Fri 8 Jun, 2012 08:24 am
Only a few months ago, the idea of a Greek exit from the Euro was considered impossible and was virtually a taboo subject. However, today there is a whiff of inevitability about the so-called “Grexit” so it is worth reflecting on what this would actually mean.
According to one school of thought, a devalued Drachma would boost tourism, make industry competitive and attract inward investment. But it can be argued that this is based on false assumptions and that the reality may be far worse than many imagine.
When the Euro was created, no provision was made for a member country to secede. Such a process, therefore, involves amending the Maastricht treaty which requires all states to agree and several to hold referenda. So in practical terms, there is no legal way for Greece to leave or be forced out of the Euro without leaving the EU itself. This, of course, would mean an end to huge agricultural and development subsidies and to access to the single market
The logistics of introducing a new currency are formidable. Several months are needed to create a currency and for banks to prepare for the changeover. But at any time during this period, a run on the banks could be triggered which would threaten a collapse of the entire Greek banking system. Under such pressure, banks would need to be nationalised and despite a period of prolonged bank holidays, and strict exchange and border controls, it is hard to see how massive capital outflows could be avoided.
Almost simultaneously Greece would be faced with the problems of withdrawal from a major currency union, sovereign default and massive devaluation. No country has ever had to cope with all of these at once. At the same time, this would be accompanied by corporate default on a large scale and an almost total collapse of international trade.
Legally, the switch to the Drachma would be a minefield as all basic financial transactions, including mortgages and loans, would need to be redenominated. And of course any debts still in Euros would be virtually unpayable.
In order to service loans and pay wages and meet other costs, the central bank would have to print money on a large scale which would soon lead to high inflation. This creates a vicious circle because as the Drachma devaluates, the need to print increases. So the new currency will go through the floor and inflation will go through the roof.
Without credit, Greece would only be able to import goods to the value of its own meagre hard-currency earnings so would have very little buying power. There will therefore be shortages of the most basic necessities including foodstuffs, fuel and medicines.
History shows that when a monetary union collapses this is often accompanied by mass public unrest and even by civil wars. At the very least, the political system will be greatly weakened and there will be a shift away from the centre and towards more extremist leftist and nationalist parties.
The theory goes that a devalued Drachma would attract foreign investment. But how likely is this given that a post-default Greece would be seen as a financial pariah? As it is, Greece does not have a strong industrial base and after the exit is likely to have a barely functioning economy. Furthermore, a climate of civil unrest and great political uncertainty is hardly conducive to inward investment.
The argument that Greece would become an attractive tourist destination is also deeply flawed. The tourism sector has never had a coherent strategy and it is hard to see how it could develop in the absence of credit or investment. Nor does it follow that a Grexit would lead to lower prices as hotels would still need to import goods, service loans and meet increased costs. In any case, are tourists really likely to flock to a country rocked by economic and social turmoil?
The suggestion that once it had left the Euro, Greece would be forced to become more competitive may also be wishful thinking. It is just as likely that at a time of political, economic and social chaos we will see a return to many of the bad old ways including cronyism, corruption, patronage and the invention of make-work public-sector jobs
And it would be unwise to rely upon further support from the international community. The EU will prefer to divert funds previously earmarked for bailing out Greece to the prevention of further contagion. And the IMF might provide an emergency one-off loan, no doubt with stringent conditions, but after that Greece would be left to fend for itself.
So it is to be hoped that Greek voters and politicians think very carefully before concluding that once Greece adopts its own currency, all its problems will be solved. However hard life has become for ordinary Greeks, it is nothing to the misery that would follow an exit from the Euro.