Greece could soon find itself in the middle of a daunting economic experiment.

Ever since Greece became part of the euro over a decade ago, the common European currency has been entrenched in the lives and activities of the country’s 11 million people. But as Greece’s debt crisis escalates, the chances increase that the euro may be replaced by a new, national currency.

Precedents for such a transformation may not exist. Economists say they cannot think of a time when a developed country with an open economy dropped out of a shared currency and set up its own new money.

“There is no modern parallel,” said Michael P. Dooley, professor of economics at University of California, Santa Cruz. “That’s one of the reasons why there is so much hesitation to do it; no one really knows what will happen.”

Much has to happen before Greece reaches the point of an exit from the euro, or “Grexit.” And there is no provision in European treaties for a nation to leave the monetary union.

Still, the probability that Greece will depart from the euro soared over the weekend, after the Greek government announced that it planned to hold a national referendum on the terms that Europe is offering the country in exchange for new aid.

Greece’s announcement came just days before the European part of Greece’s current bailout program expires on Tuesday. Europe’s leaders have refused Greece’s request that talks be extended beyond Tuesday so that the country could hold the referendum on July 5.

Complicating matters further, Greece on Tuesday faces a debt repayment of 1.6 billion euros, or $1.8 billion, to the International Monetary Fund, money the Greek government almost certainly does not have.

Polls show that the Greek people favor staying in the euro, and Greece’s leaders have said they do not want to leave the common currency. Indeed, fears of the consequences of leaving the euro could be a factor that persuades Greece’s leftist government to soften its stance and, at the last minute, forge a deal with its creditors.

Continue reading the main story

READ MORE

If a deal does not happen soon, a series of events could significantly increase the likelihood of Greece tumbling out of the euro.

On Sunday, the Greek debt crisis entered a new and dangerous phase. In recent months, the European Central Bank has made emergency loans available to Greece’s ailing banks, increasing the size of the support as depositors have taken euros out of the banks. Despite signs of large withdrawals over the weekend, the E.C.B. did not announce that is was approving a further increase, but instead said that it was maintaining the loans at their current total, which is thought to be around €85 billion.

With the supply of euros into Greece now restricted, the country’s government acted on Sunday to stem the flow of the currency out of the banks and the country. These include the closing of banks and a cap on cash withdrawals. .

Cyprus imposed similar restrictions on the movement of money after its economic and banking crisis in 2013. And Cyprus managed to stay in thAdvertisement

But Cyprus was much helped by fresh financial aid from the I.M.F. and Europe. Greece cannot expect such assistance if there is no new agreement with Europe — and if it has defaulted on the big debt repayments to the I.M.F. and the E.C.B. that come due in the remainder of this year.

“If this is divorce, and not a separation, then Greece must have a new currency,” said Arturo C. Porzecanski, a professor of international economics at American University.

In recent decades, many countries have adopted a new currency, including nations in Latin America. Countries like Greece sacrificed some of their sovereignty to become part of the euro. But in most cases, these countries were leaving behind a weak currency for one that turned out to be stronger. If Greece set up a new drachma, the name of its pre-euro currency, it is most unlikely that it would be stronger than the euro.

A new drachma might also have a hurried and chaotic birth.

When, in the postwar period, countries changed their currency, it usually took many months of careful planning. Of course, Greece may have been secretly preparing for a new drachma. But even if it has, its government has not had long to lay the groundwork.

“The first and most important thing to remember is that you don’t introduce a currency quickly,” said Stephen Kinsella, an economics lecturer at the University of Limerick in Ireland. “You just don’t.”

Huge logistical and technical challenges could also occur.

Global payments systems have to be reprogrammed to accept the new currency. And then the task of actually acquiring a new physical currency can take a few months, though Mr. Kinsella said economies have shown that they can operate for a while with a shortage of physical cash. That was the case in Ireland, he said, when bank tellers there went on lengthy strikes in the 1960s and 1970s.

Continue reading the main story

One of the potential benefits for Greece of having its own currency is that it can keep printing it until monetary policy is loose enough to stimulate economic growth. A weaker drachma that falls in value against the euro and the dollar could also bolster Greece’s exports. And the government can pay its own bills — huge outlays like government worker wages and pensions — in the new currency.

The danger, however, is that the government prints so much of the new currency that it falls too far, creates inflation and soon lacks credibility with the Greek people.

“The moment people got it, they would want to spend it,” said Guillermo Calvo, an economics professor at Columbia. “Who knows where the exchange rate will go; it could overshoot like crazy.”

Greece regularly devalued its old drachma, taking it to over 300 per dollar before it was replaced by in 2002, from 30 to the dollar in the 1970s.

An exit from the euro could shake Greece in other significant ways. Banks might become overwhelmed with losses. This could force the government to take them over, said Raoul Ruparel, co-director of Open Europe, a think tank that focuses on European issues.

A barrage of litigation could also hit Greece if it were to leave the euro. Greek companies that borrowed in euros might find it hard to pay them back if they are mainly earning a new drachma. The companies’ creditors and suppliers might refuse to be paid in the new currency, and take the issue to courts in London and New York.

Making matters worse, fear of the new drachma could prompt foreign companies to step back from entering into new contracts with Greek companies.