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Jacob Wolinsky
Jacob Wolinsky
Articles  | Author's Website |

Should Greece Abandon the Euro?

May 11, 2011 | About:

The speculative debate revolving around Greece leaving the Euro is not new. The debate actually started in 2002, when Greece adopted the currency. The truth is, as most argue, Greece and Italy never had a big enough economy to adopt such a strong currency to begin with. Many predicted that if or when a recession hit Europe, Greece and Italy would incur a lot of financial damage and their economy would collapse as a result, leaving no other option for the two comparatively weak countries but to leave the euro to print their own respective currencies to meet the obligations of their citizens.

Without a doubt, having the euro as the main currency has numerous advantages for Greece. Controlled transaction costs, exchange rate certainty, affiliation and backing of the strong European countries and transparency with healthy competition being some of the obvious benefits gained by the economies who have the euro as their currency.

However, there are also various negatives of using the euro such as excessive adherence to fiscal policies and responsibilities and inability of devaluing currency by a country independently to stimulate economy. For countries like Italy and Greece, having the benefit of gaining from the healthy competition within the European Union was out of the question since the beginning, as their economies were not in sync with those of more powerful countries like France and Germany.

It is first necessary to summarize what actually happened with Greece. After the adoption of the euro as their currency, the government of Greece indulged in high borrowing in order to cater to the increasing public spending. However, the lack of income tax received from the public was not enough to balance their budget. Tax evasion, among other things, is viewed as being the primary cause of the economic downfall of Greece. According to an article in the WSJ from 2010, the shadow economy in Greece makes up 25% of GDP, compared to 7.2% in the U.S. Speculators have also added to the downfall of the Greek economy by betting against insolvency of Greece.

Coming to the main subject under concern, it makes sense for Greece to exit the Eurozone and switch to Drachma, their original currency, based on basic optimistic assumptions. Ditching the euro would lead to Greek currency devaluation, reducing government expenses and promoting tourism and export, which would stimulate the economy by increasing the flow of revenue in the country. Greece would be able to become competitive and would likely lead to job growth. However, it will not be easy for Greece to leave the Euro; neither will it solve all the problems.

As pointed out by Brendan Keenan, an economist and group business editor of independent newspapers, Greece is highly dependent on foreign aid to fund their public debt, and if after leaving the Euro, Greece fails to drastically boost their exports, their economy would face a fate far worse than the current situation. Moreover, as highlighted by George Provopoulos, governor of Bank of Greece, some of the consequences which Greece would probably face with the abandoning of the Euro are:

l The debt would turn into foreign currency debt. Devaluation of currency of Greece against the Euro would automatically increase debt burden.

l Increase in import costs, leading to inflation and further deterioration of the standard of living of the people of Greece.

l Having no association with European Central Bank, meaning the monetary policies would lack credibility and powerful support, further raising inflation expectations.

l No economies of scale to benefit from.

l Increase in exchange rate uncertainty leading to difficulty in conducting business.

l Increase in nominal interest rate which would shift resources from productive sectors.

l Increase in country and currency risk leading to further devaluation of the Greece currency to as much as 50% of the current value against the euro, as estimated by the German Finance Ministry.

The negative impact is not only limited to Greece alone. If Greece decides to leave the euro, European Central Bank will also suffer as they would be forced to write off a significant fraction of its claims as irrecoverable, the total worth of which, as estimated by the Finance Ministry officials, sum up to be at least €40 billion. Furthermore, the confidence in the European currency would “shock” the euro, as proved after the recent release of the report of Der Spiegel regarding Greece considering leaving the euro.

Conclusively, the opinions regarding the abandoning of the euro by Greece is irrefutably diverse. Greece is not the only country to face the consequences, but the impact would extend to other European countries as well. Realistically, there are more cons than pros when talking about Greece leaving the euro, but it is also fair to consider that there is a possibility of recession in Greece extending beyond the predicted time period. That would result in Greece being in a much weaker state than before, with little or no chances of possibly recovering through switching of currency to Drachma.

Disclosure: None

http://www.valuewalk.com/

About the author:

Jacob Wolinsky
My investment ideas have been inspired by many of value investors including Benjamin Graham, Charles Royce, John Neff, Joel Greenblatt, Peter Lynch, Seth Klarman,Martin Whitman and Bruce Greenwald. .I live with my wife and daughter in Monsey, NY. I can be contacted jacobwolinsky(AT)gmail.com and my blog is www.valuewalk.com

Visit Jacob Wolinsky's Website


Rating: 2.4/5 (9 votes)

Comments

marcolanaro
Marcolanaro - 8 years ago    Report SPAM
Dear Jacob,

I read always your very good articles here on Gurufocus, however this time I cannot agree with you.

First of all you compare greek and italian economy as they were similar but actually the greek economy is just 20% the size of the italian.

Those two economies are structurally very different, just as an example, Italy is the second exporter in Europe behind Germany.

Greece has a dramatic deficit while Italy has a very small primary deficit, the only thing where this two economies are similar is in the size of the debt in relation to their GDP.

If Greece abandons the Euro, my opinion is, that it would be very difficult for Greece, as you have explained in detail, but you forgot to mention that it would be a nightmare for the other countries sharing the Euro too. I remind you that even before the sovereign debt crisis, french and german banks owned and still own a quite sizable chunk of the greek debt and an exit from the euro will bring also a default on the greek debt, so that the whole banking system in Europe would be at risk of imploding.

I believe that Greece will not abandon the Euro and probably some kind of restructuring, some call it soft restructure will happen, any other outcome will be a disaster.

Best regards,

Marco
batbeer2
Batbeer2 premium member - 8 years ago
How is leaving the euro going to relieve Greece of its debt ?

A few facts:

- The Greek government spent much more than it could afford.

- They simply lied about it when reporting to the EU central bank.

- Greece now depends on artificially low rates provided to them by other EU member states.

As far as I can tell, the poeple of Greece are not ashamed about this.

WOW.

I guess the only solution acceptable to the poeple of Greece is that they default on the debt, (ehm.... "restructure"), and keep the euro. As ridiculous as this seems, I guess it's the most likely outcome.
itemirus
Itemirus - 8 years ago    Report SPAM
Comparing the economies of Greece and Italy is like comparing apples to oranges. You should have pointed to a country like Portugal or Ireland. As to Greece abandoning the Eurozone, I don't think it's a probable outcome because Germany and the other strong EU economies will not allow that to happen as it would trigger another global financial crisis and throw Europe in a disastrous recession or maybe another Great Depression. It is more likely that Greece will be forced into a major privatization of state owned assets and an extension of sovereign debt repayment terms.

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