The Beginning Of The End For Greece’s Membership Of The Euro

The results of the Greek election have once again raised the possibility of a Greek exit from the Eurozone. In fact, many market commentators (myself included) now think a Greek exit inevitable.

If Greece ends up with an anti-austerity government it seems inevitable that the Troika, that is the European Commission (EC), the International Monetary Fund (IMF), and the European Central Bank (ECB), would curtail it’s programme of bailouts. Certainly it seems unlikely that fresh bailouts would be granted beyond July – which is when the current funding is due to expire.

This would mark the beginning of the end for Greece’s membership of the single currency. This could quickly be followed by the introduction of capital controls, to try to stem the flight of capital and deposits out of the country, followed by a bank holiday and the introduction of the New Drachma.

Assuming the New Drachma is introduced at an exchange rate of 1 to 1 with the euro, all bank deposits, financial assets, obligations and contracts governed by Greek law would be redenominated into the New Drachma. The new currency would then be devalued by anything from 40 to 70% vis-à-vis the euro, making imports very expensive, but providing a huge boost to tourism which makes up around 18% of Greece’s GDP.

The benefits of a cheap currency for the tourist industry could be felt fairly quickly, however unless the adoption of the New Drachma was coupled with meaningful structural reform of labour markets, product markets and the public sector, Greece would likely suffer the effects of high inflation, fuel shortages, a further reduction in living standards, increased social tensions, and even social unrest. Not to mention several years of political isolation.

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