Does Greek default mean Greece leaving the eurozone?

I get this question a lot; by the way this guy advocates one and not the other.  “Not necessarily, but probably” is the answer.

Let’s say Greece opts for a large default.  The Greek government’s commitment to the Greek banking system could then be seen as either stronger or weaker.  Stronger because they have more money left over, or weaker because they are breaking their commitments.  Note that Greece is still borrowing to meet current budget, so a large unauthorized default probably weakens the commitment to the banks.  They’re still out of money and then some.

In my view the commitment of the Greek government to its banking system needs to be seen as much stronger.  If perceptions remain the same or weaken, the silent run on Greek banks will continue or worsen.  Sooner or later, the Greek government, through guaranteed or nationalized banks, will be redeeming “a euro” for “less than a euro,” at which point they have de facto left the eurozone.  Remaining in the eurozone means making the bank redemption promise truly credible at a one-to-one rate.  Default makes that tougher rather than easier.

Even if Greece, after a large default, has enough cash to back its banks, the market still might be thinking Greece will leave the eurozone for optimal currency area reasons.  That will lead to a continuing exodus of deposits from Greek banks.  It’s not clear how the Greeks can stem that additional pressure and it means we’re again back to a weak Greek commitment to its banking system.  Leaving the euro means getting that pressure over with and beginning the process of Greek bank recapitalization, long and painful though it might be.

To sum up, I expect that default would lead to Greece leaving the eurozone, though you can write down conditions (more cash on hand for the government, consequences of default vanish quickly, stronger guarantee to banks, no subsequent fear of eurozone desertion) where that doesn’t have to be the case.


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