Many friends have been asking me whether or not Greece will default and leave the euro zone, and what the fallout would be.
Floyd Norris does a good job explaining that, following the example of Argentina in 2001, Greece has both the incentive and means to leave the euro zone.
If Greece were to follow the example set by Argentina nearly a decade ago, it would simply convert its debts from euros into its old currency, the drachma, at the old exchange rate of 340.75 drachmas to one euro. It could also convert euro currency in the country at the same rate. So if you owned one million euros in Greek bonds, they would be converted to bonds with a face value of 340.75 million drachmas.
With a printing press available, Greece could meet those obligations. Of course the drachma would soon be worth a lot less — perhaps 1,000 to the euro. So bondholders would have lost two-thirds of face value. Greece might do O.K., but for reasons we will see, the move could be devastating to the rest of Europe.
But, of course, there are two caveats: the effect on the rest of Europe, and the effects inside Greece.
On the first:
When Argentina did it, there was no immediate ripple effect. But in Europe the result would very likely be explosive. There would be a run on banks in peripheral countries. If Greece can do it, what about Portugal, or Spain, or Italy?
On the second:
The Argentine experience was not pretty, but it may well be more attractive than the seemingly endless rounds of austerity, strikes and missed fiscal targets that seem to be leaving the Greek economy in a permanent recession. From the Greek perspective, the course could seem attractive.
And then there’s the possibility Norris does not consider: a restructuring of the Greek economy so that, in contrast to the experience in Argentina, those who have been asked to pay the costs of austerity (and would be asked to pay the costs of default) are given a say in how the new economy would be organized and run.