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What Happens If Greece Quits The Euro?

  • Rikard Jozwiak

Will Greece be forced to reintroduce the drachma?

Will Greece be forced to reintroduce the drachma?

BRUSSELS -- On June 17 Greeks go to the polls in a general election that could determine whether the crisis-hit country remains in the 17-nation eurozone. What happens if Athens quits -- or is forced out of -- the single currency?

How important is the general election in Greece on June 17?

This is a repeat election after the May 6 vote resulted in no party having enough support to form a government. The leftist Syriza party, which is tied in the polls with the conservative New Democracy, has promised to tear up Greece's stringent 130 billion-euro ($164 billion) deal with the EU and International Monetary Fund (IMF) that is needed to avert a Greek default.

It's not clear if Greek parties will be able to put together a coalition government this time either. But if Syriza emerges as the clear victor, expect market turmoil -- central banks in some major economies have already announced they are ready to take steps to stabilize the markets if needed.

And, "even if there will be a government, if that government will not have an agreement with the IMF and the eurozone partners, then the IMF and the eurozone partners will stop financing Greece further and money will run out at the end of June," warns Zsolt Darvas, an economist with the Bruegel think tank. If that happens, a Greek exit from the euro is likely.

What would a Greek eurozone exit look like?

No one really knows because no country has left the common currency before. Janis Emmanouilidis, a policy analyst at the European Policy Center, notes that the EU treaties only foresee an exit from the European Union -- but not explicitly the eurozone. "In legal terms, any country exiting the EU or the eurozone would have to exit the EU and re-enter the EU under new conditions," he says.

But Emmanouilidis says he's convinced there must be a so-called "friendly exit" in which everyone involved -- including the EU institutions, the EU member states, and Greece -- agrees on a procedure on how the country should leave. The catch is that this might require a decision in the Greek parliament or a Greek referendum -- something that might prove tricky considering polls indicate that 70-80 percent of Greeks want to remain within the eurozone.

How would leaving the eurozone affect Greece?

Initially, at least, a "Grexit" is likely to be extremely painful. "The financial sector would collapse, most of the private sector would default, the economy would fall much further, unemployment would be higher, budget revenues would also largely disappear because nobody would pay taxes since the economic activity will go down," Darvas says.

There are already smaller bank runs happening in Greece with people moving their money to other parts of the EU, Switzerland, or under the mattress. Greece's economy shrank by 13 percent between 2007 and 2011 and it's estimated that an exit from the eurozone would cause the economy to shrink by 40-50 percent in the first year. Greece would have to introduce a new currency -- likely the drachma -- which would plunge in value, raising the cost of imports.

The flip side of the plummeting currency is that Greek exports would become more competitively priced, bringing benefits to the economy over the longer term.

What will happen to the rest of the eurozone if Greece leaves?

A Greek exit could further erode confidence in banks, such as in France, that are most "exposed" through lending to Greece and through their Greek subsidiaries.

And then there's the risk of "contagion." Emmanouilidis notes: "People might start saying that 'what happened to Greece was something which a year or two years ago was said would not happen to the country. We were always told that no country would have to leave the eurozone.' So then psychologically people will start asking the question, what does that mean for other member states?"

The cost of borrowing for other "weak" economies such as Spain and Italy would likely rise. This could spell danger for Madrid, whose yield on benchmark 10-year Spanish debt this week surpassed the 7 percent threshold that triggered bailouts for Greece, Portugal, and Ireland. That's despite a eurozone deal reached last weekend to help Madrid by lending its banks up to 100 billion euros ($125 billion).

The Fitch rating agency said this week that this measure should help cushion Spain from any contagion unleashed by a Greek euro exit. But it said banks in Portugal and Ireland would be more vulnerable as these countries "could be perceived 'next in line' for a euro exit."

What would be the impact on the U.S. dollar and gold?

A Greek exit would lead to a decline in confidence in the euro and a subsequent appreciation of the U.S. dollar -- a move not expected to be welcomed in Washington, as it would make the U.S. economy less competitive, undermining what is already a weak recovery.

Gold should rise, too, says Cinzia Alcidi of the Center of European Policy Studies. "The price of gold started to increase significantly when the financial crisis started in 2007 and the price has followed a steep upward trend. The main reason for this is that when there is uncertainty, gold becomes a secure investment."
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    Rikard Jozwiak

    Rikard Jozwiak covers the European Union and NATO for RFE/RL from his base in Brussels.​ Write to him at rikard.jozwiak@gmail.com


     

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