Grexit - a possible solution to the Euro crisis?

A caveat: Grexit is not a proper English word!

Grexit is a slang formed by the combination of two words- Greece and exit. Coined by Citigroup's chief analyst, Willem H.Buiter and Ebrahim Rahbari, it refers to the prospect of Greece leaving the Euro and getting back its old currency, the drachma. Impossible as it may sound, this possibility is more real than it seems. There is some serious thinking going into pushing for the Grexit.

Is this a good idea? Would it indeed help in solving the Euro crisis?

To get that answer, we need to look into what caused the crises at the first place.

 In the aftermath of the housing bubble that finally led to the 2008 crisis, slow growth became the norm.  Greece, which had been spending way beyond its limit, without much care of the widening deficit, was the first to feel the pinch. Last February, Greece, a primary default candidate, under pressure from neighbours, approved of austerity measure to cut down on the budget deficit. The government spending were decreased, tax rates increased. The target was to bring down the deficit, which had risen to 13% of the GDP by 2009, to about 3%. But every coin has a flip side. With the austerity drive, and no funding, the growth slows down. And with that, so do the taxes, and as a consequence, the deficit widens. But Greece had no other option. The credit rating of major Greek banks slipped. With Spain and Portugal also giving signs of instability, fears of a European crisis widened. The credit rating of Spain slipped to double A, and as Greece agreed to become the first EU country to be bailed out by EU and IMF, and euro plummeted,  the writing was on the wall. Ireland too faced the music, with a credit down-rating following austerity measures approved by the tiny nation. The consequence of all this is that the country's bonds have become unstable and the investors stay away for the fear of volatility. The ECB (European Central Bank), hence, has had to buy the government bonds of Spain and Italy.  The concept of Euro bonds, issued by EU as whole was discussed. But Germany was vehemently opposed to it, and naturally so, for joining hands with Greece and others would make borrowing more expensive for it.

This summarizes the Euro crisis. But I have anyways never been too fond of the fundamental principal on which Euro runs. Losing your sovereignty and having a common body controlling the monetary policy of the whole region was not a good move. The birth of Euro as a currency is flawed. It allowed countries like Greece to borrow beyond their means and they were safely nestled in the security that Euro, which was established to challenge the might of US dollar, provided. Such consequence, hence was inevitable.

With Euro zone in such a place, how would the Grexit change things? For Greece, it might seem like a blessing. Which it is not. The standard approach of devaluing your currency may not be the best alternative. The depreciation of a currency is useful when there is no issue with the production, but an issue with the relative pricing. With Greece, that is certainly not the case, as the depreciation of currency may increase productivity marginally, but that would be more than offset by higher import bills. A devaluation of currency would lead to higher uncertainty in the banking sector, which is already suffering from liquidity issues.

 As far as the Euro is concerned, this might not be the best move even for them. For one, Grexit may sent a dangerous precedent and lead to Spexit, Irexit and Porexit in lieu of the failing economies of Spain, Ireland and Portugal. Then there is the point that if such exits become a norm, then none of the Euro country would be ready to cover up the liabilities of a fellow country's banks and make up for the huge debt that may be piled up by it. The contrary argument to this is that it may make the Euro countries sit up and be careful, but the threat offered by the former outweighs the latter argument. Also, a system needs to be developed, a European super body, that would need to look into the affairs of European banks. Then there are logistics issue. How would the Greece economy run when currency change is taking place? Form where would the capital of banks come, as there is no-one willing to invest in Greece?

It is clear that the best way forward for Greece and the Euro is not Grexit, but reforms. Strong structural reforms are the need of the hour for the Greeks as they try to correct the wrongs of their previous leaders. Would Germany and others stick with Europe? As long as they are true to the terms and conditions of the austerity measures. I think the Greeks are ready to brave the terms rather than having to face an exit.