The Euro Zone periphery countries are major news drivers in the markets right now. Developments surrounding these so-called PIIGS (Portugal, Ireland, Italy, Greece, Spain) have become big drivers in not just the euro, but in the whole forex market. In fact, they have been moving stock, bond, and commodity markets as well. No doubt this is something which will carry on for a while.
The Greek bailout is probably the most dominant aspect of the sovereign issues right now. There have been voices on all sides talking about the need for a Greek default and exit from the euro, the extreme negative impact of a default/exit on the markets making that unthinkable, and everything in between on the opinion scale. I want to speak to the euro exit idea in this post.
Think on this question. What happens if Greece leaves the single currency?
Those who favor that kind of solution – or who at least think that's the inevitable course – see that kind of move as being a way for Greece to clean the slate and become more competitive. The latter would be as a result of what would presumably be a weaker drachma than the euro. That would be good for the balance of trade, at least in theory. Sounds pretty good, right?
I'd put forth two potential major problems, however.
First, if Greece goes back on the drachma and it does indeed lose value relative to the euro, what impact would that have on the price of goods for businesses and consumers? Does Greece import a lot from the Euro Zone? Would the weaker drachma produce a price inflation via import prices? That certainly wouldn't help the Greek economy at all.
Second, what happens to the existing debt of government, businesses and individuals that is currently denominated in euros? In a falling drachma situation, the cost of debt maintenance for euro-denominated liabilities would rise. That could have a potentially meaningful negative impact on the Greek financial system and economy, an impact not improved at all if there's a rash of defaults.
There's been a serious issue with this very sort of problem in Eastern Europe where consumers took out loans denominated in Swiss Francs. The Franc has been rising steadily for some time now, making those mortgage payments in local currency terms get more and more expensive to the borrowers. Imagine the impact on your monthly budget if your mortgage payment rose by 40%, which is about how much the Franc has gained against the dollar in the last 12 months.
So the question is what kind of exposure are we talking about here? Does the Greek private sector have a major euro liability exposure?
The impact of a weak drachma on the Greek economy in these sorts of terms is not something I've seen any discussion of so far. If a removal from the Euro Zone is to be contemplated, the questions above would have to be satisfactorily answered.
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