Home > Greece > Throwing Greece out of the Euro

Throwing Greece out of the Euro

from Dean Baker

In response to questions from people everywhere, I will share a couple of quick thoughts on the possible departure of Greece from the euro. First, several people have raised the possibility of Greece being thrown out of the euro.

There is no way that Greece can literally be thrown out of the euro in the sense of being prohibited from using the euro. Any country has the option to use any currency it chooses. This was an issue that came up in the referendum over Scottish independence. The independence movement wanted to leave the United Kingdom but to continue to use the British pound as its currency. U.K. Prime Minister David Cameron said that the Scots could not keep the pound if they left the United Kingdom.

This was not true, unless the U.K. was prepared to invade Scotland and physically prevent their banks and stores from using the pound. The Bank of England could refuse to support any of the Scottish banks, which would make it highly undesirable for them to use the pound, in addition to the fact that the U.K. would not be setting monetary policy for the benefit of Scotland, but Scotland would certainly have the option to continue to use the pound for their currency.

In this vein, there are several countries around the world that use the dollar for their currency, including Panama, Ecuador, and Zimbabwe. They did not need to get permission from the United States to use the dollar, they just opted to do it (in the case of Ecuador and Zimbabwe to end hyperinflation).

In this way, Greece will have the option to keep the euro indefinitely. It is difficult to see why it would want to if it lacks the support of the European Central Bank, since it would almost certainly mean a substantially worsening of its economy from its current Great Depression levels of output. However if Greece’s leaders decide that keeping the euro is more important than reviving the economy, the eurozone authorities cannot keep them from doing it, short of an armed invasion.

  1. July 1, 2015 at 9:05 pm

    Technically true, and note that several countries in Europe are using what is called “currency substitution”, importantly Kosovo, and Montenegro (as well as many very small ones like the Vatican, Andorra, Monaco, etc.)

    However, in practice, if the ECB refuses to act as lender of last resort to the Greek banks, then the only way to keep the banking system alive is to either introduce a law which re-denominates all banking deposits and loans in another currency, or apply a massive haircut on deposits. This is what Cyprus did, but Greece doesn’t have that second option because there simply aren’t enough deposits any more after the long and slow bank-job. Greece would have to apply a haircut of some 70%, while not haircutting loans from banks. Unthinkable in political terms, as all loans would become non-performing, braking the banking system yet again in spite of the haircut; doesn’t work.

    So in practice it does depend 100% on the ECB, and the ECB has the power to force Greece’s hand to make them not just ‘print’ their own currency, but re-denominate all loans and deposits at the same time, and create a central bank which can act as lender of last resort to inject liquidity into the banking system.

    • July 1, 2015 at 9:58 pm

      Greece doesn’t need a foreign central bank to act as lender of last resort, it needs to change its banking system to one in which the banks simply manage a credit card type system wherein the individual family, business or government project and not a mythical sovereign is responsible for paying off its own debts by earning its own keep: i.e. by continuing to reproduce that which we consume. This is not a case of anyone owing someone else, it is more like a hitch-hiking, where beneficiaries gratefully keep going what in their youth has been essential for them.

  2. July 1, 2015 at 10:25 pm

    As soon as ECB refuses transfers\shuts off Target2 creates new drachma. Quite simple.

  3. July 2, 2015 at 3:24 pm

    It would be worth to elaborate on this. Following a No vote I think the situation will be as follows. However disclaimer, I’m not qualified to speak on these matters:

    – Euro deposits in Greek banks are liabilities of the Eurosystem to individual Greeks. After a No vote that stays the same. Whatever Euros you had you still have, at least on paper.

    – There’s no legal basis for converting Euros to Drachmas overnight. It would probably be a form of property seizure. Also, no-one would want to. Why devalue perfectly good euros?

    – Of course the ECB may decide to cut off reserves to Greek banks and let them go bust. Liquidity may be solved by capital controls, but bad Euro loans may lead to insolvency.

    – In practice, assuming a No vote and deadlock, Euros in Greece will be like gold. No MFI creation, therefore haircut until deposits equal reserves.

    – I don’t see how Greece can avoid issuing Drachma parallel to the Euro, letting it be used for domestic payments privately and to the state.

    – Although Greece won’t redenominate Euros to Drachmas forcibly, it may step in and “guarantee” Euro deposits in Drachmas after the ECB gives them a haircut.

    – There’s a lot of frozen debt in Greece’s black market. Teacher owes to plumber, plumber owes to dentist, dentist owes to teacher, etc. New Drachma should monetise this debt, if properly introduced, and lubricate as well as formalise the economy.

    – Euro will be a tourism and import/export currency, just one that is widely circulated. It may lead to a two-tier economy where anyone receiving Euros has advantage, but that’s inevitable.

    That’s how I imagine it. Grexit doesn’t look like overnight conversion of Euros to Drachmas. Instead Euros will be precious and hard to come by and Drachma will be introduced alongside as the money everyone can have. I hope this scenario is palatable given the public’s loss-aversion and psychological attachment to the Euro.

    Would anyone more knowledgeable on the mechanics of the Euro system care to comment?

  4. Macrocompassion
    July 2, 2015 at 3:45 pm

    On a previous posting I already suggested that there should be a return of the Drachma in parallel to the Euro in Greece. The two currencies should be freely inter-changeable. The Greek government owes an enormous lot of Euros but it can still manage to pay interest on them and to return slowly its enormous debt. By buying Euros with its newly printed Drachma, it would have these Euro funds available and this action it would stabilize the Drachma as well, stopping inflation.

    All of the Euro fuss over Greece is about how the big loan is to be paid back and what conditions need to be imposed. Agreed that this money should be returned but for all that there should be no pre-set condition as to when, provided it is being done.

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