Greece is again “looking into the abyss”, says The Economist. And this time, it may fall in. There has been no sign of a deal between Greece and its creditors, the International Monetary Fund and the European Union. The Greek central government has ordered local governments to move spare money to the central bank. With several major repayments looming, the country seems likely to run out of money, and default on its debts, in a few weeks’ time. Then what?
“No one really knows,” says Hans Humes of Greylock Capital. There is no legal provision for a country leaving the euro, Jorg Haas of the Jacques Delors Institut notes on focus.de. It would be like “changing an omelette back into an egg”. If it happens, it is likely to be chaotic, with events overtaking any formal legal changes.
That said, “there is no EU ruling that says you have to leave the eurozone when you default on your debt”, notes Wolfgang Munchau in the Financial Times. Greece could theoretically fail to pay, yet still stay in the euro. Here is an overview of what could happen next.
Default and exit
The basic default-and-leave scenario looks like this. Greece runs out of money and misses a payment. The only way to get money would be to print its own, presumably called the drachma, to pay pensions, salaries and top up the banking system. As the banks are losing €700m a week, capital controls would have to be imposed to stop people taking their money out (they are already doing so in order to stock up before the potential arrival of a new currency that would fall sharply against the euro).
This is all the more important as the European Central Bank (ECB) is currently keeping the Greek banking system afloat with emergency loans. If Greece defaultson its debt, it is likely to stop doing this.
With the new currency likely to plunge against the euro, Greece’s competitiveness should ultimately receive a big boost. But the short-term costs would be high. Reintroducing notes and coins could take several months, with the uncertainty denting confidence. A slumping currency would fuel inflation, possibly triggering a wage-price spiral. And the debt burden – still in euros – would be worth a lot more, making a fresh default inevitable.
Any alternatives?
Greece could in principle default and stay in the eurozone. After all, it did so in 2012. But that was a managed reduction in its debt burden agreed with eurozone partners. This time, the other countries are determined not to let Greece off the hook of structural reform and austerity that comes with the rescue package. With the ECB unlikely to keep the Greek banking system afloat, staying in with impunity looks a remote possibility.
The actions of the ECB are crucial here: ending liquidity support is a “de-facto expulsion” from the eurozone, as Bank Austria’s Stefan Bruckbauer puts it. It means the Greek banking system would soon run out of money, necessitating domestic money printing.
The ECB is loath to be seen as the actor that pulls the plug, so it would defer to eurozone policymakers. But if it is not being paid back its emergency loans, it is hard to see how this is anything other than a default by Greece.
One way Greece could get round its euro shortage, says The Economist, is by issuing scrip – a type of IOU – instead of payments to its citizens. But this would only buy a little time. Greek scrip would be seen as less desirable than euros, as it could only be used domestically. Greeks would still take euros out of banks, forcing the introduction of capital controls, and they would hoard them too, leaving the monetary system full of scrip and drained of euros.
With a parallel currency and capital controls, “the gap between default and exit would be paper-thin”. In short, as Capital Economics notes, “while there is no automatic link between default and exit, one surely makes the other more likely”.