Can Greece "Just Print Drachmas"? Goldman Answers

A few days ago, in advance of the new Greek parliament throwing in the towel in its negotiations with the Eurogroup and conceding to virtually all demands, we showed what, in a worst case scenario, the new Greek currency would look like using data from a previous News247 report. Some of the proposed samples are shown below.

 

But how realistic is a Greek monetary conversion out of Euros and into a "Nea Drachma"?

For the answer we go to Goldman, which after late last week reported that the possibility of a Grexit is now substantially lower...

... the Greek government chose the solution that would be the least costly to the economy and the country overall – that of the acceptance of a mutually agreeable framework in order to continue negotiations for an updated Greek programme. And this rational choice is significant as it reveals the reaction function of Greek officials.

It also notes that "GRexit is not the binary event it is often portrayed to be. Transitioning from the Euro to a new national currency is no straightforward task either for Greece or for Europe to pursue."

Goldman then proceeds to explain "why Greece can’t just (re)introduce a national currency."

Here is the full take why, at least according to Goldman, Greece really has zero leverage even when threatening with a Grexit, something which after the February negotiations, it most likely will no longer do, at least until another, even more "radical" cabinet takes power.

Debt Unpaid is Not Debt Forgiven

 

One of the first and most important issues to understand is that Greek debt structure does not resemble that of other Euro-area nations. The loans given to Greece as part of a) the first Greek Loan Facility, b) the EFSF/ESM-funded second Greek programme and c) the IMF sum up to more than EUR200bn, or 2/3 of the Greek debt stock. For all intents and purposes, they are foreign treaties with other governments and failure to pay them does not lead to an automatic write-off, particularly as maturities of those loans are primarily 15-30 years in the future (except for IMF loans that mature in the years ahead). They also cannot be redenominated.

 

Furthermore, about half of Greece’s marketable debt of EUR66bn is in foreign law as a result of the PSI bond restructuring. There are also cross-default complications with the official sector as part of the co-financing agreement.

 

Overall, failure to meet obligations would not lead to a default and write-off of part of the debt stock. Instead, liabilities would most likely run in arrears that would need to be paid off before Greece could ever tap financial markets. And costly litigation would probably drastically reduce the flow of EUR funds in and out of the country.

 

There is of course the possibility of a mutual agreement on a write-off of a significant chunk of Greek debt following an exit. But that voluntary restructuring of official sector debt would require concessions on the Greek side. In the current Euro-area set up, this would probably involve a new MoU with fresh conditionality backing a “recovery” programme. And such an option is already on the table, at less punitive terms for the Greek economy. It may also take time to reach such a consensual agreement during which the Greek economy would come under severe strain.

 

Secluded from International Capital Markets, Greece would not be Able to Issue a Globally Traded Currency

 

With senior liabilities outstanding, Greece would be secluded from international capital markets. This would not just hold for the Greek government. It is likely that the implications touch the Greek private sector too, with Greek exporters and importers not being able to rely on letters of credit provided by Greek institutions. In such a case, Greek trade would collapse to the level that can be sustained by cash businesses in Euros.

 

Should a Greek currency be introduced following failure to pay, it would likely have very limited convertibility into Euros outside Greece. It would purely be a means of internal transactions, in all likelihood.

 

But is this an equilibrium solution for Greece? No. Because in such an event, it would be hard to convince even the Greeks to hold any drachmas. Put simply, while public sector employees, pensioners and government supply providers would be paid in drachmas (and be expected to pay part of their tax liabilities in the new currency), they would not be able to use that currency to buy imported goods. Exported goods would also become too valuable to be bought in drachmas, as they would correspond to hard currency receivables. Anticipating this, even providers of domestic services (taxi drivers, hairdressers etc) would avoid receiving payments in drachmas if possible.

 

If at all, the drachma would trade at a huge discount to the Euro. The economy would remain largely euro-ised but without a natural source of Euro-liquidity.

 

Drachma Would Prove An Unsustainable Means of Taxation

 

Ultimately as we discuss in our note with Huw Pill, it would be very hard for Greece to introduce a viable new currency unilaterally. Baring the complications of actually printing a new note, such a move would likely lead to a collapse in Greece’s international transactions and trade (both for the government and the private sector), would expose the country to litigation risks and trigger a significant destabilization of the banking system.

 

The only function of such a new currency would be to “tax” parts of the population that would not naturally receive hard currency as part of their payments structure. But that tax would not lead to a natural increase in government receivables as the economy (both the internal and the external economy) would shrink in a downward spiral.

 

The equilibrium outcome of such a situation would be a deep recession that would help build current account surpluses despite declining export activity. Once such recessionary surpluses were realized, a natural flow of hard currency would be established, which would help Greek authorities start meeting external financing requirements again.

 

As we conclude, we would like to point out that this is a highly theoretical exercise. We do not think that such an outcome is either desirable or feasible by the current Greek leadership. Instead, this exercise is meant to illustrate the strong disincentive for unilateral default and currency introduction from the Greek side.

In other words, sorry Greece: you are stuck: according to Goldman you can't go back to the Drachma, even if you wanted to.

And now, let's focus on the Greek government using the "far more sustainable means of taxation", the Euro, where the new (and all previous) governments have shown an amazing inability to actually collect.... regardless of what currency is used.