How and why Greece would leave the Euro (part 3) The pain and mechanics of leaving the Euro
How and why Greece would leave the Euro (part 3)
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- Now that we have a reasonable understanding of why austerity is very difficult.
- 1) There probably isn't the political will to do it.
- And even more, it might drive Greece into a bigger recession.
- And we also understand why defaulting isn't an option for Greece
- and we understand what a monetarily independent Greece would have done.
- We can now get a good sense of what Greece is likely to do, outside any other intervention,
- outside any help from other Euro Zone members.
- In future videos, we will talk about why other Euro Zone members do have some incentive to try and stop Greece from doing what I'm about to articulate.
- So in an ideal world, Greece, if it had its own currency, would just print away and be able to inflate away its obligations.
- Also, if it had its own currency, and this is not necessarily a good thing to do,
- because it will undermine investor trust going forward,
- but even defaulting would be an option, because they would still have access to their own currency
- and then they could just keep printing and then lending to that government,
- then the government could continue to pay the nominal obligations,
- but since they're getting inflated away, in real terms they would become lower and lower.
- So what Greece, if it doesn't get any help from other Euro Zone members,
- if it does not get bailed out in some way, what is likely to happen is that Greece leaves the Euro.
- And the actual mechanics of that, and it will probably go back to a new form of the drachma.
- And the way that that would actually happen mechanically is that they would declare a banking holiday.
- And it sounds like a very nice thing like everything which had a world "holiday" in it
- but a banking holiday is essentially a forced shut down of all of the banks for some period of time,
- over which they can do transition into the new currency.
- And so, entering into the banking holiday the Euro was the currency,
- and the money you had in your bank was denominated in Euro,
- but exiting the banking holiday the drachma will be the currency,
- and the money that you have in the bank will be the drachma.
- And what the government will essentially do is set some type of conversion rate over that banking holiday.
- They'll maybe say every one Euro you have will be converted into one drachma.
- And then just the exchange markets will determine
- what the actual exchange between a euro and a drachma is going forward.
- And so then everybody would buy and sell in drachma.
- And the government would also say all of our obligations are now in drachma.
- Which would essentially be a default because if they told to their debtors
- that "we no longer owe you....[where is the number?] 356 billion euros",
- or actually close to 400 billion or whatever the number is,
- "we do not longer owe you 400 billion euros",
- they are now going to say "we owe you 400 billion drachma."
- Or they can even say, we're only going to pay you 200 billion drachma,
- or a 100 billion drachma. But no matter what they say,
- even if they say they are going to give you a trillion drachma, that would still be a default on the debt
- because these debtors, in order to fulfill these obligations, they were expecting euro.
- And if you give them anything other than euro,
- if you give them strawberries or bananas or drachma, that is a default.
- So no matter how many drachma they say they're going to give,
- this would constitute a default on their debt.
- But the Greek people could actually then move on with their lives.
- And there's all sorts of crazy things that would happen,
- but at least now the government would be able to print its own money and use
- it to buy government debt, and continue to fund government spending
- and eventually inflate away its obligations.
- You could imagine a situation that, right now,
- its real GDP is, let's say it's the equivalent of 100 drachma.
- And then by just keep printing drachma, the actual productivity of the economy doesn't change.
- It actually might improve if money is printed, but you don't get to hyper inflation.
- Let's say over the next 10 years that the real GDP doesn't change,
- but the nominal GDP, due to inflation over the next 10 years, becomes 500.
- Prices in general, ...so inflation, you had 5x inflation.
- Things become worth 5 times as much, you produce the same goods and services,
- they are now worth 5x as much. But now, that debt that you have,
- your taxes are going to grow with inflation because they are a % of your GDP
- but your actual debt obligations won't change.
- So in real terms, they'll be 1/5 as much, which all of a sudden, makes them sustainable.
- Now, as I said, this is not a simple thing to do. And not a painless to do.
- And we haven't even started talking about the repercussions for the rest of Europe, and why this might be scary,
- and make other people suspicious of countries like Spain and Italy, etc.
- And even in Greece this would be painful. Because you can imagine,
- you can imagine, we're already starting to see this in May of 2012.
- The government will say every euro in your bank account will now be a drachma,
- but the people there they know better than just believing that a drachma is going to be worth the same as a euro.
- They're going to know that as soon as the drachma starts exchanging on foreign exchange markets,
- that the actual reality is 1 drachma is going to be worth something closer to maybe .6 of a euro.
- Or .7 of a euro.
- Let's say it's .7 of a euro.
- So essentially by this happening, everyone's savings and deposits,
- in real terms, in terms of their global buying power is going to go down by 30% overnight.
- And the Greek people are already seeing that.
- They are seeing the possibility of a banking holiday, and a conversion to the drachma.
- And so that's why you have people waiting in line before this happens and trying to withdraw their euros.
- So people are starting to withdraw their euros,
- and if they have a Swiss bank account they can deposit it there
- or they can just take the euros and stash in their mattresses.
- And that by itself is a little bit scary. The bank's deposits are depleted.
- But remember, they have a fractional reserve banking system.
- They do not expect everyone to show up on one day and expect all of their deposits to be accessible.
- So this is essentially going to lead to a run on banks.
- And you're already starting to see this in Greece, and it is actually rational behaviour.
- If you think that 30% of your savings is about to swiped away because of this thing right here,
- I'm going to give you .7 of a euro for every euro you have,
- you would rationally go to the bank and get your deposit back.
- But because everyone is going to start doing that, the banks won't have their reserves.
- The Greeks don't have their own central bank that can back up the banking system there.
- So this might lead to massive bank failures.
- And essentially, the entire Greek banking sector could go down because of this.
- And they don't have an independent central bank, independent of the European central bank,
- to kind of fight the fires the way that the Fed would in the US.
- So this is not a clean situation; it is not a painless situation.
- But, outside any help, it seems like the only option that Greece has at this point.
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