How to leave the Euro?

Stergios Skaperdas

The author is a professor of economics at the University of California, Irvine.

Greeks protesting Austerity measures imposed by foreign creditors

Greeks protesting Austerity measures imposed by foreign creditors

Having been led down an ever-worsening spiral by the euro zone and its own government, Greece now faces two options, both of them painful: stay the course, or default and exit the monetary union.

Each presents difficulties and uncertainties, but in the long run there is no question that default, and a return to the drachma, offer the better chance of economic growth and employment.

Staying the course — which, despite the impending change of government, is still Greece’s plan — means continuing austerity and unemployment for the foreseeable future. The young and skilled will go abroad, leaving behind an older, less productive and needier population to endure a crushing debt. In the meantime, all important economic decisions will be made in Paris, Berlin and Brussels.

Default at Greece’s initiative, by contrast, would allow Greece to influence its destiny. The process would be largely governed by Greek law, instead of its being a matter of private discussions between the German chancellor and the French president, and would thus lead to a more sustainable debt burden.

Because of problems with financing Greek banks and pension funds, default would be likely to mean leaving the euro. But that’s a good thing, as it would give Greece control of its own monetary policy. This is especially important now, with Greek credit and liquidity severely restricted, most critically in its vital small-business sector. Moreover, since the “new drachma,” as the post-euro currency might be called, would depreciate, both tourism and exports would rise, and imports decrease, all of which would make Greece more competitive.

So why have Greek leaders stuck with the euro at all? In part, it’s because the thought of defaulting and leaving the euro after nearly a decade is so intimidating. But while not without costs, it would in fact be relatively straightforward, especially if preparation is underway behind the scenes.

To minimize the number of days banks would need to be closed, the decision to move to the new drachma should be made on a Friday. Bank deposits and domestic debt would be immediately converted to new drachmas at the initial exchange rate. It would fall to the Greek courts to determine whether pre-2010 public debt would follow suit, but there is no reason to think they would treat it any differently from domestic debt.

Loans from the European Union and the International Monetary Fund, though, would probably be kept in euros. That’s a problem, because once Greece leaves, the euro itself would substantially increase in value — and thus the loans’ price in drachmas would increase. But since incomes would also drop if the country stayed in the euro zone, the real, productive resources the country would need to service that debt wouldn’t be much different.

Apart from these steps, the transition would take time. It could take perhaps months to print enough new drachmas to support domestic transactions, and during that time euros would stay in circulation. Banks would also need time to adjust their accounting, computers and clearing routines. Still, a few distinctive details of the euro aside, managing the transition from one currency to another is well understood: the change of currencies that followed the breakup of Czechoslovakia, for example, took several weeks and by all accounts went well.

True, such a move would close off access to international bond markets, making bilateral borrowing from another country Greece’s only option abroad. But this is less a concern than some think, because Greece is soon expected to achieve a primary budget surplus (the government budget surplus, excluding interest on debt) which would make domestic borrowing sufficient.

Initially, foreign exchange would be scarce, making it harder to import essential goods. In the short term, then, Greece would need to limit the outflow of foreign capital, an aggressive but not uncommon practice. The private, euro-denominated external debt of banks and other companies would also need support through government guarantees.

Some of these steps may seem daunting, but they are not much different from what Greece faced before its adoption of the euro. In any case, the policies followed so far have demonstrably failed. Greece must contemplate, and then undertake, an exit from the euro zone. The sooner a transition occurs, the better for everyone.

Photo courtesy of Ian Choo. The article was first published by the New York Times on 9 November 2011.