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A Greek exit: Good idea, hard to do

Athens would be better off outside the eurozone. But can it head for the door without bringing down the house?


 

It may be time for Greece to leave the eurozone. Analysts have been saying since late last year that a Greek exit, now known as “Grexit” among economics dorks, was a likely scenario. Last weekend’s messy elections and this morning’s bombshell statements by the country’s left-wing Syriza bloc make it all the more likely. So what would a Grexit actually look like, and would it be good or bad for Canada and the rest of the world economy?

The short answer is that letting Greece slip out of the eurozone is a good idea in theory, but a hard one to pull off without disastrous consequences in practice. David Smith, economics editor of The Sunday Times, summed it up nicely in a post he wrote before the election results came out:

A Greek exit, should it occur, would eventually be good for Greece and remaining eurozone members. Getting there, however, without triggering a domino effect, and without a hugely damaging impact of the banking system, is the difficult part.

Certainly, a return to the drachma would be no cakewalk for Greece. It would require Greek debt to be re-denominated in a much weaker currency, something ratings agencies and investors would probably see as a default. The International Monetary Fund and the EU would probably shut off flow of emergency funds to Athens, and it’s unclear how the government would keep paying pensions and wages for its vast ranks of public-sector workers in that case.

Nonetheless, going back to a currency of its own would probably be good for Greece in the longer term. It would allow the government to reduce its debt burden via inflation–which might be the the first and most important step toward economic recovery. Plus, a cheaper currency would be a boost for Greece’s exports, as it has proven to be for Argentina’s after that country unpegged its currency in 2002.

The eurozone, on the other hand, would offload its most troublesome member, which right now is weighing on its financial resources–by requiring a constant stream of bailout money–and negatively affecting the risk rating on the debt of other eurozone economies.

That said, the problem is that if Greece actually heads for the door, there’s a chance it’ll bring down the house. There are two main reasons for that: One, a de-facto Greek default would mean trouble for any European bank that still holds a lot of Greek debt. The continent’s banks have been furiously offloading those risky Greek bonds for some time now, but experts still disagree as too the extent to which they would be “safe” should Greece becoming insolvent. Cyprus, for one, still holds loads of Greek debt. Two, if Athens goes solo, investors are going to demand even higher interest rates from the rest of the eurozone’s weakest economies, namely Italy, Spain, Portugal, Cyprus and probably Ireland too. That could in turn trigger a domino effect wherein those countries become unable to service their own debt and are forced out.

Still, as this ratings report from Fitch points out, the doomsday scenario of a chain-reaction of eurozone exits could likely be avoided if the European Central Bank and Brussels stepped in aggressively to buy Italian, Spanish and Portuguese bonds and put in place some sort of credible semi-fiscal union that could calm investors’ nerves.

To make a long story short, as hair-raising as the prospect of an actual Grexit may be, it is looking more and more like not just the most probable scenario, but the better one too.


 

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