Should Greece Ditch the Euro?

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Talk about drama. Before Greek Prime Minister George Papandreou on Thursday backed away from plans to hold a controversial referendum on the bailout for Greece, he, German Chancellor Angela Merkel and French President Nicolas Sarkozy emerged from an emergency meeting on Wednesday with a bombshell: Greece will have to decide if it wants to remain in the European monetary union. Merkel and Sarkozy suspended all further bailout funds until that fateful choice is made.

What a shocker. The very idea of a member of the euro zone bolting the monetary union has been taboo, even as a debt crisis has raged throughout Europe for two years. There isn’t even a mechanism in place through which a country could exit the union. The fact that this possibility has even been mentioned is a major break with the past, and leaves the future uncertain.

What happens now? Hard to say. It had seemed that a referendum Papandreou called for on Monday to seek public approval of Greece’s participation in the latest euro-zone bailout scheme (agreed to last week at a summit of European leaders) would be transformed into a vote on the country’s continued membership in the monetary union. But events in Athens have changed rapidly and unpredictably. There were reports out of Athens on Thursday that Papandreou might scrap the referendum plan. He not only reportedly walked away from the referendum but also dismissed calls for his resignation, inviting the opposition to join negotiations on the bailout. Papandreou told an emergency Cabinet meeting that early elections would force Greece to leave the 17-nation euro currency, with disastrous effects for both Greece and the other European economies. His about-turn (he also said he never intended to hold a referendum, but rather was seeking broader Greek approval for the bailout plan) could help him win a confidence vote in Parliament on Friday night. But the situation is still fluid. Greece’s future in the euro zone will remain an unknown as long as the country’s domestic politics remain in turmoil.

This amazing series of events has raised an important question: Would Greece be better off in or out of the monetary union?

The conventional wisdom has been that Greece’s departure from the euro zone would be a calamity. If Greece bolted, it would lose its European bailout and most likely default, sending shock waves through Europe’s banking system and global financial markets. The Greek banking sector would likely collapse, while the government, frozen out of capital markets, might even be unable to pay its bills. For the euro zone, Greece’s defection would raise the specter of a cascading series of departures if other weak economies, also suffering in the debt crisis, chose to follow Athens’ example. In sum, it could get ugly.

But there is another, less terrifying scenario. By leaving the euro, Greece would lose its bailout money — but it would also regain control over its economic future. By returning to its own currency, Athens could depreciate its way to better competitiveness, something it simply can’t do as part of the euro zone. Rather than suffer under German-imposed reforms and retrenchment, Greece could press forward with a drastic restructuring of its national debt, a step the leaders of the euro zone have been anxious to avoid. None of this means the process wouldn’t be painful — Greeks will have to endure years of austerity measures and reform with whatever currency they use. But departing the euro zone might give the country a better shot at halting its economic free fall and returning to healthy growth, at least in a more reasonable period of time.

And the euro zone might gain from a Greek exit as well. Those tens of billions thrown at Greece in bailouts could then be redirected to recapitalize banks, shore up Italy and Spain and protect the core of the monetary union. How would global financial markets react? Hard to predict. The exodus of a country from the euro zone would be unprecedented and destabilizing. But then again, Greece’s exit would not be surprising to anyone who hasn’t been stranded on a South Pacific isle for the past two years. That suggests the impact might not be as dramatic as many fear, especially if Europe acts fast to back up its banks and defend the remaining euro-zone member states.

In many ways, Greece is like a contestant on the old game show Let’s Make a Deal. The country has a choice of two doors: one that leads it out of the euro and on its own, and one that keeps it a part of Europe and its great experiment in integration. We can only guess what is behind those doors, and there is no way of knowing which door is best to open. Greece could end up with a shiny new Cadillac. Or a year’s supply of canned tuna. It’s not a choice I’d want to make. I wish them luck.