By Andrew Rosenbaum
ANKARA
The report on Saturday by the magazine Der Spiegel stating that the German government “would allow Greece to exit the euro,” has struck fear into the international financial community.
The consequences for the single currency would be devastating. As University of California Economics Professor Barry Eichengrun puts it: “The answer is no. The decision to join the Eurozone is effectively irreversible. However attractive the rhetoric of defection is for populist politicians, exit is effectively impossible,” in a note posted in May 2010, when such an exit first loomed.
“The insurmountable obstacle to exit is neither economic nor political, then, but procedural. Reintroducing the national currency would require essentially all contracts -- including those governing wages, bank deposits, bonds, mortgages, taxes, and most everything else -- to be redenominated in the domestic currency. The legislature could pass a law requiring banks, firms, households and governments to redenominate their contracts in this manner. But in a democracy this decision would have to be preceded by very extensive discussion,” Eichengrun explains.
But the consequences for the euro system are at the “shock-and-awe” level. As the IMF noted in its original study of a Greek exit in 2010: The European Central Bank supports Greek banks as a lender of last resort. Any announcement of plans to move off the euro will start a run on Greek banks, as those who have euros in Greece will not care to exchange them for drachma. There will be vast capital flight, leading probably to bank failures, as the ECB won’t be supporting Greek banks any longer.
Exiting the euro would also constitute a default on euro-denominated bonds, and raise questions about all other euro-denominated securities.
The result, as the IMF pointed out in 2010, would be a global banking crisis that would, as Eichengrun puts it, “would be Lehman Bros. squared,” referring to the global banking crisis on an unprecedented scale set off by the failure of the Lehman Bros. investment bank in 2008.
Among the more important of those risks is the resulting run on the Greek banks and further collapse of the Greek economy, as economist Desmond Lachman, formerly a deputy director in the International Monetary Fund's Policy Development and Review Department, points out. The immediate devaluation of the currency would lead to heavy pressure for wage increases, as well as making the country’s deficit hopelessly outsized.
Nor would an exit permit the Greeks to default on its bailout debt to the IMF, the EU, and the ECB. In fact, payments of international debt with a devalued drachma would be even more onerous. As for a default, it would destroy the credibility of the European Monetary System, Lachman said in a note published in The Hill on Dec. 18.
“In September 2008, when U.S. policymakers were faced with the decision as to what to do about Lehman Brothers' acute financial difficulties, they grossly miscalculated the likely fallout from letting Lehman go bankrupt. That decision had devastating consequences for both the U.S. and global economies. One has to hope that European policymakers have learned the lessons from that sad episode and that they weigh very carefully the pros and cons of letting Greece go before they come to any decision that they might later come to regret,” Lachman warns.
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