Greece Must Reform Its Economy and Stay in the Eurozone
Leaving the eurozone would be catastrophic for Greece and dangerous for the global economy
May 16, 2012
Greece leaving the eurozone would be catastrophic for Greece and very dangerous for the global economy.
For Greece, a reintroduced drachma would be devalued against the euro by at least 50 percent. This would cause imported inflation, ending up in double-digit values. Greek interest rates would also increase substantially, making business and personal loans very expensive. Greek firms relying on foreign imports, or those with loans in foreign currency, will see their costs soar, leading to increased business closures and unemployment. As a euro exit will almost certainly be accompanied by a Greek default, international markets will provide Greek firms, banks, and the Greek state very little credit. Greece will then face shortages of basic commodities, such as oil, medicine, or even foodstuffs. Very importantly, leaving the euro would deprive Greece of its only reference point of stability, its EMU status. An isolated Greece will lack policy/institutional credibility, putting off foreign investment. With international money markets inaccessible, a still deficit-generating Greece will regress into an increasingly closed-economy status, having to print money to pay for its internal debts. The medium-term result will be stagflation and a dramatic fall in living standards. If an economic and social breakdown follows, one may not completely discount the probability of an authoritarian, or even totalitarian, regime emerging.
For the global economy, a Greek euro exit risks contagion to countries such as Portugal, Ireland, and most prominently Spain and Italy. Europe will enter a period of increased uncertainty, threatening the euro's very existence and very likely resulting in a major international recession through two channels. First, through a new credit crunch: The international banking system is highly exposed to European bonds. A collapse of the EMU periphery bond market will result in significant balance-sheet losses, leading to a financial crisis similar to, or perhaps worse than, the one of 2008-9. Second, through the trade channel: With the world's largest economy, the eurozone, in recession, international trade will be suppressed, affecting growth in developed as well as emerging countries.
To sum up, a Greek exit from the euro would be catastrophic for Greece and highly damaging for everybody else. To avoid it, Greece must commit credibly to promote actively the long-overdue reform of its economy, while the rest of the EMU member-states must allow Greece a less rigid framework within which to do so.