What happens if Greece quits eurozone?

There is more and more speculation that Greece is about to leave the euro.

Greece has been unable to form a government, and new elections seem set to give power to parties that reject the spending cuts that have been agreed with other eurozone governments and the International Monetary Fund.

But without those spending cuts, the Greek government will receive no more bailout loans, it won’t have the money to pay its debts, the Greek banks will probably go bust, and the European Central Bank may be forced to cut Greece loose from the single currency.

What would this mean for Greece and the rest of Europe?

1. Greek meltdown

Greece’s banks would be facing collapse. People’s savings would be frozen. Many businesses would go bankrupt. The cost of imports – which in Greece includes a lot of its food and medicine – could double, triple or even quadruple as the new drachma currency plummets in value. With their banks bust, Greeks would find it impossible to borrow, making it impossible for a while to finance the import of some goods at all. One of Greece’s biggest industries, tourism, could be disrupted by political and social turmoil.

In the longer run, Greece’s economy should benefit from having a much more competitive exchange rate. But its underlying problems, including the government’s chronic overspending, may not go away.

2. Bank runs

Ordinary Greeks may queue up to empty their bank accounts before they get frozen and converted into drachmas that lose half or more of their value. Depositors in other eurozone countries seen as being at risk of leaving the euro – Spain, Italy – may also move their money to the safety of a German bank account, sparking a banking crisis in southern Europe.

Confidence in other banks that have lent heavily to southern Europe- such as the French banks – may also collapse. The banking crisis could spread worldwide, just like in 2008. The European Central Bank may have to provide trillions of Euros in rescue loans to the banks. Some governments may not have enough money to prop up their banks with the extra capital needed to absorb losses and restore confidence; the banks could then go bankrupt.

Greece has been unable to form a government, and new elections seem set to give power to parties that reject the spending cuts that have been agreed with other eurozone governments and the International Monetary Fund

3. Business bankruptcies

Greek businesses face a legal and financial disaster. Some contracts governed by Greek law are converted into drachmas, while other foreign law contracts remain in Euros. Many contracts could end up in litigation over whether they should be converted or not.

Greek companies who still owe big debts in Euros to foreign lenders, but whose main sources of income are converted to devalued drachmas, will be unable to repay their debts. Many businesses will be left insolvent – their debts worth more than the value of everything they own – and will be facing bankruptcy. Foreign lenders and business partners of Greek companies will be looking at big losses.

4. Sovereign debt crisis

Sovereign debt is the money a government borrows from its own citizens or from investors around the world. But if Greece leaves the eurozone, setting a precedent that such a thing can happen, then investors will become very nervous about lending to other struggling eurozone countries.

This could leave the governments of Spain and Italy short of money and in need of a bailout. These two huge countries together account for 28% of the eurozone’s total economy, but the EU’s bailout fund currently doesn’t have enough money to prop both of them up. Even France’s government could get into trouble if it needed to bail out its enormous banking sector.

5. Market turmoil

Nervous investors and lenders around the world may start selling off risky investments and move their money into safe havens. Stock markets may plunge. High-risk borrowers could face sharply higher borrowing costs, if they can borrow at all.

Meanwhile, safe investments such as the dollar, the yen, the Swiss franc, gold and perhaps even the pound would rise, while safe governments such as those of the US, Japan, Germany and even the UK could borrow more cheaply. And it’s not all bad news – the oil price may well fall sharply.

6. Political backlash

As eurozone governments and the European Central Bank face enormous losses on the loans they gave to Greece, public opinion in Germany may turn against providing the even larger bailouts probably now needed by big countries like Italy and Spain. The ECB’s role of quietly providing rescue loans to these countries in recent months would be exposed and could become politically explosive, making it harder for the ECB to continue to prop up their economies.

However, the threat of a meltdown might push Europe’s or the eurozone’s governments to agree a comprehensive solution – either dissolution of the single currency, or more integration, perhaps through a democratically-elected European presidency tasked with overseeing a massive round of bank rescues, government guarantees and growth-stimulating infrastructure investment.

7. Recession

Crisis-stricken eurozone banks may be forced to slash their lending. Businesses, afraid for the euro’s future, may cut investment. Faced with a barrage of bad news in the press, ordinary people may cut back their own spending. All of this could push the eurozone into a deep recession.

The euro would lose value in the currency markets, providing some relief for the eurozone by making its exports more competitive in international trade. But the flipside is that the rest of the world will become less competitive – especially the US, UK and Japan – undermining their own weak economies. Even China, whose economy is already slowing sharply, could be pushed into a recession.

8. Greek debt default

Unable to borrow from anyone (not even other European governments), the Greek government simply runs out of Euros. It has to pay social benefits and civil servants’ wages in IOUs (if it pays them at all) until the new drachma currency can be introduced. The government stops all repayments on its debts, which include 240 billion Euros of bailout loans it has already received from the IMF and EU. The Greek banks – who are big lenders to the government – would go bust.

Meanwhile, the Greek central bank may be unable to repay the 100 billion Euros or more it has borrowed from the European Central Bank to help prop up the Greek banks. Indeed, by the time Greece leaves the euro, the central bank may have borrowed even more from the ECB in a last ditch effort to stop the Greek banks collapsing.