ECFR: Two dangerous myths about a ‚Grexit‘
Two myths about a Greek exit from the euro have recently gained traction. Both are misguided and both are extremely dangerous. Here are the reasons why.
After the Greek parties failed to form a government and the country now heads towards new elections in June, everyone is talking about a possible exit of Greece from the euro area (or, as the slightly ugly term has it, a ‚Grexit‘) once again. In principle, the mood is the same as when I first wrote about the Greek exit on ECFR’s blog earlier this year.
However, at least in Germany, the debate has become more and more bizarre, and two dangerous myths have gained traction. While the problems of a Grexit for the rest of the euro-area are belittled, the problems for Greece are blown out of proportion. It is now regularly claimed that with the EFSF in place and the increased volume of the ESM decided, contagion in Europe will not be a problem. At the same time, you can read that the re-introduction of the Drachma is close to impossible. It is claimed that it would take months to prepare a change-over of the currency, because printing money would alone take weeks and computers and ATMs would have to be reprogrammed, that the Greek administration would not be able to manage it at all, and that you would need to close Greek borders and guard them by military to prevent capital flight. Finally, it is said that after a Grexit, the Greek would not be able to pay for basic imports such as fuel and medicines anymore and the population would basically starve.
Unfortunately, this narrative is highly dangerous. If politicians and people in Germany believe that only Greece has to lose from a Grexit and we don’t have to worry, the natural policy conclusion would be to remain firm and not to make any concessions to Greece. In fact, one could even help the exit a little bit by making demands from the currently elected parliament which it cannot really fulfill.
However, at closer examination, most of the claims have little foundation in truth, and although they look plausible at first sight are plainly wrong uponfurther examination.
Myth 1 – Leaving the euro would be impossible for Greece to deal with
Let’s start with the claims that a currency changeover would take months, entail closed borders and would be close to impossible to administer. All this is false, in my opinion. A re-introduction of the drachma would just entail a simple law, changing all contracts, all bank deposits and all bank loans from euro to drachma. In addition, the government would default on all of its outstanding debt. The banking sector could then quickly be recapitalised with newly issued bonds which would be serviced and could be handed in at the Greek central bank to borrow new drachma.
For bank money (your deposits and bank transfers) this would not necessitate any reprogramming of computers; as there were no euro accounts left in the Greek banking system one could just say that whenever anything says euro, it means drachma. In the moment after the enactment of the law, you could again make bank transfers within Greece – now in drachma, not in euro. If anything, you might need a few days where the banks are closed and the staff is given instructions.
Getting the new cash into the system would be a little more complicated. However, I cannot imagine that printing the required few million banknotes necessary for Greece would take several weeks. The US alone prints 38 million banknotes a day. Some of the private banknote printing companies worldwide will certainly be able to squeeze in an order for the Greek government. Moreover, the initial banknotes do not need to be of high quality, they could be replaced later. Greek banks could start distributing the new drachma as soon as they are printed and just in the quantity as they come available. Even if it takes a week or two before this cash starts circulating, the Greek economy would not necessarily come to a complete standstill. After all, bank transfers can still be made. In addition, there is still enough euro cash in circulation to be used in daily purchases.
There is no reason why you would have to close borders during this time. After the enactment of the changeover law, no one would want to keep money (both euro and drachma) from leaving the country. If euro cash is brought abroad, this means that the Greek citizens are putting money in foreign bank accounts. No problem with this. And if drachma leave and are sold against hard currencies, the drachma will just depreciate – something which will happen in the process anyway.
What about the problems paying for imports? Of course, the price in drachma for fuel and medicine would skyrocket. If the drachma depreciates to 4 drachma to a euro (something which happened to the Argentine peso after the country exited the currency board in 2002), the price of petrol can be expected to triple (it will not quadruple, as a large share of the price is tax). Imported medicine would quadruple in price. This all is brutal, but economic theory would let us predict that the Greek will rather cut back on the import of Chinese-made plastic toys and German Mercedes than of necessities such as fuel and medicine. In addition, many Greek have assets abroad which could be used to pay for imports. Also, circulating euro notes can of course be used to pay for imports as they are as good as any euro note circulating in Germany. This all should be enough to cover imports for a couple of years. After all, Greece as a country is not importing much more than it is exporting anymore. Of course, it still runs a significant current account deficit, but this is mostly explained by interest payments to the rest of the world, the remaining deficit in trade in goods and services is manageable (and a default would mean that these interest payments are not made anymore).
Certainly, purchasing power for the average Greek would fall significantly (rule of thumb calculation with current import shares hint that a depreciation to 1 to 4 would mean a loss of a little more than 40% of purchasing power of wages), but at the same time, competitiveness would increase dramatically. And, yes, Greece is not having a large manufacturing sector which would benefit, but tourism certainly would. Personally, I would at once choose the Greek islands as holiday destination over the German Baltic sea if prices in Greece were to drop by 75%.
This does not mean that a Grexit would be pretty for Greece. It would be brutal, destroy the savings of the middle class, and further strain the social fabric. However, the costs might be not as outrageous as some outside Greece claim, and one could even make the case that they are lower than the costs of perpetual austerity as prescribed by Germany.
Myth 2 – Contagion from a Greek exit could be contained
Let us come to the other part of the myth: that EU firewalls will shield the rest of Europe from contagion. This is a bold claim. We all know that the ESM and the EFSF framework are not sufficient for a program for a large country such as Italy. Of course, the ESM could be topped up somewhat. But what we are going to see after a Grexit is a capital flight from Italy and Spain in so far unknown proportions. Of course, the ECB and the national central banks could intervene and provide liquidity in the trillions of euro then necessary. However, I am not sure how the German establishment and the Bundesbank would react if the balances in the TARGET accounts (which record claims between central banks and have been a hot political issue in Germany) increase further and the Bundesbank sees its claims against the euro-system increasing by another €1000 billion.
In addition, even a large ESM/EFSF package for Italy and Spain would not solve the problem of contagion to the private sector of these countries. EFSF/ESM packages could of course take the governments in these countries off the market and provide them funds necessary. However, corporations and households in these countries would still be faced with prohibitive interest rates which would push these countries further into recession. So far, the political system in Italy and Spain has stood up surprisingly well. However, my bet would be that from unemployment rates of 30% upwards, even the Spanish party system might start to unravel and the pro-euro consensus crumble.
Even if you believe that you have put decent air bags into your car, you do not want to be inside it for the crash test. Policy makers should therefore be very careful playing with the Grexit.