The Rebirth of the Drachma?

Some two millenniums before William Shakespeare was born, theatre was alive and well in ancient Greece.  The ancient Athenians created plays that are still considered among the world’s greatest works of artistic expression.  From tragedies to comedies to satires which made fun of political and cultural leaders, Greek theater captivated audiences and served as a means of expressing political thought and ideology in the ancient world.  The most well-known and prodigious playwright of the time was Sophocles, whose play Oedipus the King was popular with his audiences.  The story of Oedipus begins with his arrival to Thebes, a stranger to this small town; Oedipus finds that the town is under the curse of the Sphinx who will not free the city unless her riddle is answered.
Today the financial world waits and wonders if the riddle of the Greek debt crisis will be answered. Greece’s current tragedy has been well chronicled but what has been less talked about and debated are the options currently available to Greece to solve its problems.  From our vantage point Greece’s voluntary exit from the European Union, while suboptimal in the short term, appears to be the most logical solution.
With the creation of the European Union members believed that the benefits and economies of scale of creating a single currency would be a boon to member-states’ GDP.  In reality many of the Eurozone members have benefitted mightily since the introduction of the euro.  All seemed reasonably well with the euro as it became the second most transacted currency only behind the US dollar.  But upon closer retrospection Greece’s inclusion in the Eurozone probably made little sense; after all the Greek economy is largely sustained by tourism and the export of olive oil.  Neither of which can significantly reap the benefits of international trade like say the German auto makers.
But we are where we are - so what is next for Greece? It is important to remember that Greece IS part of the European Union so the “what’s next” options are finite.  They can decide to either remain a member or they can decide to leave.  What makes the “what does Greece do” question critical and complex for investors/decision makers is the interconnection of the fiscal health and well-being of the 17 euro-using Eurozone members and the potential cascading impact.  Simply put, the outstanding Greek debt at €350+ billion is in and of itself not the problem; the problem is the potential European domino effect.  In all likelihood this is a primary topic of discussion at the G7/G20 meetings now happening.
Since the introduction of the euro Greece has run-up unfathomable debt levels and a corresponding mind blowing (for them) interest expense that has contributed to the approximately 170% debt-to-GDP ratio. Many financial economists calculate that a debt-to-GDP ratio above 90% is a recipe for disaster, and ideally the ratio should be closer to 50% to ensure sustainability.    Further, a condition of the prior Greek bailout was that Greece implements an austerity program to cut their expenses in order to pay back the outstanding debt and make interest payments. Notably Greece has yet to implement the agreed upon austerity program.  In a country where unemployment is approximately 16%, and salaries have been slashed and individuals’ tax burdens have been increasing, it is understandable that the last thing the Greek populous wants is more pain from further cuts.  We believe that all of the austerity that has happened will be all that will happen.
But that gets to the crux of the situation — if you are Greece you know that remaining a member of the EU means interest expense payment, debt repayment and austerity.  So Greece’s leadership must ask themselves is the benefit from being in the EU greater than the costs of voluntarily exiting.  We would submit that the only real way for Greece to get control of their economy over the long term is to rid itself of the debt/interest expense and devalue their currency. The effect of getting rid of the debt is clear- better debt to GDP ratios and greater ability to raise cheaper debt; and the devaluation of their currency would make Greece more competitive on the world stage a la Argentina in 2001.  The most direct effect from a devalued currency is the likely increase in tourism dollars.  No outstanding debt, increase in revenues, decreased interest expense—Ouzo for everyone!
The problem is that the only way to do the aforementioned is to NOT be part of the European Union.  Staying in the EU categorically means that an individual member-state cannot simply rid itself of accumulated debt and there is only a single currency so a member-state cannot simply devalue the currency [as part of inclusion into the Eurozone country specific currency - e.g. Greek drachma - disappeared and some monetary sovereignty was relinquished by member-states to the European Central Bank].  
So if Greece is problematic then the other EU members should encourage or allow them to leave, right? No. if Greece leaves and essentially gets a do-over then there is potentially that other problematic member-states would follow that same path – recall that Italy has €2 Trillion of debt outstanding.   Ok, so if the debt is the underlying problem why doesn’t the IMF or ECB or Germany just buy out the debt to resolve the situation? Certainly the monies exist to buy up the Greek debt but what happens when another member-state wants forgiveness or buyout of their debt (e.g. Italy, Portugal, Spain etc.)? What if all problematic member-states wanted debt relief? There is not enough euros in the coffers to satisfy all of the outstanding debt (let’s say it again, recall that Italy has €2 Trillion by itself). In either case there exist the real potential of a contagion or domino effect to other sovereign European nations who are ALL incented to do what is in their countries’ best interest.
We believe that the euro and the EU have largely been beneficial for the global capital markets; it is just in this specific case Greece was probably not a good choice for inclusion; that poor decision, however, could have calamitous effects. No one can say for certain when this current drama will unfold but if the capital markets are a good indicator – and we believe that they are- the current rates on credit default swaps indicate that whatever happens to Greece it will be sooner than later.  
In the final act of Oedipus the King Oedipus solves the riddle of the Sphinx.  Since the king had recently been murdered, he becomes the king and marries the queen.  But this was in no way a happily ever after ending because in time, Oedipus comes to learn that he is actually the king’s son, who was cast out of Thebes as a baby; thus he had killed his father and married his mother.
“The horror of darkness, like a shroud. Wraps me and bears me on through mist and cloud.” – Sophocles, Oedipus
The ancient Greeks certainly had a flair for the dramatic as do our contemporaries; but when all is said and done we hope the current Greek tragedy playing out on the world stage will not end so painfully.