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Grexit Or No Exit?

What will be the result of Greece leaving the eurozone both for Greece itself and for the EU? In this article, based on his presentation to the London Academy of Diplomacy Diplomatic Forum, Charis Xirouchakis examines the issues and weighs up the likely outcomes


With Greece as its greatest example and potentially its greatest victim, the eurozone crisis is certainly not new to the headlines.  The potential risks of economic rifts linked to monetary unification were known to economists, but were considered secondary in light of the expected benefits at the establishment of the euro in 1993.

Greece’s entry to the European Community, as it was then called, was the result of a policy of enlargement and a will to disprove the image of the Community as a ‘rich man’s club.’ Greece, then as now, was not short of entrepreneurial flair and expertise, but it suffered from a weak administration.

The eurozone concept was the result of the Maastricht Treaty, which introduced the EU in 1993. To enter, the eurozone nations would agree to maintain a level of deficit of no more than 3 per cent and a national debt ratio of no more than 60 per cent.

Very few countries in the eurozone achieved this constantly. Credit Default Swaps (CDS) enabled them to get round these conditions. Through CDS’s mechanisms, international banks could buy a country’s debt, enabling it to reduce its debt arrangements to meet the eurozone’s conditions. Indeed, Greece was not alone when it balanced its books demonstrating its eligibility to enter the eurozone, which it did in 2001.


In 2008, Greece was shielded from the financial crisis as a member of the eurozone but by 2010 the Greek economy itself was in trouble and approached the EU for a bailout to cover the costs of interest on the deficit and debt.

The bailout required the signing of a Memorandum of Understanding with the ‘Troika’, (the EU, the European Central Bank and the International Monetary Fund) under certain conditions. ‘Austerity economics’ were thus born.

Austerity economics mean deflating the economy by increasing prices and decreasing wages and then increasing taxes. In Greece, as in other countries, there has been huge adverse reaction to austerity economics and resentment at the EU, seen as responsible for its imposition.


Austerity economics may work economically but does it work politically? Is reducing the wealth of the people over a number of years by 25 per cent sustainable in any European economy?

To answer that question we need to look at the success of Syriza, a left-wing party that came to power in the January 2015 election in Greece. Syriza is a creation of the crisis. Alexis Tsipras, the new Prime Minister of Greece, is practically the ‘spiritual’ child of Angela Merkel’s austerity measures. I say that provocatively but how else could a radical left-wing party with 3 per cent of the vote win the support of overwhelming numbers of the Greek middle classes to become the dominant party of government?

The question now is how the new Greek government can handle the financial and fiscal austerity measures. This is an ongoing political and economic debate and it is interesting to see how that debate is developing.


Two theories dominate the debate over Greece’s future: the ‘contagion’ theory and the ‘deadweight’ theory. According to the ‘contagion’ theory, the Greek government fails to pay its debts to a neighbouring country, which in turn fails to pay its own debts, creating a domino effect under the weight of which the EU could collapse.

The ‘deadweight’ theory presents an alternative scenario. A member unable to service its debts creates a deadweight on the Union as a whole. By dropping out of the Union the deadweight state allows the rest of the Union to survive. This is the theory behind the Grexit proposal.

This debate has been going on for a few years now and neither theory has prevailed. Had Greece failed in 2012 – the time of the last major crisis – the eurozone would have been unprepared and might have collapsed. Since then, the European Central Bank, which has proved to be a very competent administrator of EU finances, has been building a firewall to protect the EU against such an eventuality.

This firewall was tried out in a dry run earlier this year, focusing on instructions for the largest banks in Europe on how to proceed in the case of a Grexit. The firewall is to protect the interests of other national banks and of the bondholders, private and public, including, in large part, the European Central Bank itself, who are the main holders of the Greek debt.


Despite the firewall, of course, it could still all go wrong. What are the ongoing risks? Some are very real and some are speculative.

First of all is Devaluation. Any new currency (e.g. the restoration of the Greek drachma) will have to be installed almost overnight and depreciated heavily against the major international currencies. This would make exports cheaper and imports more expensive, allowing the balance of trade to be gradually re-established.

Secondly, Rising Interest Rates. This will lead inevitably to insolvencies. Private companies in debt may go bankrupt and we have no way of estimating how many companies would be affected in this way.

Thirdly, Capital Controls. Currently capital can flow freely between members of the eurozone, but this may not be possible any longer.

Fourthly, Suppliers Contracts. Some of them may have to be stopped and inevitably a certain amount of blackmarketeering will take place.

Fifthly, Insolvency. Greece’s debt is currently 175 per cent of GNP. This is in fact the largest in the eurozone. However, the issue is not the amount of the debt but the ability to maintain production, pay interest and thus remain solvent.  The problem for Greece is that, in the past few months, it has not been producing enough to service its debt repayments and that is a negative development.


What can Europe do to solve the crisis with minimum damage? On the economic side, the EU firewall should protect bond holdings.  On the political side, however, a Grexit would be a declaration of failure by the EU and a major blow to further political integration. This is why Germany and France, among others, have been so insistent on a bailout package for Greece.

In conclusion, a Grexit will be an incalculable economic risk for Greece, but one that could bring potential political benefits. For the EU, a Grexit will bring incalculable political costs but manageable economic cost so the answer is compromise. For Greece, a Grexit will bring even more short-term austerity so it should do all it can to avoid that risk.

One thing is clear. Austerity economics has proven insufficient to solve the problems of a sovereign state like Greece. So that policy needs to be re-examined. In the meantime we hope for the best that we can avoid a Grexit, which would be the worst scenario for everybody.


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