(MoneyWatch) Although no one knows exactly what would happen if Greece were to repudiate its debts and leave the euro, the prospect is frightening. Here is an overview of why the ailing country might exit the currency union and how it might happen:
Why would Greece leave the euro?
Polls shows that the large majority of Greeks do not want to quit the euro and return to using the drachma as the nation's currency. Yet most people in Greece also seem to believe the country's economy will never recover if it sticks to EU mandates to cut government spending enough to repay its debts. The EU has said that Greece cannot abandon its debts and continue to use the euro as its currency. So if Greece cannot form a new government in the weeks ahead and next month elects political leaders determined to reject the current EU/IMF bailout plan, then the nation will have little choice but to start printing and using its own currency again.
Of course, not everyone believes the EU will force Greece into this position. The leaders of Syriza, the left-wing political party in Greece that recently finished second in Greece's May 6 general elections, think the EU is bluffing. This is why they have rejected any offer to form a government unless it preemptively rejects the bailout plan. They believe EU leaders won't risk this move because the impact would likely be to drive up interest rates for Portugal, Ireland, Spain, and Italy. One reason to think that might be true, at least for now --payment, despite the risk that it would renege on the agreement.
How would Greece leave the euro?
This is an even bigger unknown than the question of what would happen if Greece exited the eurozone. No nation has ever done it before, and the framers of the EU never considered it as a possibility. As a result, so there's no process in place to manage a country leaving the currency bloc. The easiest part would be re-instating border controls between the EU and Greece. People and goods going into or out of Greece would no longer have the automatic free entry they currently do.
The EU can't formally stop Greece from using the euro any more than it can tell shopkeepers to not accept payment in dollars or other currencies. What leaving the currency really means is that Athens won't have access to the European Central Bank as a source of funds. It will then have to issue its own money. It would also swap all the euros now held in Greek banks for the new drachma, which would be worth substantially less than the euro.
In order to protect their financial assets, Greeks and other people with financial assets in local banks would likely try to withdraw it before switching from euros to drachmas. When nations have re-denominated their currency in the past, they have generally closed the banks -- and the borders -- for a time immediately beforehand. This is supposed to stop bank runs and prevent money from being taken out of the country.
However, such a move in Greece would be the first time this has happened since the advent of electronic banking. That means people don't have to be physical present to stage a run on a bank or when moving money, and that makes stopping it a whole lot harder.