Euro Leaders Consider Ejecting Greece From Euro

European leaders have for the first time raised the prospect of ejecting Greece from the euro zone, forcing Greece to decide whether it’s in or out when it holds a referendum on a bailout package next month.

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The single-currency union yesterday cut off financial aid for Greece until an early December vote determines whether Greeks will accept austerity measures required by Greece’s troika of lenders — the European Union, European Central Bank, and International Monetary Fund — if it is to receive a second bailout package.

“The referendum will revolve around nothing less than the question: does Greece want to stay in the euro, yes or no?” said German Chancellor Angela Merkel to reporters in Cannes yesterday following crisis talks. French President Nicolas Sarkozy said Prime Minister George Papandreou’s government won’t receive a “single cent” of assistance if voters reject the plan.

Papandreou’s decision to put the matter to a public vote immediately preceded a G-20 summit where euro-zone leaders intended to showcase their revamped crisis-fighting strategy, hashed out last week after all-night talks in Brussels. The plan would include a 50% writedown on Greek debt.

Instead, Merkel and Sarkozy are meeting again today in Cannes with leaders of Italy and Spain and other European Union officials to work out how to prevent Greece’s referendum call from reverberating across the region. The October 27 package was not just meant to to aid Greece, but prevent the government from going into default and contaminating other at-risk economies, namely Italy.

As part of last week’s talks, euro leaders also agreed to increase the now 440 billion-euro European Financial Stability Facility to 1 trillion euros and told banks to raise 106 billion euros by the end of June in order to fortify their capital. Meanwhile, after pushing through deeply unpopular austerity measures that led to strikes, protests, and rioting, Papandreou sought to squelch criticism of the deal by announcing on October 31 that he would put the decision to voters.

The referendum is set for December 4 or 5, and until that time, an already delayed aid installment of 8 billion euros will remain on hold, said Merkel and Sarkozy. Polls show that most Greeks object to the austerity measures required for aid, but more than seven in 10 favor remaining in the euro, something Merkel and Sarkozy have said will only happen if they accept the terms of their bailout, as is.

EU treaties make no provision for how a country is to exit, or be ejected, from the currency. In December 2009, the European Central Bank said an expulsion “would be so challenging, conceptually, legally, and practically, that its likelihood is close to zero.”

Though leaving the euro would allow Greece to regain control over its own exchange and interest rates, its new currency would probably drop 60%, according to economists at UBS AG, and local borrowing costs would rise at least 7%. The cost could be as much as 11,500 euros a person in the first year outside the euro, and 4,000 euros a person each year thereafter.

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“We would like Greece to remain a member but we’re not saying Greece has to stay a member at all costs,” said Luxembourg Prime Minister Jean-Claude Juncker, who chairs meetings of euro finance ministers.