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Greek Euro Exit? More Pain Than Gain

Given the resistance of the Greek populous to the existing imposed austerity, additional austerity could trigger a popular uprising and result in a Greek exit from the European Monetary Union (EMU), i.e., the euro, or from the European Union (EU) itself.

The founding Maastricht Treaty (1992) and original amendments didn't discuss provisions for a member's exit from either the EMU or the EU. The Treaty of Lisbon (2009) does allow for an exit from the EMU, but that appears to be predicated on a negotiated rather than unilateral withdrawal. It is clear, however, that the EMU was meant to be an irreversible arrangement. (For a detailed discussion, see P. Athanassiou's ECB working paper entitled "Withdrawal and Expulsion from the EU and EMU."

The "New Drachma"

Putting aside the legal questions, an exit from the EMU and formation of a new Greek currency (call it the "New Drachma") has its own set of troubling issues. Once again, a look at the recent Argentine experience is enlightening.

A decision to leave the EMU would need to be done quietly, as public knowledge would cause a run on the banks to acquire euros causing nearly instant failures in the banking system. So, severe restrictions on euro withdrawals would have to be imposed, like the much hated "corralito" that was imposed in Argentina in 2001. That government imposed policy restricted withdrawals to a nominal amount per week. This was a key repression that led to the social unrest, riots, and the eventual toppling of the government.

Next, Greece would need to decide what to do with its debt. Hard choices would have to be made on externally held debt. Any attempt on the part of the Greek government to convert externally held debt to the new currency on a 1:1 basis would be met with massive resistance.

Keeping external debt denominated in euros would become crippling as the value of the "New Drachma" would immediately devalue in the forex markets. And, all of the "extend and pretend" would be for naught, as the Greek sovereign assets on the balance sheets of the banks would be repaid in a devalued currency.

Impairment is Inevitable

Thus, the results of an imposed austerity likely leading to a Greek exit from the EMU are the same as a simple recognition on the part of those banks that hold Greek sovereign debt that those assets are impaired. Facing up to this basic problem would seem to be a better than the current "extend and pretend" approach in which we ultimately end up in the same place, but without the social unrest and bloody carnage that accompanies it. Recognizing today's value of the Greek debt on financial institution balance sheets is called "transparency." Accounting standards, both in the U.S. and internationally, have been pushing for transparency for two decades. Yet, now, governments are madly scrambling to cover up the true values of such assets on the books of their "systemically" important institutions.
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