With its back to the wall and a rapidly deteriorating economic situation, it is hardly surprising that all eyes are turned to Greece in recent times, where one wrong move could potentially destabilise not only the country, but the Eurozone itself.
The notion of ‘Grexit’, where Greece would leave the Eurozone in favour of printing new drachmas, is still a heavily debated topic in financial circles, despite recent updates. Supported by a landslide referendum where over 60% of voters wanted another option to harsh austerity measures as well as major European financial institutions making contingency preparations, the move to abandon the euro seemed highly likely. Yet barely a week after the referendum, the same 60% who voted no for accepting another bailout deal were greeted with their country accepting its third bailout package in 5 years, with stricter conditions attached than originally planned. Whether the bailout makes an economic difference remains to be seen, but for the beleaguered Greek financial institutions and government, the deal provides precious time where if they don’t use it to find a long term resolution to stabilise, then at least they could start extensively planning how to make the switch.
How would the Drachma be introduced?
Similar to its entrance into the Eurozone in 2002, Greece firstly needs a large quantity of the new drachma, which it would obtain by printing either domestically or hiring a third party to do so. It would also be kept low key, given the consequences of speculation could compromise implementation. Greece would then announce the decision to leave the euro and alongside defaulting on a large portion of public debt, it would have to redenominate all domestic prices, accounts and wages as quick as possible. In order to stimulate consumer confidence in bank deposits, a target inflation rate as well as implementing strict fiscal policies would also be needed. These measures would be done prior to ‘Grexit’ day.
On the announced date, financial authorities would have to fix the exchange rate between the euro and the drachma, most likely at equivalent value in order to encourage the population to exchange. Implementing capital controls addressing cash outflows such as limited withdrawals and prohibiting the use of the euro for domestic transactions would also help the transition. Although it is inevitable that key transactions would need to be conducted in euros, this would only be necessary until enough drachmas have been printed to meet liquidity demands and then total transition to the new currency would be complete.
The silver lining
In the best case scenario, the move is not only accepted by the public, but the short term economic downturn of introducing the drachma is weathered without suffering irreparable damage. Like most newly introduced currencies thus far, the drachma would be expected to depreciate against other currencies after capital controls are relaxed, which would help stimulate domestic economic activity. Foreign consumers would be able to purchase Greek goods at a cheaper price, which would increase demand for these goods and thus giving Greek exporters a much needed advantage against foreign competitors. Furthermore, tourism in Greece would become even cheaper than its current prices, which would attract tourists and hopefully a sustainable source of revenue that could help pay off the remaining debts or be used as investment to help stimulate economic activity in other sectors.
What if it goes wrong?
Introducing a new currency may not necessarily pull Greece out of its mess. As the drachma depreciates, Greece’s current recession is amplified. Savings kept in accounts and unable to be withdrawn would instantly become worthless and the value of domestic goods would skyrocket relatively as the drachma falls in value, forcing a situation akin to post war Germany where rampant inflation was prevalent. Imports would also fall, as it becomes increasingly expensive for domestic consumers to purchase foreign goods, creating shortages in areas such as medication and food.
Moreover, Greece would also fall into a unique situation where a major portion of its exports would be bottlenecked given potentially limited import capabilities. 37% of Greece’s exports are dedicated to refined petroleum, which is derived from imported crude petroleum as Greece has barely any natural oil reserves to meet the demands of production. Combine this with multiples losses of trade pacts that Greece enjoyed whilst remaining in the Eurozone and suddenly, a major source of revenue dries up.
Source: Trading Economics
There are hardly any modern precedents that Greece could learn from should they embark on this path. The closest scenario that similarities could be drawn from is Argentina, which in the early 2000s, was facing a similar economic nightmare similar to Greece today. With crippling outstanding debt, a stagnating economy, and similar unemployment rates, Argentina decided to float its currency, which was formerly fixed at the US dollar rate. Although it left over half the country beneath the poverty line facing shortages in goods deemed necessary in the short term, by 2005, Argentina managed to rebound and since then, has become an emerging economy with heavily reduced poverty rates and reporting strong growth. However, it should be noted that this was heavily aided by the abundance of natural resources within Argentina, an economy already geared for exporting and the worldwide commodity boom driven by China, which has since slowed down.
Greece however, doesn’t possess similar export capabilities or an abundance of natural resources, which may prove to amplify the short term downturn given its limited access to international capital after its transition. Furthermore, it needs to make the switch to the drachma, as opposed to Argentina who has always been with the peso. As such, making the transition may not necessarily yield Argentina’s outcome, which would be the best case scenario.
What are the possibilities going forward?
Despite agreeing to another financial bailout package, Greece could once again find itself having to revisit the conundrum of whether it should stay in the Eurozone or leave for the new drachma. For the country where over a quarter of the population remains unemployed, the bailout merely delays the decision, providing short term liquidity but not a solution. Without any new sources of cash inflows to address the crippling debt, eventually the $96 Billion would dry up and authorities would face this decision once again.
However, given the additional austerity measures introduced with the bailout, when the time to decide whether to ‘Grexit’ or not could be met with a more one-sided vote to leave the Eurozone as the largely disaffected populace continues to suffer. To make the transition would allow Greece to escape the crippling austerity measures but it would also become the largest economic experiment in history, whether it succeeds or not remains unknown.
The CAINZ Digest is published by CAINZ, a student society affiliated with the Faculty of Business at the University of Melbourne. Opinions published are not necessarily those of the publishers, printers or editors. CAINZ and the University of Melbourne do not accept any responsibility for the accuracy of information contained in the publication.
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