Greek Exit from the Eurozone is Inevitable

Back in 1999 I was working at a software company that produced accounting systems for the financial services industry. In the months leading up to the launch of the Euro, I was frantically writing business requirements and instructional content. Our clients had many questions on how they were to deal with the new currency that was soon to replace the legacy currencies of the initial 17 European countries adopting the Euro.

As part of my research I recall reading many comments — both pro and con — for the new currency, but it was comments made by Milton Friedman that really struck a chord with me. Friedman believed the move would end in disaster and predicted that within ten years, the union would fall apart.

Well, the ten year point passed some time ago, but Milton’s prediction of a collapse in the union is still very much in play.

In arriving at his position, Milton noted that there had been successful monetary unions in the past but these arrangements were based on an actual commodity such as gold; the Euro union would be the first based on a fiat currency and this, in Milton’s view, was untenable.

Unlike a union of provinces or states as exists in Canada and the U.S., the Euro members are sovereign nations with, in many cases, very little in common both socially or economically. No matter how integrated the collective becomes, someone from France will continue to consider themselves French first and foremost, while someone from Finland will continue to consider themselves Finnish. Neither will ever believe they have much in common with each other.

This is the reality facing legislators and economic policy makers; no matter how it tries, the European Central Bank (ECB) will never arrive at a policy that is effective in all jurisdictions. Worse still, policies that benefit, say Germany which has a robust manufacturing industry, are likely the exact opposite of what is needed in Greece which depends largely on tourism and agriculture.

The tradeoff to this point has been for the more prosperous nations to provide emergency funding to the weaker members in the union but this cannot last forever. At some point, funding will cease and loans must be paid back despite the pronouncements of newly elected Greek Prime Minister Alexis Tsipras who has vowed to fight the conditions limiting spending that were placed on earlier rescue packages.

To further amp up the brinksmanship, key Eurozone officials are now indicating that they are prepared for a scenario in which Greece leaves the union.

Impact of Greece Leaving Eurozone

By leaving the Euro and bringing back the drachma, Greece will almost certainly suffer a dramatic reduction in the country’s GDP. Some estimates place the decline at 30–40% of current levels due to the immediate and overnight flight of capital to a safe-haven currency.

The one bright spot is that by abandoning the Euro, Greece will retain control over its own economic policy. The short to mid-term lookout however, is bleak and it will be downright ugly for several years. Of course, this look to a brighter future will require a massive restructuring of the country’s taxation laws and public pensions — you know, the things Greece promised, but failed to do as part of the acceptance criteria to join the union in the first place.

For the rest of the Eurozone, there will be a decline in confidence in the long-term stability of the Euro. This may even cause other nations to opt to return to their own currency in a bid to insulate themselves from the Euro. This would be a worst-case scenario but is precisely what Friedman predicted when the Union was first established.

Scott Boyd has been working in and writing about the financial industry since the early 1990s and has worked with several of Canada’s leading financial institutions.

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