How Greece leaving the euro would actually work

Greece has two big problems right now. One is that the Greek state is running out of euros, which it needs to pay its employees and social assistance recipients. The other is that the Greek people think Greece’s banks will fail and have been pulling their euros out of the Greek banking system. The two problems lock together in a kind of deadly circle: With banks unable to operate normally, the economic activity is strangled, and with economic activity strangled, tax collections are plummeting — leaving the Greek state’s coffers even emptier than before.

The most likely solutions involve either the introduction of a parallel currency, Greece leaving the eurozone, or Greece somehow managing to finagle some more money out of its European partners.

Here’s what those three options would look like.

One option would be to borrow an idea from California, which in 2009 ran out of dollars and instead paid many state bills with IOUs. Instead of actual money, various county agencies, small businesses, and tax refund recipients were given legal tokens through which California acknowledged that it was legally obligated to pay.

Of course, you can’t take an IOU to the store and buy bread. But maybe you could take €100 worth of IOUs to a guy who wasn’t urgently in need of bread and trade them for €98. In this sense, Greek IOUs could begin to circulate as a kind of “parallel” currency even while the euro remained the country’s currency of record. Finance Minister Yanis Varoufakis seemed to be suggesting something along these lines over the weekend, and got himself fired for talking out of turn.

This was a great solution for California, because the reason California was running out of money was political gridlock between then–Gov. Arnold Schwarzenegger and the Democratic-controlled state legislature. Nobody was actually talking about not paying what was owed; they were just disagreeing about how. Once the deadlock was resolved, dollars became available, and the IOUs were redeemed.

The problem for Greece is that people will worry that Greek government IOUs will either not be paid at all, paid at a discount to their face value, or paid in new drachma (or some other hypothetical currency) rather than in euros. Consequently, people are unlikely to give you €98 for a €100 IOU. Maybe you could get €70? Maybe only €40? Nobody really knows.

Unlike California, Greece is a sovereign state. If it has bills it needs to pay, it could do what the vast majority of countries around the world do — print its own currency. In Greece’s case we’ll call the new currency the new drachma, after Greece’s old currency.

Of course, it takes time to physically print money. But an electronic switchover can be done faster. It would look something like this:

As with the IOUs, it’s an open question what value the market would place on a new drachma. But unlike with IOUs, a formal currency could be traded on international markets rather than informally in storefronts, so price discovery would happen relatively quickly.

Last but by no means least, Greece is still trying to reach a deal with its creditors that would allow it to avoid either scenario — Greece would agree to a package of structural reforms and fiscal austerity measures, and in exchange would get a bunch of euros from European governments and robust support for its banks from the European Central Bank.

Given that exactly such a package was rejected by the Greek government last week and then rejected again by the Greek voters in a weekend referendum, the path to a deal looks very murky. Now, on top of all the other issues to be negotiated, there is a major lack of trust between the Greek government and other European countries. But as of yet, everyone’s official position is that negotiations are still ongoing and they are searching for a way to keep Greece from needing to resort to these other options.