A replica of the last edition of the drachma in central Athens—but could the currency make a comeback if Greece leaves the euro?
How do you get out of the eurozone? Leaving a monetary union is about the messiest thing that a country can do, short of entering into a war. But what if you have to leave the eurozone? Greece might soon be in that situation—so too Portugal.
Assume that something goes wrong in Greece. Perhaps Lucas Papademos cannot hold his quarrelling coalition together. Perhaps Greece will not be able, or willing, to comply with the austerity demands of the International Monetary Fund and the European Union. Perhaps Greece and the banks cannot agree a deal to restructure the debt. Countless other things may happen: an outbreak of violence, the murder of a foreign diplomat—the kind of event that used to trigger a war, and that would now trigger an exit from the euro. What then?
First, it is legally not supposed to happen. The euro is the currency of the EU. Just as Scotland cannot break out of the pound, Greece cannot break out of the euro. Britain has an opt-out, and so does Denmark, but for the others, the euro is obligatory. Once you are in, you are in. The only way to get out is to leave the EU, which is possible under the Lisbon Treaty. So the strict legal answer is that, to leave the euro, Greece would have to leave the EU.
European law has many trapdoors. A European official once told me that Greece could leave the EU on Sunday night, and re-enter on Monday morning. Sure, this is not what Article 50 of the Treaty on European Union intended, but who knows what the European Court of Justice might decide if such a case landed on the bench.
At this point, we have to assume a number of different scenarios. Is this exit agreed with the others, and if so, will they support it financially? Or is it a unilateral act, which Angela Merkel learns about in the newspapers? An agreed exit could come about when a consensus is reached both inside and outside Greece that the adjustment burden is too high, and that the costs of subsequent rescue programmes would become economically and politically indefensible. A sudden exit could be the result of an accident, or a mistake. I would assume Greece would remain in the EU in the first scenario, but not in the second.
In the worst-case scenario, an enraged Greek prime minister gets his cabinet to vote to exit the euro on a Friday afternoon. At this point, he cannot go to parliament. He must issue a decree—a temporary act to be ratified by parliament later—to leave the euro and reintroduce a national currency.
When he leaves the cabinet meeting, he will have to commit a raft of legal and constitutional breaches, possibly even crimes. He will immediately have to do the following: close the borders; enforce a prolonged bank holiday; stop all transactions; and cut off the banks from international communication, including via satellite. He might have to send in the police or army to enforce the transactions ban. The bank holiday will last as long as it takes, perhaps a week.
Once he has secured the borders and throttled the banks, he goes on television and announces the decision. Of course, he will ask parliament to ratify this decree subsequently, but first he will have created all the facts. It is, of course, impossible to leave a monetary union while going through an open parliamentary procedure. The banking system would have collapsed before the opposition leader had a chance to speak. Secrecy is important for this to work. For a country to leave the eurozone, democracy will have to be suspended.
At that point, the changeover starts. All money held in accounts, and all securities, would be redenominated in new “Greek euros” at a conversion rate of one-to-one. You might call it a drachma, but at this stage you are not going to fuss over the name or look of your bank notes. There is no time to issue notes and coins anyway. All euro banknotes in the banking system will have to be stamped. Obviously, you cannot stamp all the money in circulation. You either decide to take the hit, or to maintain border controls indefinitely, preventing people from leaving the country with suitcases of unstamped euro banknotes. Within Greece, old euros would cease to be legal tender, and the central bank would exchange old euro notes for stamped ones at the official conversion rate of one-to-one.
The prime minister would also immediately announce a default on all foreign debt. There is no way that Greece, or any other country likely to leave the euro, would be able to service the euro-denominated debts. At this point, there will be no more capital inflows from abroad. Greece would be in a position where it needs to raise all public spending from domestic taxes. But since Greece has a primary deficit—a deficit after interest payments—the government must immediately impose an extreme fiscal contraction, much larger than anything that has happened so far.
This fiscal contraction would initially much outweigh the benefits of a depreciating currency. The banks would collapse, and have to be propped up by the new central bank, which has now regained the monopoly to issue a new domestic currency and to act as a lender of last resort to the banks and the government. New Greek euros would soon be convertible, and then depreciate. The government would impose stringent wage and price controls to ensure that the rise in wages does not outweigh the improvements in competitiveness. On the bright side, Greek tourism would suddenly become ultra-competitive. But we should not fool ourselves. By that time, Greek economic output would have collapsed.
What difference would a consensual exit make? The eurozone could agree to continue to support the Greek banking system for a while. It could help Greece fund the deficit, allowing a more gradual reduction of the primary balance. Greece would continue to receive structural funds from the EU, which would not be the case if it were to leave the euro. An agreed separation would be preferable to a violent, unilateral exit. But of course, it would be hard to get agreement if you default on your debt. And without being able to default on your debt, it would make no sense to leave.
The only country that could conceivably exit unilaterally, and still breathe afterwards, is Italy, which has a primary surplus. It could afford to default on its foreign debt and still function. But it would be an incredibly violent act against the rest of the eurozone, triggering a potential collapse of the financial system, especially given German and French exposures.
There is no way that Mario Monti, Italian prime minister and a former European commissioner, would take such a step. He could have threatened to do so when Merkel imposed an austerity regime on everybody. But he did not. He could have extracted eurobonds as a quid pro quo for accepting a German-style fiscal regime.
Given the crisis remains unresolved, an exit of one or more countries may become inevitable. But it would be indescribably messy and at best borderline legal. It would create financial instability in the country and elsewhere. And it might trigger further exits. So be careful what you wish for.