The Consequences of Greece Leaving the Eurozone

21 Jan

Although the reputation of the Greek economy has been mostly shattered over the past four years, the Economist recently published an article warning that it would be imprudent for the EU and Greece to cut ties at this point.

Examining the article

Context: Greece is holding an election on January 25th to decide whether or not to withdraw from the EU. A withdrawal would entail Greece installing its own currency (the drachma), severing the ties between the EU Central Bank and its own, and becoming fully responsible for domestic monetary and fiscal policy.

Facts:
The Economist notes that the drachma would rapidly depreciate against the Euro, which is logical due to the current weakened state of the Greek economy. This is good because it could help kick-start the Greek trade and tourism industries. A weak drachma means exports will be cheaper and national production will rise. Furthermore, wealthy EU citizens would enjoy a high level of purchasing power if they take their six weeks of guaranteed vacation in Athens. However, the Economist warns this process could be very messy in the short-term, as the country must redenominate a significant portion of its debts and assets. A weak Greek economy may not be able to withstand a volatile economic shock, and the citizens could face stagnation or hyper inflation as the drachma becomes worthless.

Furthermore, a significant change could completely undermine the faith of foreign investment. This would make it impossible for Greece to borrow money to pay off currently held foreign debts. If the drachma depreciates as expected, the Greek government could be forced to default on all foreign debts held, and domestic debts would be settled at well below value.

In reality, Greece has been on the road to economic recovery. The government has run surpluses the past two years, and international trade is starting to rebalance. The Economist believes that a withdrawal would be detrimental to both the Greeks and the EU, and I agree. When we wonder about the economic stability of the EU, the Greece example shows that its stability is unlikely be challenged by the weakest economies. Instead, we should focus on the incentives the strongest economies gain by remaining members of the trade bloc.

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