It is a brutally unemotional person, who fails to admire the randomness of George Papandreou. The man who managed to single-handedly send markets into havoc. The damage done by the referendum he called (probably by accident) was limited after a quick smack on the bottom by Angela Merkel and Nicolas Sarkozy. After a high-light reel career as Prime Minister of Greece, Pap the First stepped down despite gaining a vote of confidence, a true man of the people.
Enter Pap the Second.
Saying that Lucas Papademos has a job on his hands would be an understatement. Greece’s new Interim Prime Minister, who has a background in banking, will hold the reins until elections in february, with his new Unity Government receiving the support of both the Socialist party and the Centre-right New Democracy party. He has stated that it will be his Government’s job, to target structural reform and a wider tax base. Not only this, but he has moved quickly to underline that Greece must stay in the Euro, there is no Plan B. This is a wise choice. There are those that will disagree and suggest that a fall out from the Euro would be the best move for Greece, as a the current liquidity packages limit them to stagnant growth and painful reform for the foreseeable future. However, leaving the Eurozone may be crippling for an unpredictable length of time. The problems facing countries who seek to leave the Eurozone are outlined below.
1. Political Problems.
What small amount of credibility, that the Greek economy still has would be severely undermined following a Eurozone exit. On paper, credit ratings to banks and the newly functional Greek central bank would be cut, though this would likely not matter as it would be difficult for establishments to see the economy as reliable, and international liquidity may still be a severe issue (despite having regained control of monetary policy, which would to some extent offset the loss of liquidity). Politically, the reputation of the Government would be undermined, adding tension to trade. Politicians however, are likely to be more forgiving than the Markets, and investment would plummet in the short-term with capital flight, and would be difficult to restore in the long-term.
2. Menu Costs.
Completely switching currency will bring about its own costs, and demand a lot of work. All monetary capital from coins to bank machines would need to be replaced, which would incur to the Government large costs which they can scarce afford as it stands. It would be inconvenient and public support would be hard to come by. It would not only be currency that would need to be exchanged, but financial contracts, at pre-determined rates which may or may not be accurate, which would not only be again inconvenient, but “v awks.”
3. Conversion rates.
Agreeing an accurate conversion rate would be difficult for any country but more-so for the Greeks given the volatile atmosphere surrounding their economy currently. Come in too high, and there may be an outflow of Greek savings as the value of their currency may be expected to depreciate, and confidence in whether or not people would be willing to hold an over-valued Drachma may be low. A lot of people (bankers) might profit massively at the expense of the Greeks if the conversion rate was not estimated correctly with respects to market confidence, and other major currencies. Not only this but a new currency would massively impact nominal and real values for things such as wages, and strong trade unions may barter for increased nominal wages due to the devaluation in currency, increasing labour costs, and perhaps contributing to inflation.
So, if you were to ever overhear a passer-by discussing how it would be beneficial for Greece to leave the Euro (however unlikely it is for man on street to be having an intelligent and in-depth economics debate whilst walking past you slowly enough for you to catch every word), feel free to pipe up with an “Actually Sir and/or Madame, if Greece left the Euro…”