GREEK EXIT WILL BE AN ECONOMIC AND POLITICAL NIGHTMARE / THE FINANCIAL TIMES COMMENT & ANALYSIS ( A MUST READ )

Greek exit will be an economic and political nightmare
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Lorenzo Bini Smaghi
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June 15, 2012

Permalink Exit from the euro by Greece, or by any other member state, has become a fashionable topic for academics, commentators and market participants. The analysis is most often conducted on the basis of the economic costs and benefits, and the possible social and political consequences of such an exit for Greece and for the rest of the euro area. Most recognise that, under prevailing circumstances, the costs are too high. Even Alexis Tsipras, leader of Greece’s Syriza party, who wants to renegotiate the terms of the International Monetary Fund and EU programme, has committed in the FT to keep Greece in the euro.

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It is generally taken for granted, including by Mr Tsipras, that Greece can exit the euro if it decided to do so and adopted a new currency. It is, however, not that simple.

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First, it would be very difficult for any Greek government to impose on its citizens the use of a new legal tender, such as the new drachma. The value of the new currency would depreciate substantially against the euro and be eroded by high inflation, given that money creation would be the only way to finance the budget deficit and to recapitalise the failed banking system. As experienced in several other Balkan countries, such as Bulgaria or Montenegro, households and companies would immediately try to protect themselves against currency debasement by indexing their contracts to the euro, and using the existing banknotes in circulation as a parallel currency. Of the three main functions of money – as a medium of exchange, store of value and unit of account ‑ the new drachma would most likely perform only the first one, and for only a fraction of the transactions, while the euro would retain the other two. Greece would have a de facto euro-based economy.



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Second, by exiting the euro Greece would violate the Lisbon treaty. When adopting the euro Greece committed to a series of obligations, including the renouncement to its own currency, which is irreversible. The European Commission, as the guardian of the treaty, or any other of the 26 signatories of the treaty, could sue the Greek government at the European Court of Justice if they felt that the decision to exit the euro had materially damaged them or any of their citizens. Citizens of any EU states – in particular creditors whose contracts were redenominated in the new currency – could sue Greece in their respective courts, which most likely would defer to the ECJ. Greece could also be sued in the European Court of Human Rights for violating property rights. Any judgment issued by the ECJ or the ECHR would have to be taken into consideration by local courts in EU countries, including Greece. This could give rise to sanctions by the European authorities in case of non-compliance.

Greece could avoid these sanctions only by disavowing the authority of the supranational institutions. This would mean that Greece would exit not only the eurozone but also the European Union as a whole. There is no exit for the euro without exit from the EU, as explained in a 2009 working paper by Phoebus Athanassiou, a lawyer at the European Central Bank.

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The only alternative would be for Greece to negotiate with the other 26 EU countries a new treaty, allowing Greece to adopt a new currency. Even assuming that the other countries were willing to accept entering such a negotiation, developments in Greece would practically make that impossible.





As soon as the negotiations were made known, or even the intention to hold them, Greek citizens would immediately begin a run on their banks to withdraw euros and transfer their accounts abroad.
This could not be accommodated by the European authorities. Bank holidays and capital controls would have to be imposed, preventing Greek citizens from cashing in their savings and taking them abroad. All loans to Greek residents would be frozen immediately, including to the state. The country, therefore, would not have the means then to pay for basic expenditures, such as pensions, health care, civil servant wages. Conditions would rapidly become chaotic.




If Greece remained democratic, the government would most likely lose support from its own citizens for its request to leave the euro. It would then have to start negotiating with its partners on the terms for staying, rather than leaving, the euro from a much weaker position.



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Exiting the euro is an economic and political nightmare and thus practically unfeasible. The reason is that the eurozone is not only an economic and monetary union; it is also a political union, albeit imperfect.