Greece default: Euro goes up or down?

Economics Economics Questions
1

If the Greece government defaults on its debts, should the Euro go up or down in value (relative to most goods)?

I would guess that:

  1. Destruction of bond obligations won’t result in a direct change in the money supply. I don’t see how fractional reserve banking changes this, assuming that money isn’t pyramided on bonds.

  2. If the Greek government defaults, it will no longer be redeeming its maturing bonds. Hence, its demand for Euros will decrease.

  3. Holders of the now worthless bonds will have an opposite and roughly equal increase in demand for Euros. (It’s hard for me to understand a big difference in marginal demand between the bond issuer and bondholder.) This increase in demand cancels effect #2, leaving the overall demand roughly unchanged.

  4. After a default, there will be a reduced risk of inflation (helpful to the Euro) .

So the overall result is a rather tenuous up. Can anyone shed better light on this?

Edit: fixed some errors

2

Up or down in value in terms of what? Versus the dollar? Versus gold? Etc..?

3

Up or down in value in terms of what? Versus the dollar? Versus gold? Etc..?

Yes. A government default is related closely to the currency involved. I would expect US$/Euro, Gold/Euro, and cheeseburger/Euro ratios to change in a similar way, although the latter would take a long time to catch up since cheeseburgers aren’t traded internationally. I guess my question isn’t completely scientific but involves entrepeneurial speculation. The market could do something quite different from what’s rationally expected.

4

It is. The ECB accepts Greek junk bonds as securities for loans.

As of right now, the crisis of Greek sovereign bonds is also undermining the credibility of Greek banks. Savers are pulling money out of Greek banks, probably due to fear of bank failures. See this Reuters article:

Data also showed Greek bank deposits had fallen 8.4 billion euros, or 3.6 percent of the total, since December.

If Greece indeed defaults, we can assume that this trend will accelerate and a number of banks will go down. There is no European FDIC and a bankrupt Greek government will lack the means to save those banks. In a fractional reserve system, bank failures equal a contraction of the money supply. Not to mention that failing Greek banks might start a domino effect of bank failures, especially in the weaker parts of the EU.

If Greece is allowed to fail and no third power intervenes, we might see a series of bank runs that will lead to a massive contraction of the money supply that will, in turn, induce an economic contraction.

In terms of money chasing goods, this might lead to a temporary upswing for the Euro. But since it would send Europe into a deep depression, speculators may feel pressured to shed their Euro reserves anyway.