A Greek Euro departure but Euro based economy.

If Greece leaves the Euro and adopts a new currency then any devaluation in the currency will need to be matched by a rise in domestic Drachma based wage inflation if Greeks are to be able to maintain the lifestyle they currently have importing the same things they currently do. If local wage inflation is below the FX inflation effect than on a relative basis greeks are being paid less than they were. Which is the same as them remaining in the Euro and experiencing wage deflation in Euro terms and a fall of relative wealth.

Whilst leaving the Euro means regaining domestic monetary policy it is probably safe to assume that Greece won’t be needing to raise rates to control growth and that with Euro rates already on the floor there is no room to lower them. Any rate adjustment is therefore likely to be in order to defend FX related capital flows so there is little reason to leave the Euro to regain monetary control. Whether they stay in or out, Greece still has to adjust its relative pricing. This occurs through inflation in local terms or through deflation in Euro terms. Though identical in outcome the difference is psychologicaly and politically very different. Taking a wage cut dents personal pride (it is an individuals decision whether to take a cut or resign) whereas inflation can be pinned on others. Blaming others for your mistakes is a politicians escape route, or even ladder to glory, and one which Putin is utilising to worrying consequence. It is also the catalyst for nationalistic behaviour that can either be used as a focus for productivity (to fight the evil others) or more likely raise anger and destruction.

Greece really can’t blame anyone else for it’s overspend of the capital flows that have come its way, however it can blame others for reneging on implicit and explicit agreements and not seeing sense (a great post here from M. Pettis on the problems of capital flows in Europe). But an exit from the EU and resulting inflation undermining domestic wealth could easily be blamed on the EU. So for Syriza an exit and its wealth destroying effects would be easier to handle politically as well as leaving it clear of debt having defaulted (let’s assume that heir s no point in leaving if debt load stays the stay). But 70% of the population don’t want to leave the EU, leaving Syriza somewhat painted into a political corner. If it leaves the EU against the wishes of 70% of the population it will be hated. If it stays and has to swallow the German pill it will be hated for not brokering the deal it promised. The EU must know this and though the negotiations are currently EU vs Greece over debt, there is probably a sub-plot to embarrass Syriza to the point that they look fools from all sides and are removed from office. Removing the most rebellious EU government within the EU would do the EU master-plan overlords no end of good towards promoting their form of political unity and defuse rising anti-EU political movements who are all watching Syriza as a test case. For Syriza, perhaps being forced out of the EU and having it seen as not their choice would be their best outcome politically, if not the best outcome for the Greek people. This could explain their current negotiating stance.

But there is a half way option. Greece’s economy is so Euro’ised that any EU departure would most likely see the Euro continued to be referenced by the private sector with  goods and services continuing to be priced in Euros. This bypasses the wild volatility a new currency would inflict on business planning and could easily be facilitated by the population running and transacting through offshore Euro bank accounts, thus bypassing any local bank enforcement of Drachma (you only have to go to the Turkish resort of Bodrum to see this in effect where Euro prices are ubiquitously applied). However new currency paid State employees would be the ones to suffer.

If they do leave of course they will be needing a name for the new currency and a new RIC code to identify it. I suggest the ‘Formally Known as Drachma’, RIC code - FKD