Financial Times
June 15, 2012
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.
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.
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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