The first days of the Greek exit

Given widespread discussion of a possible imminent Grexit (aka ‘Greek exit’) – including by some European officials – it’s worth briefly sketching out what it would look like.

In terms of actually introducing a new currency, I think this is a massive logistical challenge that would take months – just in terms of printing notes, distributing them, reprogramming ATMs, etc, let alone the legal quagmire. But in the immediate aftermath of the decision, I would expect all of the following three things from Greek and European leaders:

(1) Greece would pass emergency legislation introducing capital controls and creating the new currency in legal (if not yet physical) form. This would unilaterally violate the Maastricht Treaty, which provides for free movement of capital between EU members. The widely-expressed legal view is that there isn’t a legal mechanism for quitting the euro, unlike for quitting the EU – so this Maastricht violation might be the first step towards an EU exit and consequent application to rejoin the EU or EEA post-Grexit.

(2) The New Drachma would start trading at a shadow exchange rate, even before it exists physically. The currency would no doubt depreciate heavily against the euro.

(3) The institutions of the euro area would have to announce, immediately, a massive extension of support to the remaining periphery. There’s been a lot of talk – e.g. from the Dutch finance minister today – about the ‘firewall’ Europe has put up since the start of the crisis. This counts for absolutely nothing: if you’re a depositor or investor in Portugal/Ireland/Spain/Italy and you see Greece exiting and people with money in Greece frozen there by the overnight imposition of capital controls – in spite of two years of protestations that there will be no Grexit – then the rational thing to do would be to pull your cash immediately and ask questions later. In the short term, the policy response would have to include:

  • a clear public announcement by the ECB that they’re willing for banks in the remaining periphery to become reliant on central bank cash on whole different scale to what we’re used to (as a result of depositor flight and wholesale funding freezes), including larger banks there, and probably as part of a jointly-guaranteed Eurosystem scheme (which means loosening Eurosystem collateral standards) rather than nationally-guaranteed ELA funds;
  • pre-approved second EFSF programmes for Portugal and Ireland to ensure their funding (if required) through to late in the decade and precautionary credit lines for Spain and Italy; and
  • perhaps most controversially, some sort of explicit commitment by the ECB to deploying its balance sheet to support any euro area sovereigns that need it, either through: (i) an explicit cap on secondary market yields for euro area states; or (ii) giving the EFSF a banking license and letting it borrow as needed to fund euro area states.

None of this sounds pleasant. But they’d have to act like this after a Grexit because the consequences of not acting would be too catastrophic – and I’d bet in this situation (and here’s sticking my head out…) that the imminent continent-wide economic catastrophe and consequent changing electoral arithmetic would lead even the Germans to sign up to this programme.

I think Greece could leave. But if this doesn’t jolt the institutions of the euro area into belated action, nothing would.

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