A couple of years ago, when the debt crisis in Greece really got going, That Retired Guy had a look, and came to the early conclusion that default was inevitable, but that exit from the Euro was not necessarily required. In a way, events so far have proved him right, but alas, this story isn't over yet, and TRG can now see that he was wrong; Euro exit is probably inevitable.
TRG now believes that we will see a return of the Drachma before long (probably this year). The reason for this belief is simple; among the solutions that might work, leaving the Euro is the most likely to actually work, and it is, in fact, the best solution for the Greek people. Let's look at the possible solutions in turn:
Austerity has been tried, and it is not working. It's the same story everywhere, cutting government spending and raising taxes at a time when the economy is soft is counter productive. There used to be a debate about the effectiveness of austerity. The debate is over. Austerity has been tried everywhere, and everywhere it is failing. Greece has made a heroic effort, but the mountain is just too high.
Fiscal transfer is the idea that someone (IMF, ECB, Germany, whoever) will give Greece the money they need with no (or limited) strings attached. Silly as it sounds, it is basically what West Germany did for East Germany in the nineties. The main difference of course is that Greece does not really want to be absorbed into another country! With enough will, the European Union could actually become a real United Government of Europe and provide this sort of help for it's struggling members, but let's be real; a truly United Europe is about as likely as a Britney Spears comeback.
Without a more united Europe, only a small scale fiscal transfer is possible. Unfortunately, small scale isn't going to do the job. Realistically, Greece probably needs something north of 400 Billion as a direct payment (not a loan) to end their turmoil. Nobody has the ability to make a gift that large.
Partial default already happened, and the remaining debt holders are now the ECB, EFSF and IMF. Given that fact, default is basically Fiscal Transfer by another name, and for that reason, it's just as unlikely.
Leave the Euro
Leaving the Euro will not be easy. It's hard to overstate just how hard it will be. It will involve using the military to enforce marshal law in order to avoid people running across the boarder with as much cash as they can get their hands on. It will mean banks closing, and being nationalized. It will involve years of difficult court battles to determine what currency should be used for existing Euro contracts. In the short term, it will decimate the Greek economy. But there is one thing that a Euro exit will provide that none of the other ideas can... HOPE.
Exiting the Euro provides a real, credible path to a future with economic growth. Once the tactical difficulties of switching the currency are complete the population of Greece will become unable to afford imports, and the local Greek economy will come to life to fill the gaps. Exports will also be possible because Greece will provide a competitive labor market. This is not some sort of hazy economic theory, there are multiple examples (most recently Argentina) the illustrate how effectively, and rapidly currency devaluation can spur an economy.
There's another benefit to exiting the Euro. It will be painful, but the pain will be equally spread. Austerity is having a unbearable effect on the young and poor in Greece. Exiting the Euro will hurt too, but once the new currency is established, the benefit will come first to those looking for work. Prices on anything locally produced (food especially) will be affordable. People will see the benefits quickly, and the path to future prosperity will be believable.
The political situation in Greece may be the ultimate catalyst. By some estimates, Greece will be out of money in June if they don't get the next batch of support from the Troika. It appears that new elections will be required, hopefully, it can be done quickly, and provide a government strong enough to make the difficult decisions required. Probably the Euro goes no matter what, so hopefully, it can be done without too much ciaos.
The big question really is what happens to the rest of Europe (especially the other periphery countries) if Greece leaves the Euro. That will have to be discussed in another post.