Hazardous Greek-Exit Scenario

Wall Street Journal
May 15, 2012

There is no legal provision in European Union treaties for a country to exit the euro zone, putting experts in uncharted waters when trying to assess method and the repercussions. But if Greece were forced to leave after losing financial support, it would show that Europe's historic currency project can disintegrate as well as integrate. Here are some possible answers.

How does Greece leave the euro?

In one scenario, a Greek authority would have to agree on a date with the rest of the euro zone for its departure and for the introduction of a new currency (let's call it the new drachma). It would say that from that date, all public salaries, contracts and pensions would be paid in drachma. Bank deposits would also be redenominated. The authority would likely decide an initial conversion rate on domestic contracts from euros to new drachma—say one-to-one—then it would likely let the exchange rate of the new drachma be decided by the currency market. This would likely result in a sharp devaluation. If Greeks anticipate that, there is a risk of increased bank withdrawals and capital flight. This could trigger capital controls, making an orderly exit unlikely.

Could the drachma ever recover?

Ultimately, it would find a level that made Greek products and services internationally attractive again. What would happen then would depend on how policy makers, the Greek central banks and Greeks themselves reacted to the devaluation, because the competitive benefits of devaluation could be easily inflated away. The two most recent parallels, Argentina and Russia, saw their currencies fall by between 60%-70% after bankruptcy forced them to abandon their currency pegs. But comparisons are difficult. There is no obvious equivalent for Greece to the upturn in oil and commodity prices in 2001 that helped those two countries recover.

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