drachma danger

Currency Reform, Not Inflation

Currency AP_distort (2)
The drachma: friend or foe?
  • Why it matters

    Why it matters

    With Greece still on the path to bankruptcy, economists are playing out scenarios for the destitute country to survive a possible Grexit.

  • Facts

    Facts

    • Greece’s last chance to receive a bailout deal is a meeting of all 28 European Union member states on Sunday.
    • Capital controls have been in place in the country since last week and will continue at least until Monday.
    • In last Sunday’s referendum, the Greeks rejected the latest bailout package proposed by the country’s international creditors.
  • Audio

    Audio

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If Europe’s heads of state and government do not let themselves be persuaded into a compromise on Sunday by Greek Prime Minister Tsipras, the country and its banks will run out of money next week.

To stave off a state bankruptcy, it has been suggested that Greece follow the example of California, and pay its employees, pensioners and vendors with promissory notes, or IOUs. But the promissory notes of a country facing bankruptcy might not find broad acceptance, especially not as a currency parallel to the euro.

To simply continue using the euro after an exit from the currency union is also unrealistic. Because after a national bankruptcy, government bonds held by Greek banks would be worthless and the banks would therefore also be insolvent.

The country’s citizens would no longer have accounts to process their payments. The cash in circulation in Greece and bank deposits abroad couldn’t make up for these losses for long.

And after a state bankruptcy, in order to prevent the entire Greek economy from running dry and collapsing, the Greek government would have no other option but to leave the monetary union and introduce a new currency as the sole legal tender.

The government must also by law convert the prices, wages, pensions, bank deposits and debts from the euro to a new drachma.

The obvious thing would be to convert all euro amounts in Greece to the new drachma at the same rate, for example 1:1. But then the Greek banks would remain insolvent because their liabilities, for example the bank deposits of the citizens and companies, would be converted at the same rate as their assets. The banks’ balance sheets would still have the same gaping capital shortfall because of now-worthless Greek government bonds, bank loans to the state and tax claims.

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