On January 1, 1999 the euro currency officially came into existence and two years later in 2001, Greece joined the EU currency zone. The euro began to circulate in physical form on January 1, 2002, eliminating the previous national currencies, including the Greek drachma.

A Brief History of the Greek Eurozone Crisis

In 2008, EU leaders agreed to a €200 Billion stimulus package to help boost the European economy following the global financial crisis. In April 2009, the EU ordered four countries  – France, Spain, Ireland and Greece – to reduce their budget deficits due to impending financial instability. By October of that year, it became clear that there had been rampant corruption and overspending in Greece, and George Papandreou's socialist party was elected. This new government admitted that Greece had debts of over €300 billion, the highest level of sovereign debt in modern history. 

Greece's debt burden accounted for 113% of its GDP, nearly double the Eurozone limit of the 60% debt to GDP ratio. Credit ratings agencies began downgrading Greek corporate bonds and government debt. When credit ratings are downgraded, the price of bonds fall while their interest rates, which respond inversely to bond prices, rise. Higher interest rates translate to higher borrowing costs and less capital investment. All the while, Papandreou insisted that his country was not about to default on its debts. 

The EU launched an investigation into excessive Greek debt and condemned severe irregularities in Greek accounting procedures. Its budget deficit was subsequently revised upwards to 12.7% from 3.7%, more than quadruple the maximum level permitted by EU rules.

Rumors of a Greek Exit

In early 2010, rumors begin to circulate that Greece would have to exit the Eurozone, but the European Central Bank (ECB) dismissed this as mere speculation. Soon after, Greece announced an austerity plan intended to reign in its deficit. EU regulators responded by insisting that Greece make even deeper cuts with its austerity plan, sparking riots and protests on the streets of Athens and other large cities. Meanwhile, the Greek government continued to insist that it does not need a bailout from the ECB.

By April of 2010, the ECB and the International Monetary Fund (IMF) agreed to provide Greece with a safety net of €30 billion in emergency loans in response to revisions to the Greek deficit that showed its debts to be 13.6% of GDP, even higher than the staggeringly high 12.7% previously reported. The emergency loan facility proved to be insufficient, and on May 2nd, the IMF issued a €110 billion bailout package to rescue the Greek economy.

Fear of contagion rose as other peripheral EU nations including Portugal, Ireland, Spain and Italy (PIIGS) also experienced sovereign debt crises.

A Spiraling Crisis Ultimately Averted

By early 2011, nothing had improved for Greece. EU finance ministers set up a permanent bailout facility of over €500 billion and additional, smaller such funds for Portugal and Ireland. In mid-2011, politicians in Europe began demanding that Greece be ejected from the Euro currency zone. The Greek government responded by enacting even more severe austerity measures and an additional €109 billion was allocated to prop up the Greek economy and prevent contagion.

In early 2012, "the Troika," consisting of the the European Commission, the ECB, and the IMF, and the Greek government come to an agreement with holders of Greek debt, but this only sparks more protests as it comes at the expense of Greek citizens and includes even more unpopular austerity. By March of 2012 a further Greek bailout of €130 billion was required, and the permanent bailout facility size was increased to €1 trillion. By 2013, the headline Greek unemployment number had reached a staggering 27%.

During 2013 and much of 2014, the Greek government changed multiple times as new elections were called and cabinets were reshuffled. Politicians knew that enacting austerity was the only way to secure bailout money from the Troika, but austerity was becoming increasingly unpopular with the Greek people. Nevertheless, Greek politicians seemed to gain the upper hand, alleviating concerns of a Greek exit, and by the middle of 2014 Greece had returned to the financial markets issuing new bonds for the first time in years, and its credit rating was upgraded by Fitch from B- to B.

The Greek Crisis Returns

In December 2014, the Greek government, under increasing pressure from it's citizenry, unexpectedly called for an early election. The next day, the Greek stock market dropped 12.78%, the most since 1989. Voters scrambled to understand the situation, and on December 29th the election failed to choose a new president for Greece leading to a new round of emergency elections to be held on January 25th, 2015.

Though Greece has been on this road before, this time may be different because the popular vote will probably support a political party bent on leaving the Euro currency zone and eliminating the austerity measures necessary for its continued financial bailout packages. This has sent the value of the Euro to 9-year lows against the US Dollar.

A European Catastrophe

If Greece leaves the Euro and reinstates the drachma, it will finally be able to recover from years of austerity and economic depression, but with very dire consequences for the Euro and for Europe. There would be a capital flight out of Greece initially as people seek to offload the new Greek currency, expecting that it will promptly be devalued. In response, the Greek government would likely impose a series of strict capital controls to prevent massive outflows of deposits, a measure currently forbidden by EU policy.

Distrust in the new currency would also create a massive black market for goods and services operating outside the law, not taxed by the government, and at a significantly different exchange rate than that set by the Greek central bank. The Greek economy would experience massive inflation as prices skyrocket and the value of the new drachma plummets. The central bank would be enticed to print more money to maintain civil services and make interest payments, but this can lead to the risk of a hyperinflation.

Civil and political unrest would once again takeover the streets of Athens. According to a 2011 report by UBS, a Greek exit would lead to a 50% drop in GDP. Doing it today would have even worse consequences.

The ECB would be under fire as the institution responsible for maintaining the price stability and credit worthiness of the Euro. After spending over a trillion euros to prevent Greece from exiting, the ECB would more than likely face a crisis of trust. At the same time, global banks – but mostly European banks – would suffer exceedingly large losses, threatening their solvency and leading to potential bank runs. The euro would fall in value relative to the dollar and other world currencies creating a vicious downward spiral for all European assets.

The Bottom Line

The Eurozone crisis involving Greece has persisted since 2008, but the ECB and Eurozone governments have continued to bail them out, maintaining the stability and credit worthiness of the euro currency at the expense of crushing austerity on the Greek people. With no other way out, Greek governments were forced to adopt austerity measures, all the while making things worse by quashing demand.

Recently the Greek people forced a new election, in which a pro-exit party might actually be elected. This would end austerity, but it may also spawn widespread financial disaster and perhaps even civil unrest.