High & Low Finance: How Greece Could Escape the Euro

So why not get out now?

One answer is the same one that was given when Greece’s cheating was revealed: Legally, there is no way out. The euro was designed to be the Roach Motel of currencies. Once you enter, you can never leave. There is no provision for departure.

But, of course, there is a way out. It would be messy, and perhaps disastrous. But no one is going to send an army to Athens to force it to keep the euro.

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.

In 2002, Argentina’s currency, the peso, was officially tied to the dollar at a one-to-one parity. There was a “currency board” that was supposed to assure the tie could never be broken, and it had worked for a decade. But Argentine inflation had outpaced that of the United States, and the peso was seriously overvalued.

In early 2002, a new Argentine government ended the peg and did much more. It defaulted, and it required its citizens to do the same. If you had a dollar deposit in an Argentine bank, it became a peso deposit, soon to be worth about 30 United States cents to the peso. That was true regardless of who owned the bank. If you wanted to get dollars back from your Citibank deposit in Buenos Aires, you were out of luck.

Argentina was cut off from international credit. Imports plunged and the country entered a deep — but relatively brief — recession. The peso lost two-thirds of its value within a few months. Argentina was sued by everyone in sight.

But devaluation worked, as it often does. Argentine exports became competitive thanks to lower costs, and the economy rebounded. There are international judgments still outstanding against the country, but when it comes to sovereign states it can be easier to get judgments than to collect on them. Diplomatic assets are off limits — no one can grab the Argentine Embassy in Washington — and monetary assets can be kept with the Bank for International Settlements in Switzerland, which will not allow them to be seized.

Argentina’s decision to abrogate private contracts was a crucial part of the package, said John Hempton, an Australian hedge fund manager who has studied what happened. “The Argentine banks all had lots of U.S. dollar funding,” he said. If they had to repay those dollars, while their assets were devalued, “then they would all have uncontrolled defaults, a true disaster, and the country would lose its institutions.”

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.

There are some important differences, of course. Argentina had a currency that still existed, and there were peso notes. There are no drachma notes floating around Athens or anywhere else. If the drachma suddenly became the legal currency again, currency would be needed. Printing new notes in secret would be a challenge.

Would the bond switch be legal? For some bonds, clearly it would not be. British courts “would enter judgments saying Greece owes x billion euros,” said Whitney Debevoise, a lawyer with Arnold Porter, “but would then have to find assets.”

But British courts would have jurisdiction only over the minority of bonds issued under British law. Most Greek bonds were issued under Greek law, and presumably Greece can change that law to legalize what it does. Greek bonds already trade for less than 40 percent of face value, so it is possible that their actual value might not decline all that much, assuming investors believed the drachmas would be repaid.

Greece would suddenly be forced to run a balanced budget, or to borrow from its own citizens, whose savings would have lost much, if not most, of their value.

Floyd Norris comments on finance and the economy at nytimes.com/economix.

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