Why and How Greece Must Exit the Euro

At an initial exchange rate determined by Athens, it must quickly swap paper euro for the new currency, convert existing bank accounts to drachma, and re-denominate all domestic contracts and debts.

Then, simply let the drachma float -- the new currency would fall in value enough to make Greece an attractive export platform to northern Europe, and accomplish a trade surplus to pay off its debts, now denominated in drachma.

Ironing Out the Wrinkles

Bank deposits would fall in value, as computed in terms of euro and dollars, and the potential for loss of wealth would cause depositors to withdraw funds and convert those to euro -- a run on the bank.

To curb such capital flight, Greece must impose temporary controls on capital outflows, much as European nations did after World War II. Once the drachma settled to a reasonably stable value on foreign exchange markets, those controls could be gradually withdrawn and then eliminated.

More problematic is Greek government debt, denominated in euro, to foreign bondholders, banks and governments. International law requires those be renegotiated if Greece can't pay in euros.

If those creditors insist on being paid in euros instead of drachma, Greece will never earn enough euros to pay them and be forced to default and unilaterally impose a huge haircut -- perhaps 100%.

In the end, Greece is a sovereign state, and if compelled by Germany, the ECB and other creditor intransigence, it can impose remarking of foreign debt to drachma and whatever additional haircut it chooses.

If foreign creditors cooperate and accept payment in the new currency, the losses they take will be substantially less than the haircut they will ultimately endure if Greece continues its austerity measures and remains on the euro.

Without the euro, Greece would still be a member of the European Union -- much like Great Britain and a few others who have chosen not to adopt the common currency -- however, Germany and the others could force Greece to leave if it abandons the euro.

However, if Greece were denied the tariff-free access to European markets as a member of the EU, the devaluation of the drachma necessary to accomplish economic stability and repay remaining debts in drachma would be much greater than if northern governments cooperated in the introduction of the drachma.

That would make losses to foreign creditors even larger than if Greece stayed inside the EU.

In the end, Greece, Germany and other Greek creditors will be better off accepting the euro has failed and helping Greece readopt its own currency.