Eurozone crisis: what if … Greece leaves the single currency

 guardian.co.uk, Monday 14 May 2012 22.18 BST

Collapsing banks, soaring inflation, but possible salvation – three experts give their view on what could await Greeks

A woman exits a one euro shop in central Athens. Greece faced the prospect of fresh polls after political leaders again failed to form a new government. Photograph: Louisa Gouliamaki/AFP/Getty Images

Europe's ruling elite is now openly talking about whether Greece might leave the euro, breaking a two and a half year taboo. German chancellor Angela Merkel and EU president José Manuel Barroso were among those saying that if Athens could not abide by the rules, Greece would have to leave. We asked three experts to analyse the potential consequences

 

Nick Parsons, head of strategy at National Australia Bank

The choices facing Greece and its people are deeply unattractive. On a three- to five-year time horizon, there is no policy option that will turn a bad situation into a better one, and the likelihood is that it will become even worse for many of its people. If Greece stays in the euro it faces a long, slow depression in an effort to remain solvent. If it exits, it could see the collapse of the domestic banking system, the decimation of private savings and a crippling increase in the cost of imported goods and energy.

Greece could claw back some competitiveness through devaluation, making its exports much cheaper than they are currently. But the markets would demand devaluation, and then some. The drachma was fixed at 340 to the euro when Greece joined the single currency. But if a new drachma is introduced at parity with the old currency, then €1 would quickly buy about 1,000 drachma, or possibly even more.

Just look at the evidence of Argentina, which in 2002 decided to abandon the fixed 1:1 US dollar-peso parity, which had been in place for 10 years. A provisional "official" exchange rate was set at 1.4 pesos per dollar, but within six months the market rate had jumped to 3.90. The peso had lost almost 75% of its previously fixed value. Savings were effectively expropriated and import costs tripled. It was a far from painless transition.

A similar fate awaits a post-euro Greece, with capital controls, border controls, and a potential EU exit.

Financial markets today are in a better position to withstand the shock than they were two years ago. Again, though, better does not mean good. Asset prices such as stocks will not just be volatile, but also prone to significant drops, even after their recent declines.

But a Greek exit does not mean the end of the euro. It will, instead, mark a new beginning. Germany has a long and proud tradition of currency strength, but it could not cope with going back to the deutschmark because it would rocket in value and destroy the country's competitiveness.

Some 97% of the eurozone's population will continue to use the single currency and their leaders will circle the policy wagons to protect what is left.

A Greek exit could be the trigger for a stronger and more stable euro, led by politicians and institutions with a clear interest in both its success and theirs. After a very difficult summer, should Greeks choose self-determined, rather than European-imposed pain, the outlook for financial markets should be much brighter by the year end.

 

Costas Lapavitsas, professor of economics, SOAS, University of London

Greek exit from the euro is approaching and it has little to do with state incompetence. The fundamental reason is cumulative loss of competitiveness for Greece and other peripheral countries, mostly because Germany has kept its labour costs frozen for years.

Since 2010 things have become worse as austerity increased the burden of debt across the eurozone. Greece can no longer handle the discipline of European monetary union, and Portugal, Ireland and Spain are likely to follow.

Greek default and exit would remove the pressure of debt, boosting competitiveness, lifting austerity and allowing for proper restructuring of economy and society. In the medium term the results would be better, but in the short term the shock will be severe – made worse by two years of "rescue", which will have brought 20% contraction of GDP and 25% unemployment by the end of 2012.

The first step for Greece should be to denounce the bailout agreements and default on its debt, opening the path for aggressive cancellation. Exit will follow in short order, presenting three sets of problems: monetary, banking and commercial. The main difficulty of policy would be to keep these separate as far as possible.

Briefly put: the return to the drachma should be sudden, accompanied by a short bank holiday and immediate imposition of capital controls. For a period the new drachma would circulate in parallel with the euro and possibly other state fiat money.

There are €35bn (£28bn) of banknotes in Greece, mostly under mattresses. If they could be mobilised, a lot of problems would be made easier.

Banks would find themselves in the firing line as assets and liabilities would have to be converted. To protect depositors, but also to control credit in order to prevent a wave of company bankruptcies and support employment, banks should be immediately nationalised. The Bank of Greece should rapidly build mechanisms to generate liquidity independently of the European Central Bank.

The exchange rate of the new drachma would collapse in the open markets, making it difficult to secure supplies of oil, medicine, foodstuffs and other goods. As far as possible, the exchange rate should be managed; there should also be administrative controls to ensure that vital goods reached key enterprises as well as the weakest during the first critical months.

After the initial shock, the fall in the exchange rate would prove positive for the economy. Greece remains a middle income country with a substantial productive sector that could recapture the domestic market once imports became more expensive. There is plenty of productive potential in Greece, evidenced by the technological component of its exports, which remains higher than that of Turkey, a lauded export success story.

What the country truly needs is an industrial strategy as well as redistribution of income and wealth. That is also why default and exit are necessary.

 

Ray Barrell, professor of economics, Brunel University

Should we stay or should we go? This is the question Greek voters must now ask themselves. Each must do a careful cost benefit analysis, looking at the gains from being in the euro and the European Union against the costs of leaving. If the Greeks leave and default on the rest of their debt, there is a good chance they may not be welcome at the European Union's tables, so they have to answer both questions. For them, and perhaps for most, the benefits of leaving are transitory, while the benefits from staying may be permanent.

On balance, the advantages would press the Greeks to stay. Some of the advantages of being in the EU could be kept with an association agreement, such as the one Norway has, but it would be much harder to influence trade and competition policy, and subsidies would dry up.

The euro raised growth in the past and hence we have more output now. Leaving the EU would mean slower growth for a period as some of the gains were reversed. Similar estimates exist for the benefits from monetary union for the core countries, but these benefits from increased flows of investment and greater competition still lie in the future for countries such as Greece.

Their potential would be lost on exit, and if there were no benefits from leaving, the Greeks would be poorer in future than if they had stayed.

The gains from leaving would be immediate, with a devaluation restoring competitiveness and raising employment. However, they would be transitory, as borrowing costs and inflation would climb and be more variable with a floating currency. The need to reform the labour market would be less pressing, and raising the retirement age from the lowest in Europe could be delayed. Pension replacement rates could remain generous.

But Greece would lose easy access to borrowing, and taxpayers would soon have to face the reality that they would have to pay for those pensions and support all the other structures that need reform.

Economists normally advise that bygones should be bygones, but this might be the time to remember past favours. Outside the euro the Greeks would not have been able to borrow 200% of their GDP mainly to finance a higher living standard, and restructuring their debts would have been more expensive.

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