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New Drachma

This article got first published by Marc Chandler on marctomarket.com

FAQ: What A New Drachma Would Look Like

We recognize that this drawn out Greek drama is reaching a climax. By most reckonings, this weekend is decisive.
We have argued that Greece will have its debt relief, either through default or negotiation with the official creditors.  We have argued that greater hardship is coming to Greek people.
It can choose a known and orderly type of pain and try to influence its distribution, or it can roll the dice for a chaotic collapse.  This would likely concentrate the pain on those least equipped to cope with, namely the poor, sick, young and old.    The creditors cannot escape the fact its loans to Greece cannot and will not be fully paid back.  The Greece cannot escape the fact that to put the country on more sustainable and competitive footing, various reforms will have to be implemented.    Greece will have to live within its meager means.
There has been much talk of a Greek exit from the monetary union as some kind of accident.  It is no accident.  After all, German Finance Minister Schaeuble reportedly has been pushing for it since the crisis first broke almost five years ago.   European Commission President says detailed plans of a Greek exit have been drawn and readied.   Rather than an accident, we think it would be folly.
Nevertheless, the risks of a Greek exit have risen.  There are many questions as it would be an unprecedented event.  We try to offer preliminary answers to some frequently asked questions about a potential  Greek exit.
1.  What is the sequence of events that could lead to Greece’s departure from EMU? 
If Greece and its creditors cannot reach an agreement this weekend, the ECB could claw back the Emergency Liquidity Assistance authority granted to the Greek central bank.  This would likely force Greece to provide a new means of liquidity.  This would become the basis for new national money.   We have suggested two steps that the Greek government may take that would signal a preparation for such an eventuality.  First, Greece can make good on its threat to challenge the ECB’s ELA authority.  The European Court of Justice recently gave the ECB wide berth in terms the conduct of monetary policy.  ELA is not a function of its monetary policy.  One way to challenge this would be a legal case.  The other way is to defy the ECB.  This would likely require a second measure, and that is to replace the current governor the central bank with one that would be more accountable to the Syriza-led government.  This would also give the government greater control of the country’s reserves (gold and hard currency) that become all the more important on a Greek exit.
2.  Is there another way that a new currency could be introduced? 
There are some 600k government workers in Greece.  The government could do what some companies are already reported to have done, and that is to issue scrip, which is a type of private money in lieu of access to public money.   A few years ago, the Governor of California issued scrip.  In Greece, the value of the scrip would fall relative to the euro.  Although the scrip would be said to be temporary, it could be the basis of a new Greek currency.
3.  How would Greece introduce a new currency?
It takes some effort and planning to issue currency.  There are many details.  It would need a code that would allow computer settlement for trading and payments.  The International Standards Organization issues it.  The one limit here is that it cannot go back to GRD (Greek drachma) as that code is not unique.  It would be confused with the previous drachma that is still alive in cyberspace due to ongoing payments and contracts.
4.  What about outstanding contracts? 
This is where it gets trickier.  There is a hornet’s nest of legal issues that have to be addressed.  While a new currency could theoretically be introduced rather quickly, these legal issues would take more time and effort.  There has been some suggestion that this could take a month or longer.  A key issue for investors is to understand the controlling legal framework for the contracts.  Since the private sector debt restructuring in 2012, the new government bonds are under the jurisdiction of British law, not Greek national law. This is a legal hurdle to the government’s decisions by fiat.
5.  What would happen to the new currency? 
The advocates of abandoning the euro argue that a new currency would devalue and that this would boost Greek exports.  It would also allow Greece to inflate, which would reduce its real debt burden. Estimates of the depreciation are in the 40-50% area.  This will make any debt denominated in euros more expensive to service.  Even if the government repudiates all of its debt, the private sector debt will remain.   There is some risk that a new currency, whose sole raison d’etre is to depreciate, would not be accepted by shopkeepers and other businesses.  There is some precedent for this.  It would lead to a parallel currency system or the continued euro-ized Greek economy.
6.  Could Greece still use the euro even if it exited monetary union? 
There are a number of example of a country using another’s currency.  For the euro, Montenegro is an example.  The euro is its official currency, but it is not part of the monetary union or even the European Union.  However, Greece is in a different position. It does not have sufficient access to euro funding to support its banks.  The government does not have sufficient euros to fund its debt and pay its workers’ salaries and pensions. This gap needs to be addressed.  A deal with the creditors is one way.  If no deal is reached, Greece will have to find other means besides the euro to fulfill its obligations, especially for its domestic purposes.
7.  What kind of contagion would a Greek exit entail?  
As the Greek crisis intensified, there has been some pressure on other peripheral bond markets  The premiums investors’ demand over Germany has increased.  The Swiss franc has strengthened, prompting intervention by the Swiss National Bank.  Out of the earlier phase (2010-2012) of the Greek crisis, Europe erected a number of firewalls and facilities to reduce systemic risk.  These include the European Stabilization Mechanism (ESM) that can issue bonds to raise capital for members under pressures.  The ECB has created the Outright Monetary Transaction (OMT) facility that can purchase government bonds in the secondary market as part of a large assistance program. The OMT mechanism was challenged in court by several parties, including the German Bundesbank, but the European Court of Justice recently ruled that it was indeed a legitimate exercise of the ECB’s authority.
8.  Would a Greek exit harm European growth? 
It terms of the impact on growth, it would be minor.  Greece’s economy has contracted by a quarter in the last few years. Even before it was downsized, the Greek economy was too small to have much systemic significance.  Another potential channel of contagion is via trade.  Here too Greece does not have the scale that can pose a significant disruption.  While that is true on the aggregate level, some industries and companies may have different exposures, and these need to be examined in a more granular fashion.
9.  What are the implications of a Greek exit over the longer-term? 
The contagion that we think is more worrisome is of a longer-term nature.    A Greek exit would once and for all signal that monetary union is not irreversible.   Going forward, any crisis, and we have to assume there will be others, will become an existential crisis.  Investors will have to worry, for example if Podemos wins the national elections in Spain later this year, will it too leave the union if debt relief is not forthcoming.  A Greek exit effectively turns the monetary union into a more rigid form of the European Exchange Rate Mechanism, as Martin Wolf of the Financial Times recently noted.
10.  How would European officials respond?   
The European political elite are very committed to the European Project  They have no vision of Europe and Europe’s place in the world.  Some European officials seem to favor a strategy that the Chinese refer to as “killing a chicken to scare the monkeys”.  Greece is made an example of and sacrificed.  It will harden the union, they argue though this has to be seen.  Spain will think twice or more about elected a party seeking debt relief.  In addition, as Greece was (inadvertently) the midwife to institutional change and capacity building previously, it can serve this function again.  The crisis that could lead to Greece’s exit could also spur new bold initiatives to enhance integration.
11.  What are the geostrategic implications of a Greek exit? 
The geostrategic significance of a Greek exit is worrisome.  It is most desirable that a NATO member is also part of an economic community.  A strong, competitive economy is needed for numerous reasons, including security.  As there is no formal mechanism to eject Greece from EMU, but there is from the EU, lawyers have argued a Greek exit from EMU would at the same time be an exit from the EU.   Greece would be such a weak state that it would turn to where it had to for support.  Greece’s ports are among the assets that foreign investors, including Russia and China.  Many Greeks seem to regard Germany as more dangerous that Russia.  Russia wants to build a pipeline that circumvents Ukraine and going through Greece is appealing, though the EU is more interested in reducing the dependence on Russian energy sources.  Merkel has recently noted Greece’s strategic importance in stabilizing the Balkans.  Greece is also an important buffer state between the Europe and northern Africa and the Middle East, from where refugees seek a haven.

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