There are several options left to resolve the Greek crisis — none of them particularly good. In the first option, the European Union makes allowances. Maturities of borrowings, especially near term commitments, are extended. There are concessions on interest rates. Existing debt may be replaced with securities without maturity and a coupon linked to growth, so called Keynes-style Bisque bonds. The required primary budget surplus is reduced, perhaps with some new investment from the EU to boost activity. The ECB continues to support the liquidity needs of the Greek banks. The hated Troika is renamed, to remove the odious association with the past. Despite the reduction in the economic value of the debt outstanding, the EU and lenders avoid a politically difficult explicit debt write down. Greece’s Syriza government claims to have fulfilled its mandate to stand up to the EU and Germany and reclaim Hellenic sovereignty and pride. In reality, little changes. Under this scenario, Greece and the EU are back at the negotiating table within six- to 12 months confronting the same issues. In the second option, Greece defaults on its debt but stays in the eurozone, an option originally favored by the current Greek finance minister when he was an academic. It is not clear how a defaulted nation can remain within the eurozone, other than the fortuitous absence of an ejection mechanism. Greek banks collapse if the ECB decides to withdraw funding. Capital flight accelerates, forcing implementation of capital controls. The Greek government is left with no obvious source of funding of its operations, other than a parallel currency or IOUs used during some government shutdowns in the US. Greece’s competitive position is unchanged as it purports to use the euro EURUSD, +0.07% . The EU and lenders incur immediate substantial losses on their loans. In the third option, Greece defaults and leaves the eurozone, replacing the common currency with new drachmas. It pays back its nominal debt in its new, weak currency. Domestic banks have to be supported by the Greek central bank. There is short term chaos. Activity in Greece collapses. The EU and lenders face the same problem as in the second option. In addition, the euro is destabilized. The third option allows Greece to regain control of its currency, money supply and interest rates. Sharp devaluation of the new drachma improves competitiveness, for example in tourism. The ability of the central bank to create and control money supply helps restore liquidity to the banking system and provides a mechanism for financing the government. A cheap new drachma, if appropriately managed, may reverse capital flight, as the threat of a loss of purchasing power is reduced. A devalued currency may help attract inflows of funds looking for bargains. In time, Greece regains access to capital markets as Russia did after its 1998 default.

Source