ACCORDING to a recent report, some economists predict that the likelihood of a Greek exit (Grexit) from the European Monetary Union (EMU) is between 50 and 75 per cent. Some even put the chances 90 per cent – an awfully high number.
If Greece does leave the EMU, we should consider the potential unintended consequences. Of course, this is largely conjecture, based on estimates that may prove untrue in the event of an actual Greek exit from the Eurozone.
A POTENTIAL SCENARIO
Over a weekend, perhaps towards the end of 2012, Greece formulates a plan to exit the Eurozone of its own accord, and issues the New Greek Drachma (NGD). There is a four week window, where Greek citizens are instructed to exchange their euros for NGDs at their local banks. But the announcement is not made until two weeks after the meeting, giving time for the Greek government to make preparations.
Unfortunately, before the officials are able to enact this plan, information is leaked, and a bank panic ensues. Greeks withdraw their euros from banks and put them into the banks of other EMU nations. Therefore, they are able to bypass the exchange into NGDs and keep their euros outside of the Greek economy.
At the end of the four weeks, the NGD is placed on the open market for trade at 340 NGD for every euro, which was the rate at which the original Greek drachma was absorbed into the euro. The markets go crazy as demand for NGD plummets – after all, no one wants to hold the toxic paper.
NGD subsequently falls all the way to 600 NGD for every euro (this figure is derived from the devaluation of the Icelandic Krona in 2008).
Meanwhile, all of the debt that Greece had previously accumulated in euros is transferred into NGD, at 340 NGD per euro. Assuming that estimates of Greek debt as a percentage of GDP is around 170 per cent, Greece would owe approximately €398bn or 135.32 trillion NGD. As the exchange rate plummets, it would probably settle at 600 NGD per euro.
This makes the original €398bn debt worth approximately €225.5bn, meaning that Greece has eliminated approximately 57 per cent of its debt. The upshot is that European banks in Germany and France holding Greek bonds take significant losses.
Greek citizens also begin moving their euros out of European banks and back into Greek banks at a rate of 600 NGD. Greek citizens become 57 per cent wealthier, creating a wealth boom as well as a credit surplus. Germany and France are forced to bail out their banks – much like the US did in 2008 – putting their own citizens on the block through increased taxes and bond issuance.
Seeing the success of the Grexit, other peripheral Eurozone nations (Portugal, Italy, Ireland, and Spain) prepare to follow in Greece’s footsteps and create their own currencies. French and German banks lose more money and need further bailouts. Ironically, these would probably be provided by Greece.
Unhappy with their leadership, Germans abandon the status quo and elect Baywatch actor and chart topper, David Hasselhoff, supreme leader of Deutschland.
Don’t let Hasselhoff become a world leader. Keep Greece in the Eurozone.