ€™s a real possibility that Greece could rebel against the deep spending cuts demanded by Germany Â â€“ which makes it a possibility that Greeceâ€™s days in the euro could be numbered.
What are the mechanics of a country leaving the euro?Â
The EU founders did not anticipate an exit by any member states, so there are no legal procedures for such a case. Given the immense significance of the common currency â€“ it is seen as the most important symbol for Europe's political unity â€“ considering a Greek exit was anathema in European capitals until very recently.
At their first meeting in Berlin on May 15, the new French President Francois Hollande and German Chancellor Angela Merkel both stuck to that line, proclaiming a common will to keep Greece in the eurozone. But on the same day, IMF chief Christine Lagarde warned that if Greece did not honor its budgetary commitments, Europe should be prepared for a Greek exit, â€śwhich must be orderly.â€ť
It is unlikely that the eurozone will directly kick Greece out, both because there is no legal basis for it and because it would send the wrong signal. "Solidarity" is a term Chancellor Merkel has used often when referring to Greece. But Europe can create conditions that practically force Greece to exit on its own.Â
A large majority of Greeks â€“ including those who reject the conditions of the bailout â€“ oppose leaving the eurozone, according to recent polls.
Itâ€™s possible that, after June elections, a new Greek government will refuse to comply with requirements for receiving the bailout, ending payments to Greece and prompting the European Central Bank to stop the recapitalization of Greek banks.
To prevent its banking system from collapsing, Greece would have to leave the euro, switching to its new-old currency to provide funds for its banking system. If this happened, it's unlikely Greece would ever pay back its debt.
â€śLeaving the euro means we have to default first,â€ť says Nicholas Theocarakis, economist at the National University of Athens. â€śThere is no way we can pay back debts made in euros in any other currency, say the drachma.â€ť
How would this affect the value of the euro? How would they determine the value of the drachma?Â
The uncertainty created by a Greek default and eurozone exit would certainly weaken the euro, at least in the short term. But in the longer run it could have the opposite effect.
â€śTaking out the most problematic part of the eurozone, both economically and politically, could theoretically strengthen the common currency,â€ť says Raoul Ruparel, head of economic research at Open Europe, a London-based think tank. â€śOf course it depends on whether the eurozone succeeds in preventing contagion â€“ the spread of mistrust in other countriesâ€™ ability to service debts.â€ť
A new drachma would be a very weak currency â€“ there is little in Greece's coffers to give it value. The devaluation relative to the euro could reach 50 percent, according to Mr. Ruparel. On top of that the Greek central bank would have to print massive amounts of fresh money to keep the banks afloat. These two factors could lead to hyper-inflation.
Would a Greek exit be expected to have a domino effect, or will it be possible to isolate Greece?
This is what concerns EU leaders most. Their answer is that the European Stability Mechanism (ESM) â€“ the rescue fund which will be operational in July and will contain â‚¬500 billion â€“ will be there to bolster other struggling European economies.
But the fears among investors are still there.
â€śA Greek exit sets a dangerous precedent,â€ť says Jane Foley, senior foreign exchange strategist at Rabobank in the City of London. â€śHuge amounts of investors are trying to get out of Spanish bonds right now, because they fear that if Greece goes, Spain will be next.â€ť
Consequently, the interest rates for Spanish 10-year bonds climbed to over 6 percent this week.
What EU policy makers have to do now, says Ms. Foley, is reassure the world that Greece is a one-off. â€śIf Greece leaves unilaterally and in a more or less orderly fashion, contagion might be avoided.â€ť
Given the social unrest Greece is already experiencing, and given the capital flight taking place right now â€“ according to President Karolos Papoulias, Greek citizens withdrew â‚¬700 million from banks last week alone â€“ Â an orderly exit is far from certain.
What impact would a Greek exit have on world markets? The US?
The effect on markets will, again, depend on the degree to which a Greek exit affects other eurozone economies.
Many analysts believe that the creation of the ESM and the ECBâ€™s recapitalization of private banks have provided a certain level of calm in international markets. Traders reacted rather measured to the news of a Greek election rerun.Â
â€śParticularly the US economy is in a somewhat better condition than it was six months ago,â€ť says Mr. Ruparel. â€śSo for the US recovery a Greek eurozone exit will be more of a speed bump, not a dead end.â€ť