Greece won't give up the Euro

23 February 2010

Quite often when out with colleagues, a discussion on Greece leaving the Euro comes up. Even if they do (either voluntarily, or via expulsion), Greece will continue to use the single currency. This is because any currency peg will mean no-one would bother converting, and if not pegged the risk of depreciation will mean people won't convert.

Repatriation of assets/liabilities

Transfer of assets from the ECB to a re-established Greek central bank in itself is a logistical issue, but there is a big problem in deciding how much to transfer. Leaving aside differences in how Greece's reserves would have performed outside of the Euro, and whether changes in relative GDP of Eurozone members, how would ECB's liabilities be accounted for? The latter is a big headache because of credit-rating issues, and the creditors of the specific liabilities transferred would not exactly be happy. In practice any liability transferred will have to have the ECB as creditor, if not underwriter.

Who else would touch it?

Other problem is who would want to deal with a re-established Drachma. With the possible exception of the ECB, no central bank is going to convert any of its Euro holdings to Drachma. I suspect that any attempt by Greece to rebase its debts (bonds, etc) from Euros into Drachma will have to come with some sort of peg (e.g. locked-in exchange rate) to the Euro, as investors will demand some some sort of insurance against quantitative easing. And even then international trade will still be in Euros/Dollars, with most foreign companies forcing the Greeks to take on the risks in exchange rate fluctuations. All of these don't favour a re-established Drachma being a strong currency.

..and why even locals would avoid it

With the Euro in everyday use within Greece, there is little incentive to switch to the Drachma. The starting point would be equivalent to 100% capital flight, and without a large increase in the value of the Drachma there is no real reason to use it for savings. Things like taxes will require conversion into Drachma, but anyone who thinks there is any risk of the Drachma tanking will predominantly hang onto their Euros. It is not viable to force people to convert, as strict currency controls is the type of thing that discourages buying of a given currency.