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Leaving the Euro – think twice

May 3, 2012

Published in ‘New Europe’, 13-19 November 2011, page 3

Leaving the Euro - articleIn the past two weeks, we witnessed the climax of the Greek debt crisis, when the then Greek Prime Minister George Papandreou took the other EU leaders by surprise, by announcing a referendum on the EU summit’s last decisions regarding the haircut of Greece’s government bonds. A few days later, the confidence crisis spread to Italy, where Prime Minister Silvio Berlusconi’s government has so far failed to convince the markets about its determination to carry out the much needed reforms in order to deal with Italy’s debt problem.

As the international pressure mounted, many voices in favor of leaving the euro and returning back to national currencies surfaced in both countries. For some, especially the Greek communist party, this is a matter of ideology; for others, it is a gesture of patriotism, or a way to restore “national pride.”

On the other hand, there are people who emphasize the technical difficulties of changing currency, such as the printing of hundreds of millions of new banknotes or adapting the legislation, back-offices, ATM’s, and software. A long period, probably up to a year, would be necessary before being able to circulate the new money, hence the quasi-impossibility of a surprise move to return to the drachma or the lira. However, these practical complications alone, aren’t sufficient to prevent an exit from the euro.

Let’s take Greece for example. It is my belief that the return to the drachma would be disastrous for the Greek economy and society, to an extent that goes far beyond what the average (usually misinformed) citizen could imagine, since hardly anyone seems to get into the trouble of clearly explaining the consequences that would result from such a decision.

There aren’t that many ways to change currency. The transition from the ancient franc to the nouveau franc in 1960, or the introduction of the euro (which required a three-year planning) are examples of the smooth way. Violent changes occurred in several european countries in 1945-1946, at the time when communist regimes were established. In those cases, the suppression of currencies was a conscious choice of the new regimes, aimed at destroying accumulated value and levelling off social differences.

We can assume that if an exit from the eurozone were to occur in Greece, this would happen under strong pressure from the markets, thus it would violent. In such a case, the transition scenario could be the following:

1) Over a weekend, when markets and banks are closed, the government would announce the abandoning of the euro and the adoption of a national currency, say the New Drachma. Obviously, this would be accompanied by a drastic devaluation.

2) The currency change would be backed up with a package of measures, including:

– strict foreign exchange controls (transfer restriction, tourist currency limits etc)

– daily or weekly limits to bank account withdrawals

– import licenses granted only for basic products…

3) All transactions would be denominated in the new currency; however, as the new banknotes wouldn’t be available before long, in practice, payments would still be made in euro ¾ of course, using the new devalued exchange rate.

After the first few days or weeks of chaos, a new business environment would be shaped:

4) All payments would be made in euro, or in any other hard currency (dollar…), or other form of accepted value such as gold coins (gold sovereigns are still popular in Greece as a store of value, especially among the elderly), within the limits of the amounts available in the hands of the public. And this could last long ¾ just remember 1945-48 post-war Germany, which, deprived of official currency, was reduced to use dollars and even American cigarettes as a means of payment.

5) Without euros in the coffers and unable to borrow from the markets, the government would have to delay payments of salaries and pensions for months ¾ a very common practice in Eastern European countries during the ‘90s.

6) Imports would freeze, and only few licenses would be granted for food and energy; rationing of those goods would become inevitable (Greece runs a very high trade deficit).

7) Government action would be necessary to cope with tragic social conditions; foreclosures, evictions, and charity meals would have to be organized on large scale.

8) Limitations of imports and scarcity of means of payment would cause Soviet-style shortages of goods, leading to uncontrollable black markets. The anxiety and panic of those searching for medicine, a spare part, or fuel would drive prices to heaven.

9) Within a few months, the economy would be “demonetized” due to the lack of cash, and barter would prevail. As a result, GDP would collapse, and living standards would follow. As always, the most vulnerable (elderly, unemployed etc) would be the most affected.

10) When the new banknotes would finally become available (which might take longer than normal, due to the disorganized state of government services), transactions would slowly start to normalize. Lack of trust in the new devalued currency would initially limit its use to paying salaries and pensions, while value transactions (real estate etc) would require some form of hard currency, following the well established Gresham’s Law (“bad money drives out good”).

11) As previously mentioned, distrust in the new currency and shortages of goods would fuel hyper-inflation, which in turn would cause a series of devaluations of the new currency. Endless litigation would start in international courts and arbitration authorities over the currency of the foreign debt.

12) By that time, the level of deterioration of living standards would bring about generalized corruption and criminalization of society.

Naturally, at some point, things would go better, and we might even see some benefits from the reduction in production costs and the substitution of imports by local production. The question is that reaching that point, usually takes a whole generation… Meanwhile, all the country would be left with is its “national pride” and “sovereignty.” After all, everything in life comes down to what price we’ re willing to pay.

Christos Kissas, PhD

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