Drachma Drama

Lately, there have been unsettling talk in the international economy about a “Grexit”: Greece leaving the Eurozone if it refuses to pay its debts and has to default. Greece’s debt stands at approximately 323 billion euros (366 billion dollars). Although this doesn’t seem like a huge number, especially compared to the United State’s debt of 16.34 trillion dollars, the importance of the number is in the debt-to-GDP ratio. This is simply an equation with a country’s total debt in the numerator and the country’s Gross Domestic Product (GDP) in the denominator. It is generally concerning for developed countries to have a ratio greater than 100%, although there are a handful of exceptions. Greece’s Debt-to-GDP ratio is currently an extremely high 161.3%.

Greece’s skyrocketing amount of debt began in 2008 during the global recession. Greece was hit harder than most other countries in Europe due to its high dependence on tourism for GDP growth. Obviously, taking a trip to Greece is a luxury good, and as millions experienced a decrease in income, Greece’s tourism market took a huge hit. In addition, Greece is notoriously awful at mandating policies for effective tax collection, so their revenue is substantially compromised. In 2009, Greece’s spending accounted for 54% of its GDP. After an accounting fraud ensued in the same year, private investors completely stopped their lending after hearing the news. In order to keep the economy afloat, public lending organizations such as the International Monetary Fund, European Central Bank, and the European Commission. After bailouts to these organizations in 2010 and 2012, their willingness to lend is beginning to dwindle.

Today, according to an article in the Wall Street Journal, Greece staying in the Eurozone is no longer “the base case” for European officials and that “literally nothing has been achieved” in negotiations with managing debt with the new Greek government. In order to keep up its debt repayments, Greece has to pay the IMF more than 1 billion euros in May. The European Central Bank and European Commission are also pressuring Greece to repay their loans before they mature. If Greece fails to find a compromise in debt reforms with Eurozone creditors, it will have to go into default on all of its debts. This default will destroy their credit, leading to both European and international banks no longer being willing to lend Greece any more money. Greece will then have to repay their citizens and cover their expenditure as their financial institutions fail. If they remained on the Euro, they would no longer be able to do so, meaning that Greece will have to repay in the Drachma. Switching to the Drachma will not only decrease the demand in the Euro, but will cause cripplingly high inflation in Greece as the government simply prints out a currency that has been legally unused for years.

There is a lot of debate on the economic effects of the Grexit. German Finance Minister Wolfgang Schaeuble explained to an audience in New York that the contagion risks of Greece ditching the Euro are quite limited. In economic terms, contagion is the likelihood that significant economic changes in one economy will spread to other economies. Thinking the burst of the U.S. housing bubble that lead to the Global Financial Crisis that we saw in 2008, it is clear that in our increasingly interconnected global economy, this is a clear fear. Schaeuble has a very optimistic outlook on the potential for contagion due to the fact that every bank in the European Union has created some sort of plan of action if the Grexit did occur. Jason Furman, who was elected the Chairman of the Council of Economic Advisors, has a completely different opinion. In an interview, he explains that the Grexit would not only be catastrophic for the Greek economy, but it would also take a huge toll on the global economy. He believes that it would be taking a huge and unnecessary risk with the global economy just as things were starting to stabilize.

No matter what your opinion is on the economic effects of a Grexit, it would be a political nightmare. The European Union prides itself on being a stable entity, and the event of the Grexit would certainly taint that reputation. Morgan Stanley gave predictions of probabilities of Greece’s potential actions. It predicts that there is a 55% likelihood that Greece goes back to the original bailout program where they get international funding, but has to implement increased austerity and strict economic reforms. There is a 25% chance that Greece implements extremely strict rules that halt outflows of money from banks, which will help alleviate debt. Finally, they estimate a 20% chance that they completely cut ties with the Euro. Other estimations, such as the Economist Intelligence Unit, puts the Grexit risk at a much higher 40%. Of course, this issue is ridden with unknowns, and it will be exciting (and potentially frightening) to see what ultimately happens.