Time to Admit Defeat Greece Can No Longer Delay Euro Zone Exit
Part 4: Scenarios for a Greek Exit
European leaders are now convinced that a Greek withdrawal from the monetary union would be manageable. "The risks of contagion are no longer as great as they were a few months ago," says Luxembourg's Finance Minister Luc Frieden.
European leaders, at any rate, are no longer willing to depend on the foresight of Greek politicians, and so they have instructed their experts to make preparations for the worst-case scenario. For around the last year, a "Greece Task Force" appointed by German Finance Minister Wolfgang Schäuble has been developing a possible exit resolution. Isolated from the rest of the German Finance Ministry, the group is working out models and scenarios on the potential consequences of a withdrawal, both for the rest of the euro zone and for Greece itself.
The task force's most important conclusion is that a large share of Greece's debt is now held by public creditors, most notably the ECB. According to Finance Ministry officials, the Frankfurt-based monetary watchdogs hold between 30 billion and 35 billion in Greek government bonds.
These holdings become dangerous if Greece stops servicing these debts because it is no longer receiving any money from the European bailout funds. This is why crisis experts in Berlin have dreamed up a particularly cunning solution for the problem. They don't want to completely cancel the tranches from the aid packages the Greeks are scheduled to receive. Instead, under their proposal, the country would have to do without the portion of the aid that was meant to flow into the government coffers to cover pensions, public sector wages and other expenses. But the billions that are earmarked to service the bonds held by the ECB would be paid into a special account, thereby averting problems at the central bank. In return, the ECB has already signaled its intention to resume its program to buy up the government bonds of other debt-ridden countries if they come under pressure following a Greek withdrawal from the euro.
The mechanism essentially amounts to the European Financial Stability Facility (EFSF) paying for up to 35 billion of Greece's sovereign debt. The last bond held by the ECB matures in 2030.
Of course, the EFSF's claims against Greece will remain in place, but the only question is whether the country will be capable of honoring its obligations. EU experts are convinced that it will certainly not be in that position during the initial period following the introduction of a new currency. The country's euro-denominated debts would suddenly turn into foreign-currency debts, and would multiply as a result.
Even if the Greeks withdraw from the monetary union and receive no further support payments from the European bailout funds, they will not be abandoned. If Greece remains a member of the EU, it will be entitled to the same type of assistance other EU countries can receive when they are in dire financial straits. Latvia, Hungary and Romania have received such assistance in the past, for example.
This is not necessarily disadvantageous for the euro-zone members. "Then it won't just be the member states of the euro zone paying for Greece," says a senior German government official, who preferred not to be named. "In fact, all 27 EU members, including Great Britain, will have to make their contribution."
While the exit would be turbulent for the rest of the euro zone, it would be a matter of life or death for Greece. EU diplomats in Brussels paint a dramatic picture of the challenges the country will face if it gives up the euro. No one wants to talk about it on the record, so as not to further fuel speculation on the financial markets. Nevertheless, the emergency plans have already been developed. "Of course we have something ready," says a top official familiar with the matter.
First of all, say officials in Brussels, Greece would have to introduce capital controls. Well-heeled Greeks are already believed to have moved 250 billion abroad, which could hardly have been prevented in a free internal market with a common currency. But if the drachma is to be reintroduced, the Greek authorities will do everything possible to stop the transfer of euros to other countries.
Police Guarding Banks
The introduction of the new, old currency will require detailed planning and execution. Money presses will have to produce the drachma notes. "The banks will have to close for a week until the new currency can be distributed," predicts one of the senior EU officials, who spent months studying how other countries reformed their currencies.
Experience has shown that, in such cases, police units are posted behind sandbags at bank branches. During the transition period, cash dispensers would only spit out 20 or 50 a day, so that customers could buy the bare minimum in daily necessities.
The introduction of the new currency would begin with a sort of mandatory exchange period, during which the Greeks' euro assets would be exchanged into drachmas at a fixed rate. Pensions and salaries would only be paid out in the new currency.
EU officials are preparing for the possibility that the Greeks would then no longer be able to fulfill their obligations within the EU, at least temporarily. For instance, the country, as a signatory to the Schengen Agreement, monitors the external borders of the EU. If there is a currency devaluation, customs agents will have other priorities, at least in the short term.
It would be the first time in postwar history that a Western European country declared bankruptcy and introduced a new currency. The organizational challenges are considerable, but the economic consequences would be even greater.
If the drachma returns, it will drastically lose value against the euro, with experts expecting a devaluation of at least 50 percent. Insiders say that a loss of up to 80 percent is even possible. Banks and companies with foreign debts denominated in euros could no longer service them and would have to file for bankruptcy.
As a result, Greece would plunge into an even deeper recession. The IMF estimates a decline in economic output of more than 10 percent for the first year following the return of the drachma. This would set the country back by years in economic terms.
But after that, according to the IMF, the Greek economy will grow even faster than it would without the devaluation. "The turbulence could last one or two years," says Hans-Werner Sinn, president of the influential Munich-based Ifo Institute for Economic Research. But after that, he adds, things will improve again.
The professor's prognosis is based on two assumptions. First, because imports will become more expensive, the Greeks will buy more domestic products, eating Greek instead of Dutch tomatoes, for example. At the same time, the country's exports will become cheaper, making it more competitive. The result: Greek olive oil will displace Spanish oil in German supermarkets.
Many countries have successfully exported their way out of their plights in the past through currency devaluation: Sweden in the wake of the banking crash in the early 1990s, South Korea following the 1997 Asian financial crisis and Argentina after the end of the dollar regime in 2001. In all of these countries, the economy crashed initially, only to recover all the more vigorously in the end.
Greece can reduce its foreign trade deficit by exporting more and importing less. In the last decade, its trade deficit was at a near-record 10 percent. Even in 2010, when the crisis hit with full force, the country imported 32 billion more in goods than it sold abroad. As a result, Greece, supposedly an agricultural country, is still a net importer of food products.
Another economic sector on which many are pinning their hopes is also likely to benefit from the return of the drachma: tourism. A vacation in Greece has become too expensive for many foreigners. But with the new currency, the country could compete once again with its toughest rivals, Turkey and North Africa.
It's likely, but not guaranteed, that the economic renaissance will succeed. Many economists fear that the unavoidable chaos of a currency reform could overshadow its positive effects for a long time. Savers would lose a large share of their assets, the government would face the risk of collapse, Greeks could slide into poverty and Europeans could find themselves with a costly, long-term problem in the southeastern corner of the continent.
It wouldn't be the only bill coming Europe's way. More and more Greek debts have been assumed by the public sector in the last two years. In the wake of the March debt restructuring, private creditors, such as banks, insurance companies and hedge funds, now hold sovereign debt worth only about 100 billion.
There are also loans in the amount of 73 billion that were disbursed by the members of the euro zone and the IMF in the context of the first aid package for Greece. Now Athens has also received the first tranches from the second aid package. And then there is the roughly 35 billion in sovereign debt held by the ECB. It is unclear what will happen to the ECB's claims against the Greek central bank, the so-called Target-2 balances, which recently added up to about 100 billion.
The Fitch rating agency estimates that public-sector claims against Greece will grow to more than 300 billion this year. If the majority of these claims became worthless, the German finance minister alone would face a loss of tens of billions of euros.
This is a large amount, and yet most economists believe it is manageable. It would roughly correspond to the German government's net borrowing for this year. In other words, the economic damage of a Greek withdrawal from the euro for Germany would remain within limits. "The Greek economy is simply too insignificant for that," says the Oxford-based German economist Clemens Fuest.
The conclusion is clear: The current strategy to rescue Greece has failed, but at the same time the risks of a withdrawal are shrinking. This makes it all the more important to take advantage of the opportunities of a new beginning, in the interest of both Greece and the euro zone. It would also make the euro zone more attractive to new members, such as Poland, with its strong economy. Foreign Minister Radoslaw Sikorski has already signaled Warsaw's desire to join the euro zone.
If Athens were to leave the euro zone, it would send a message that the fiscal and budgetary rules in the monetary union must be more closely adhered to in the future. It would also make it easier for the Europeans to implement the necessary resolutions to save the euro. In many countries, the situation in Greece only inflames the resistance to bailout funds and aid programs.
A comeback of the drachma would change this, so that it comes as no surprise that in Germany, in particular, many people are inclined to take a hard line on Greece. Horst Seehofer, the head of the conservative Christian Social Union, the Bavarian sister party to Merkel's Christian Democratic Union (CDU), has long called for a Greek withdrawal, and he now feels vindicated. If Athens were to reintroduce the drachma, it would be "neither the end of the euro nor the end of the EU," he says. "We must preserve Germany's economic strength. That's more important that Greece remaining in the euro zone."
The two other partners in Germany's ruling coalition are also sharpening their tone toward Athens. "Greece only has a future in the euro zone if its debts are consistently reduced and structural reforms are put in place," says Economics Minister Philipp Rösler, leader of the business-friendly Free Democrats. "A softening of, or deviation from, the established programs will not occur."
The EU's Biggest Test
Volker Bouffier, the CDU governor of the western German state of Hesse, also argues for strictly adhering to the current austerity course. "Greece has already received more money than was paid out under the Marshall Plan," he says. "The Greeks must treat the measures as an opportunity, or else they don't stand a chance."
But even with a comeback of the drachma, the Greek problem would not be solved by a long shot. A withdrawal from the monetary union would subject the EU to the biggest test in its history. It would have to continue supporting the Greeks to prevent the country from descending into chaos and anarchy.
One thing is clear: If Greece returns to the drachma, that will be the point when Europe's work really begins.
REPORTED BY SVEN BÖLL, MANFRED ERTEL, MARTIN HESSE, JULIA AMALIA HEYER, CHRISTOPH PAULY, CHRISTIAN REIERMANN, MICHAEL SAUGA, CHRISTOPH SCHULT AND ANNE SEITH
Translated from the German by Christopher Sultan