The unthinkable suddenly looks possible.
Bankers, governments and investors are preparing for
Greece to stop using the euro as its currency, a move that could spread turmoil throughout the global financial system.
The worst case envisions governments defaulting on their debts, a run on European banks and a worldwide credit crunch reminiscent of the financial crisis in the fall of 2008.
A Greek election on Sunday will determine whether it happens. Syriza, a party opposed to the restrictions placed on Greece in exchange for a bailout from European neighbors, could do well.
If Syriza gains power and rejects the terms of the bailout, Greece could lose its lifeline, default on its debt and decide that it must print its own currency, the drachma, to stay afloat.
No one is sure how that would work because there is no mechanism in the
European Union charter for a country's leaving the euro. In the meantime, banks and investors have sketched out the ripple effects.
They think the path of a full-blown crisis would start in Greece, quickly move to the rest of
Europe and then hit the
U.S. Stocks and oil would plunge, the euro would sink against the U.S. dollar, and big banks would suffer losses on complex trades.
ACT I
What would Greece's exit look like? In the worst case, it starts off messy.
The government resurrects the drachma, the currency Greece used before the euro, and says each drachma equals one euro. But currency markets would treat it differently.
Banks' foreign-exchange experts expect the drachma would plunge to half the value of the euro soon after its debut.
For Greeks, that would likely mean surging inflation _ 35 percent in the first year, according to some estimates. The country is a net importer and would have to pay more for oil, medical equipment and anything else it imports.
Greece's government and banks currently survive on international loans, and if it dropped the euro, the country would probably be locked out of lending markets, says
Athanasios Vamvakidis, foreign-exchange strategist at Bank of America-Merrill Lynch in
London. So the Greek central bank would need to print more drachmas to make up for what it could no longer borrow from abroad.
That's one reason analysts say the switch to a drachma would lead the country to default on its government debt, possibly triggering losses for the
European Central Bank and other international lenders.
Most assume foreign banks would have to write off loans to Greek businesses, too. Why would Greeks pay off foreign debts that effectively double when the drachma drops by half?
Say a small shop owner in
Athens has a (EURO)50,000 business loan from a French bank. She also has (EURO)50,000 in savings in a Greek bank. The Greek government turns her savings into 50,000 drachma.
If the new currency fell by 50 percent to the euro as expected, her savings would suddenly be worth (EURO)25,000. But she would still owe (EURO)50,000 to the French bank.
European banks would take a direct blow. They've managed to shed much of their Greek debt but still held $65 billion, mainly in loans to Greek corporations, at the end of last year, according to an analysis by
Nomura, a financial services company. French banks have the most to lose.
ACT II
Here's where things get scary.
The European Central Bank and European Union would have to persuade investors in government bonds that they will keep
Portugal,
Spain and
Italy from following Greece out the door. Otherwise, borrowing costs for those countries would shoot higher...
