Will Greece Revert To The Drachma?

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by: George Liu

Greece continues to face a sea of financial quagmires and fiscal uncertainty. It has just encountered another round of revenue shortfalls, this time from taxation that will result in a double-digit deficit and failure to achieve stated revenue targets. Also, IMF officials have expressed doubt at the efficacy of the 50-percent write-down in Greek debt, with some stating that the debt sustainability analysis is flawed when new economic forecasts are taken into consideration. IMF sources, according to Ekathimerini, now believe that sustainability can only be brought by "either a deeper haircut or additional loans from Europe."

These worrisome signs coming from Greece have resulted in the debate over its currency alternatives gaining traction: should Greece continue on with the euro, or should it revert to the drachma, its currency of choice until early 2002? Recently, firms such as ICAP Plc, an inter-dealer broker, have prepared their electronic trading platforms for contingency plans in case Greece may potentially return to the drachma. Prominent economists such as George Soros and Martin Feldstein support the return of Greece to the drachma on the basis that a return to the drachma could catalyze Greece's ability to compete with its international counterparts.

Proponents of a currency change in Greece argue that the drachma would allow increased exports and give Greece the ability to control its own monetary policy, resulting in international competitiveness, one of the main components to any substantial Greek economic recovery. They point out that international competitiveness has declined 30 percent since the adoption of the euro, and argue that the reinstatement of Greece's ability to compete will offset the potential costs.

So what are the potential costs? There is a general consensus among economists that a return to the drachma will result in, the very least, a Greek default. It could also result in a huge run on Greek banks as well as an explosion of inflation, huge increases in national debt, and the weakening of the entire eurozone edifice. Giorgos Provopoulos, the governor of Greece's central bank, warned a return to the drachma would result in shortages in fuel, raw materials, and agricultural products, as well as the devaluation of the new currency by 60 to 70 percent. He argues that "the situation would take us back to the 1950s” and result in a plunge in Greek living standards, at least for the short term.

There are foreseeable benefits to reverting to the drachma and there are valid arguments pointing out that the benefits could outweigh the dramatic costs, but they are irrelevant as long as the Greek government continues to adamantly oppose any measures of currency change; outsiders can analyze the situation and argue as long as they want, but in the end, it is up to the Greek government and the Greek people to make the final decision. And as of now, they are still strongly caught up in their somewhat romanticized notions of the prosperity one united currency and economic zone will eventually bring. Not only do Provopoulos and Greek Prime Minister Lucas Papademos oppose returning to the drachma, but the majority of Greeks also do. In a recently published Kapa Research poll, 77.2 percent of Greeks wanted to stay with the euro.

Despite the seemingly overwhelming majority of Greeks who support continued usage of the euro as the official currency of Greece, opinions could change as the European sovereign debt crisis is prolonged and Greece's fortunes continue to sink. So the answer to the prodding question of whether Greece will revert to the drachma depends on the sustainability of Greece's current austerity measures, the plans laid out at the eurozone summit on October 27, and the competency of its current government to withstand economic headwinds. However, as of now, there is little chance that Greece will revert to the drachma or even contemplate such an alternative.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.