The Greek Tragedy
8. The Exit Procedure
What procedure would be followed if Greece were to exit the euro? The trigger for such an exit would presumably be an ECB decision to deny the Greek banks any further ELA funding from national money creation. Although such a veto would require a majority of two-thirds in the ECB Council, as already mentioned, it would likely be imposed if the Greek state were to receive no further funds from the ESM, because in that case a bankruptcy of Greece's commercial banks would be all but inevitable, given their close relationship with the state, turning ELA funds instantly into losses. There is in any case already strong opposition to ELA funding because Greece's banks are chronically undercapitalised and employ dubious accounting techniques. For example, banks include about 40% to 60% of their equity as deferred tax assets in their balance sheets; such assets are worthless if these banks continue to operate at a pretax loss. 1 It is also important to remember that, as shown in Section 3, the ECB's legal fiction that the Greek central bank can be held liable for its own ELA funding has no economic basis due to the excessive refinancing credit granted, which is reflected in its Target liabilities. Commenting the weak situation of the Greek banks and the Greek government, Bundesbank President Weidmann recently stated2 that "in view of the ban on the monetary financing of states, I think it is wrong to grant banks denied market access loans that they then use to buy the bonds of their own government, which itself is denied market access."
According to the rules, every large country, or a group of smaller countries, could block the ESM funds, because a blocking minority of 15% applies to these bail-out funds, instead of the blocking majority of two-thirds required for ELA funding. Blocking ELA funding via the indirect route of denying ESM credit would force the Greek government to introduce capital controls, because the banks would otherwise very quickly be plunged into a liquidity crisis.
Even with such controls, however, the banks would not be in a position to continue to provide the Greek government with credit because part of the money spent by it would not flow back to the banks, but would be hidden in suitcases, taken out of the country or used to pay for imports. The scarcity of credit would force the Greek government to pay the wages of its employees, as well as its suppliers, with IOUs.
A similar situation was seen in 2009 and 2010 in California, when the state was on the brink of bankruptcy and received no support from the US federal government or from the Federal Reserve. Unlike the ECB, the US Fed does not buy any kind of government bonds from member states, and only allows the District Feds (in this case the Federal Bank of San Francisco) to boost their local economies by granting a very limited amount of extra credit via the printing press. If the extra credit results in net payment orders to the jurisdictions of other District Feds, the resulting Target balances (in the US called ISA balances 3) must be settled by way of transferring ownership titles in marketable securities. That is why the state of California was forced to resort to issuing IOUs. 4 The IOUs were a substitute for money, because they could be used for certain payments, such as for electricity bills.
California overcame its problems because it only faced a liquidity issue. Even at the peak of the crisis, the Californian government's debt-to-GDP ratio was still below 10%. California also had no competitiveness problems and did not have to undergo a process of real devaluation.
In the case of Greece, the issuance of promissory notes would possibly be the first step towards reintroducing the new Greek currency, because restoring competitiveness by means of a complete currency conversion would then become plausible. In fact, this move would be advisable for Greece, because only when the new currency is legal tender can it be used to orchestrate the joint devaluation of all business contracts in a way that for legal reasons would hardly be possible within a monetary union.
Specifically, the introduction of the new currency would mean that all bank accounts, price tags, wage contracts, rental agreements and internal credit contracts would be converted into drachmas. The figures wouldn't change; only they would now be denominated in drachmas rather than euros. Such a change could happen overnight or over a weekend.
The international community should further accommodate Greece by forgiving the unsustainable part of its sovereign debt. It would be conceivable to redenominate all Greek public debt to drachmas, so that the devaluation of the new currency would automatically entail a haircut for foreign creditors. Since at present these creditors are overwhelmingly public institutions, such a step should be possible, even though the Greek debt agreement was placed under English law after the 2012 haircut. It has long been clear that Greece is unable to service its debt. It is now time that the creditor countries face this truth. At the meeting of the Euro Group in Riga on 24 April 2015, the IMF also took the position that a haircut should now be considered. 5 The foreign debt of the commercial banks and the Greek central bank will also have to be forgiven to some extent.
The Eurozone finance ministers are resisting such a solution, because they would have to post the write-down losses in a deficit-enhancing manner. But this is ultimately only a cosmetic problem that really should not matter, because if you throw new money after old in order not to have to show the losses, the burdens rise instead of fall. It is high time to bring more clarity and truth to public finances, which, in view of the huge shadow budgets that were set up in the wake of the euro bailout architecture, have lost their connection to reality.
In considering debt forgiveness, we should also include in the calculus the extensive property holdings of Greeks abroad, which, as reported in Section 3, amounted to 104 billion euros at the end of March, net of foreign ownership in Greece. The gross foreign assets of Greek citizens are certainly even much higher. The Greek government should be expected to take the taxation of these foreign assets into consideration in connection with receiving relief of its own debt, especially since some of this money is illegal and since foreign governments have already offered the Greek government their assistance in detecting these funds. 6
Likewise, the international community can expect Greece to finally deliver on the promise it made in connection with the first rescue package – to privatise state assets to the amount of 50 billion euros in order to redeem part of its debt.7
Help for Greece will also be needed with regard to essential imports that will become more expensive after the devaluation. These will need to be subsidised for a time by the international community. It would certainly be irresponsible if, for example, hospitals were no longer able to buy life-saving medications.
An important factor is that, despite a return to the drachma, Greek citizens should be allowed to keep the euro banknotes they possess. In the event of a currency conversion, there would be considerable technical difficulties involved in converting euro banknotes into drachmas: faced with a looming devaluation of the drachma, everyone would try to hide their euro notes or to get them out of the country.
Thus, foregoing the exchange of euro banknotes into drachmas would also be advisable given that it would take some time for the new banknotes to be printed. In the meantime, the euro could be used for cash payments in Greece, although it would no longer be legal tender and all invoices would be denominated in drachmas. They would either be paid by credit card in drachma or in cash in euros, at the daily market exchange rate. Accordingly, a cash withdrawal from a drachma account would initially be in euros that would be issued at the prevailing exchange rate, similar to when a tourist draws foreign currency from an ATM but the receipt is in his own currency.
Immediately after making the drachma legal tender, Greeks should be strictly forbidden from keeping euro-denominated accounts, from drawing contracts in euros with Greek compatriots, or from borrowing money in euros, in order to prevent the population from remaining de facto in the euro despite a formal exit, thus undermining the devaluation necessary for restoring competitiveness. After joining the EU, many Eastern European countries made the mistake of allowing the population to hold foreign currency loans and accounts. This is having the effect of hindering the necessary devaluations, and when devaluations are nevertheless effected, the states are forced to make high compensation payments to the banks, as was the case in Hungary. To avoid such difficulties, it would be better to follow the example of Turkey, which prohibited such foreign currency accounts and contracts. Even during the D-Mark era in Germany, foreign currency contracts were not allowed; exceptions had to be individually approved by the Bundesbank so as not to limit the scope of monetary policy.
When the new drachma banknotes are printed, the banks can convert completely to drachmas and pay them out when needed. In this way, some of the euro banknotes would gradually be replaced by drachma banknotes. Most of the displaced euro banknotes would be used for purchases from other euro countries. Another part would remain as a second circulating currency in the country, as is the case today in Eastern Europe or Turkey. All these countries have unofficial parallel currency systems, where only the domestic currency is legal tender.
The net amount of euro banknotes that flow abroad would lead to a real transfer of resources to Greece, at the expense of the international community, because the money would be used, on the one hand, for goods purchases, the acquisition of property and to pay off debt, and, on the other hand, would restrict the scope of the other central banks to lend freshly printed banknotes to the local commercial banks without creating inflation. If we assume, for example, that half of the euro banknotes issued by the Greek central bank, 41 billion euros by March 2015, leaves Greece, while the other half continues to circulate there, the international community would incur a loss of half the stock of bank notes issued in Greece, i.e. 20.5 billion euros, or 11.4% of Greek GDP (0.2% of euro area GDP without Greece). In light of the 325 billion euros, or 182% of Greek GDP, that have flowed on balance to Greece as public credit as of March 2015, and which will largely have to be waived, this is a manageable amount.
Continue to Section 9: Concluding Remarks
Footnotes
1 S. H. Hanke, "Yet another Greek Secret: The Case of Phantom Assets", Cato Library, 5 May 2015.
2 J. Weidmann, "So weit hätte es nicht kommen müssen", Interview, Handelsblatt No. 92, 15–17 May 2015, p. 7, own translation.
3 ISA stands for Interdistrict Settlement Account.
4 See H.-W. Sinn, The Euro Trap. On Bursting Bubbles, Budgets, and Beliefs. Oxford University Press, Oxford 2014, especially Chapter 9: "Rethinking the Eurosystem".
5 Cf. "IWF fordert von Eurozone Schuldenschnitt für Griechenland", FAZ.net, 5 May 2015.
6 Cf. "Athen-Reise: Bern will Steuerabkommen", Handelszeitung.ch, 22 April 2015.
7 See European Commission, "The Economic Adjustment Programme for Greece, Fourth Review – Spring 2011", Occasional Papers 82, July 2011, p. 16.