With the collapse of multiparty talks to form a new government in Greece, the country’s future in Europe’s single currency area is seen as highly precarious.
Ordinary Greeks are pulling their deposits out of local banks in anticipation of a eurozone exit which could trigger a currency devaluation. The country’s president said on Tuesday that at least €700 million in savings had been withdrawn before day’s end.
Investment bank JPMorgan Chase raised the odds of Greece leaving the euro to 30 to 50 percent. It predicts a “massive capital flight” to escape capital controls and the printing of IOUs (“I owe you”) debt papers which would temporarily serve as alternative currency while Greece prints new drachmas.
Worse for the rest of Europe, a Greek exit and likely sovereign default — as it would lack the international financial aid necessary to make payments — could trigger a “capital flight from [the] rest of [the] periphery.”
If periphery countries then impose capital controls, the monetary union is effectively dead, as one country’s euros are then not the same as another country’s euros.
The precedent is Argentina which defaulted on its debt obligations in 2001 and simultaneously depegged the peso from the dollar. Dollar deposits became peso deposits and it was illegal to make any more payments in dollars.
As a result of the peso‘s subsequent devaluation relative to the dollar, ordinary Argentinians effectively lost up to 80 percent of the value of their savings.
The policy was designed to prevent a collapse of Argentina’s banks and would likely have to be replicated in Greece if its financial institutions also lose access to European Central Bank funding.
The danger is that savers in other heavily indebted eurozone nations, including Italy, Portugal and Spain, fearing default and devaluation in their own countries, will pull their money out of the banks and drive it to Germany or Switzerland. Such a bank run could herald the collapse of the currency union.
Some are willing to risk it. German weekly Der Spiegel says Greece must leave the euro. “The attempt to retroactively bring the country up to speed through reforms has failed.” If the Greeks have their own currency again and devalue it, exports would be cheaper. “The Greek economy could become competitive again.”
This would be true if Greece were an exporting nation but as Der Spiegel also notes, it has actually a tiny industrial base and is (or was) hugely dependent on public spending. The total value of its imports is twice the size of its exports.
The costs of imports would skyrocket if Greece left the euro, deepening a recession that has already shrunk the country’s economy by nearly a fifth since the beginning of the financial crisis in 2008.
One out of five Greeks is out of work. The youth unemployment rate is over 50 percent. Changing the currency won’t change any of that unless market reforms are simultaneously implemented to make the Greek economy more competitive.
Greece was supposed to implement liberalizations in the last two years as a condition for the financial support it received from its European partners and the International Monetary Fund but progress has been markedly slow. If the government in Athens — possibly a left-wing government that doesn’t believe in austerity — is no longer under pressure from the specter of default, there will only be less incentive to rein in public spending and reform.
What is more, if Greece regains its own currency, it also regains the ability to print money to try to inflate its debt away. An expanding money supply would no longer be offset by growth elsewhere as is the case in the eurozone. The value of Greeks’ money would first decrease as a result of switching to the drachma and possibly again as a result of hyperinflation.
So for Greece, there is no easy way out. If it tries nonetheless, the rest of Europe can only hope that investors and savers don’t expect other countries will follow.