Economic Concepts Found in the Grexit

Aug 6, 2015

Greece’s precarious position in the Eurozone has been the epicenter of tension in the EU due to the country’s inability to repay its massive debt that currently stands at over 175% of its Gross Domestic Product. Just recently, Greece has begun repaying its debt in order to save itself from insolvency. But in the first half of the year, pundits debated whether Greece’s debt would force the country to “Grexit,” the unique word pundits put on Greece’s potential exit from the Eurozone. If Greece had decided to exit from the EU, the country would have had to give up the Euro and reintroduce its pre-Euro currency, the Drachma, which would be devalued relative to the Euro. A split from the EU might not have been entirely detrimental for Greece though, and one reason why has to do with the country’s balance of trade.

A country’s balance of trade refers to the revenue it earns from exports minus the cost of their imports. Typically when a country’s exports generate more revenue that its imports cost, the country is selling more than it is buying and thriving in the global economy. The opposite situation is often viewed as a negative since this means a country is purchasing more than it exports, which is also known as running at a trade deficit

While some countries around the world, including the United States, India, Japan, and the United Kingdom, run trade deficits, quite a few countries such as Germany, Sweden, Qatar, and South Korea run trade surpluses.  Multiple factors, such as the cost of production, exchange rates, prices of goods at home and abroad, taxes, and regulatory barriers determine a country’s trade balance. It is possible for a country to rebalance its trade deficit by reducing its imports and increasing its exports. One way of doing so is through a currency devaluation – which could occur through the reintroduction of the Drachma.

The strength of a currency is strongly correlated with the health of an economy. If the economy is in a perilous state the currency would become devalued compared to other currencies such as the dollar, euro, and British pound. In the case of Greece’s potential “Grexit”, had the country exited the EU and the country not recovered, it could have witnessed this sort of devaluation of the Drachma. Effectively, this would make goods produced in Greece relatively cheaper to those who live outside of Greece, while simultaneously making goods produced outside Greece more expensive for its citizens.

The trade balance is an important part of current account balance. If a country’s current account balance is negative, it borrowed more than it loaned to other countries. Other things equal, by taking advantage of exchange rate parities or the value differential between the Drachma and other currencies, Greece could have potentially reduced its trade deficit. Of course, any “Grexit” could have had other potentially onerous effects on the Greek economy and its citizens.

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