Saturday, May 12, 2012

Greek exit would convert over half a trillion of external euro liabilities into drachma

As discussed earlier, Greek exit from the Eurozone may be the only way the nation could gain some control over its monetary system. Given the complete "credit isolation" of Greece's banks and the private sector from the rest of the Eurozone, the ECB is powerless to improve liquidity conditions in that nation. Some of the ECB's policymakers are beginning to agree.
Reuters: - A Greek exit from the euro zone would damage confidence in the single currency bloc but not necessarily be fatal, Irish central bank chief and European Central Bank policymaker Patrick Honohan said on Saturday.
Intrade probability of at least one nation exiting the Eurozone (basically Greece) before the end of next year has spiked in the past few days, approaching 60%. This agrees quite well with numerous other forecasts by a number of Wall Street firms.

But the exit will cost the Eurozone more than just "damage of confidence" that Patrick Honohan alluded to in his comments. There would be some serious financial damage to the Eurozone/EU and the IMF. The exit will be far more painful than simply converting to drachma (as many believe), even though some preparations for this eventuality are already under way. The problem with this conversion is that all of Greece's external liabilities would need to be converted to drachma as well. Let's take a quick look at some of these external liabilities:
  • The May 2010 Eurozone/IMF loan: €110 billion
  • The October 2011 Eurozone second loan: €130 billion
  • The Bank of Greece TARGET2 liabilities to the Eurosystem: €104 billion
  • Greek banks' liabilities to other nations in the Eurozone: €130 billion 
  • Greek new government bonds held by non-Greek Eurozone/EU banks: €25bn (roughly; possibly more)
  • Plus Greek corporate and household debt held by non-Greek Eurozone banks
This is at least half a trillion euros of debt to other countries that would suddenly become denominated in drachma. And within a short period of time, the EUR-GRD exchange rate would likely double if not triple. With its current recession, the Eurozone can hardly afford such a massive hit. That is why other Eurozone leaders are reluctant to openly discuss Greece exiting the union. But given the political turmoil in Greece, the Eurozone may not have much of a choice.
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