Leaving the Euro: Such a Cost

At the time that I'm writing this, the Greek Government is split over the bailout package requirements, and Evangelos Venizelos (the finance minister) is trying desperately to appease the Troika (the European Commission, the ECB and the IMF) whilst still asking for more time.

But the Troika is irritated. Time is running out. And various people in varying positions of authority are beginning to say menacing things like "the Euro can survive without them". Oi vey. When it stops being "our" problem, and it becomes all about "those guys", it really begins to sound like the unity is gone.

Which is only a step away from saying that they should bugger off.

So, the question that we should be asking is: why has Greece not left already? 

The answer, quite simply, is that it will be cheaper for them to stay. According to Chancellor Merkel, the cost of Greece leaving the Euro would be "incalculable". That is literally true - there are too many variables at play. But UBS analysts have come up with an economic estimate: when there are many variables at play, analysts just come up with a range.

So, to that end, I'm going to summarise the economic costs that will likely arise should Greece leave the Euro (horribly plagiarised from the UBS report - although I suppose that it's not really plagiarism once I acknowledge that fact). If you're interested in reading the full UBS report, the link is here.

To begin, I need to point out that there is no legal option for Greece to leave the European Monetary Union (EMU). There is no clause for it in any of the treaties - precisely to discourage any one country from leaving the EMU.

There is also no clause in the treaties that would permit the expulsion of Greece from the EMU. The only legal option for expulsion is an amendment to the Maastricht Treaty. In order for the treaty to be amended, there would have to be unanimous consent from all 27 countries, including the country being expelled. And even were Greece to agree to its own expulsion, many of the countries are required to take the amendment back to their people for referenda to take place. So extremely unlikely then within the necessary time-frame.

Which means that the only option available for Greece is secession. According to the UBS report (and common sense), this will come with five core economic costs:

1. Default on Domestic Debt
2. Collapse of the Domestic Banking System
3. Departure from the EU
4. Trade, Tariffs and Protectionism
5. Civil Disorder

Default on Domestic Debt

Once Greece leaves the Euro, it will need to adopt a new currency (let's assume it goes back to the drachma). The next obvious question is: will the sovereign debt (currently denominated in Euro) be converted into drachmas or remain denominated in Euro? 

If the bonds are re-denominated into drachmas, that would constitute a default. Remaining euro-denominated would mean that the debt would have to be paid using Euros earned through trade flows - which are not going to be sufficient. I mean - they're not sufficient now, and if you consider point 4 below, it makes it even less likely. Default on Euro-denominated debt is therefore virtually certain. 

That said, even if Greece stays in the EMU, default is virtually certain.

The costly part of secession would be corporate default. If the government changes back to the drachma, the private sector will no doubt be forced back as well - which means that they will default in the same way. Even if not forced, the private sector would still be earning in drachmas, trying to pay off euro-denominated debt. And given the monetary and fiscal stress that Greece is experiencing, the drachma would immediately, and drastically, devalue against the Euro. Ergo: corporate default.

Corporate default = bankruptcy proceedings.

Bankruptcy proceedings = many firings and domino effects (as one company goes, so this puts strain on its creditors, who may also go bankrupt, and so the cycle continues).

Collapse of the Domestic Banking System

In order for the drachma to function, domestic bank deposits would have to be re-denominated into drachmas. As the UBS analysts point out - there are a range of questions that arise here. Would the only accounts affected be euro-denominated? Would it only apply to bank accounts belonging to Greek residents? And foreign branches of Greek banks?

But in any case, long before the denomination takes places, there would be bank runs. Any account-holder would be foolish not to withdraw their full funds in Euro-cash immediately - and either place it into a foreign bank account, or hide it in a mattress. Could the bank runs be curbed? Possibly - by imposing withdrawal limits during the transition, or by making the re-denomination a shock event (ie. a re-denomination without warning). But the former runs the risk of civil unrest, and the latter is practicably impossible. At the very least, bank officials in-the-know would seek to self-preserve - and in doing so, their actions would become a warning.

Also at a regional level, given the ease with which the suspicion of secession can initiate bank runs, the collapse of the Greek banking system is quickest way for contagion to spread to its European neighbours.

Departure from the EU

This almost goes without saying - to secede from the EMU is to secede from the EU. The UBS report does not attempt to quantify this cost - which makes me think that it is more qualitative. Obviously, there are trade repercussions, which will be dealt with below. But in my mind, the biggest implication here, apart from trade, is that Greece would lose access to EU financial assistance.

Trades, Tariffs and Protectionism

Given point 1, the secession would make Greece reliant on its trade flows for self-financing. But secession would also leave it without a trade agreement with Europe - which encompasses most of its trading partners.

At the same time, the devaluation of the drachma may give a temporary competitive advantage - but the European Commission has specifically stated that it would "compensate" for any movement in the new currency. This could be accomplished by a trade tariff being imposed on Greece equal to the advantage created by the devaluation.

So trade would likely collapse.

Civil Unrest

The risk of civil unrest would already be high during the transition with the panic and tension of a banking sector collapse. In fact, civil unrest seems to be a real risk at the moment. If the Greeks lose access to their bank accounts, that may well be the final straw.

But also, immediately after the transition, I would think that Greece would begin the process of monetizing its debts. The Government would still need to fund its current expenditure. And given the default, and the state of the taxation system, the easiest and most immediate source of financing would be money creation. It is highly unlikely that the Greek people would take this calmly.

Political Cost

Then there is the political cost, which cannot be quantified. With secession and fragmentation, Europe would lose her voice on the international stage.

In Conclusion

Without considering the impact of civil unrest and the political cost, the UBS analysts conservatively estimate that Greece withdrawing from the Euro will cost her citizens between €9,500 and €11,500 per person in the first year, and between €3,000 and €4,000 per person in subsequent years. In contrast, the cost of bailing out Greece, Italy and Portugal altogether, assuming a 50% haircut on debtors, would cost the German population "little over €1,000 per person, in a single hit".

So Greece.

She must stay.