Only Drachmaization can save Greece and euro

September 9, 2011

By Martin Hutchinson
The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

Regional comparisons suggest Greek living standards have risen far beyond productivity since it joined the European Union, making austerity inadequate to rebalance the economy. Drachmaization would allow market forces to set Greek wage levels, induce other indebted EU members to reform without EU prodding and thus solidify the euro.

Greece’s dramatic rise in living standards to a 2008 GDP per capita of $30,400, almost the EU average, was caused not by an exceptional surge in Greek productivity, but mostly by massive subsidization and borrowing. Greece’s continuing current account deficit, estimated by the Economist at 8.3 percent of GDP in 2011 in spite of deep recession, indicates that the country remains deeply uncompetitive. In comparison, Greece’s neighbors Bulgaria and Macedonia had 2008 GDP per capita of $14,000 and $10,700 respectively, yet it is now 20 years since communism fell and market forces are dominant in both economies. Another comparison is Portugal, which joined the EU shortly after Greece. Its GDP per capita is somewhat less inflated at $24,900.

This suggests that Greece may require living standards to decline perhaps 30-40 percent to become competitive. Such an adjustment is impossible through austerity alone; the unrest in Greece surrounding recent negotiations shows that further major austerity could produce a political backlash deeply damaging to Greece’s future. Thus, assuming further massive subsidization by EU taxpayers is politically unlikely, a Greek replacement of the euro by a new drachma becomes the only practical alternative.

This would be problematic but not impossible. The two most relevant precedents are: Argentina which in 2001-02 abandoned a 1-1 peso/dollar link; and the former Soviet and Yugoslav states which introduced new currencies.
In Argentina, the government first imposed a limitation of around $250 per week on cash withdrawals from banks. Peso convertibility was abandoned in January 2002 and an official exchange rate of 1.4 pesos per dollar was created, at which all dollar bank accounts were compulsorily converted into pesos. Since the free-market peso/dollar rate settled at around 4 pesos per dollar, most capital losses were borne by savers, not banks.

Logistically, security printing of drachma banknotes would not initially be necessary. When Slovenia introduced the tolar in October 1991 as Yugoslavia was breaking up, it operated for over a year with a paper currency without security printing. In Greece cash transactions could alternatively be made in euros, available from the banks at a free-market rate once bank accounts had been converted into drachmas.

The exchange would require some unpleasant temporary restrictions. As well as restricting cash withdrawals from banks, exchange controls would be needed short term and the Schengen rights of free movement between Greece and other EU countries might have to be temporarily suspended. With these restrictions, conversion should require a bank holiday no longer than the eight-day period imposed by the United States in 1933.

Economically, the drachma’s value would decline sharply, but the drop in living standards would be smaller — the Athens price of a Mercedes would jump, but those of haircuts and Moussaka would not rise immediately. The equilibrium drachma rate would make Greek workers internationally competitive, producing a decline in living standards probably between the 50 percent necessary to reach Bulgarian levels and the 18 percent needed to match Portugal, whose 2008 living standards were also over-inflated. Greece would quickly achieve a trade surplus, with ultra-cheap tourist offerings, and Greek unemployment would rapidly decline from its current level above 16 percent. A debt restructuring similar to Argentina’s would then be undertaken, reducing the debt’s present value by around the same percentage as the Greek reduction in living standards.

This would be painful, although the increased economic vibrancy and decline in unemployment would for most Greeks make it preferable to several years of outside-imposed austerity and political chaos. For the EU and the euro, it would be highly beneficial, eliminating most of the moral hazard currently inherent in the euro zone’s fiscal and monetary arrangements. The decline in Greek living standards imposed by drachmaization would strongly encourage the euro zone’s other economic weak sisters to impose the austerity and reforms needed to make their economies competitive. The euro would emerge stronger because Maastricht-type fiscal and economic discipline would appear to be the necessity of a cruel market, and not something bargained at an EU summit and chiseled through fudging figures. Finally, such an outcome would make central EU control of member state finances unnecessary as good behavior would result from self-discipline alone.


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not a one-off. sets a precedent for tossing other weak countries out of the common currency. probably means a big change in the way the e.u. thinks about itself. very reasonable in isolation but you can’t think about it that way.

Posted by bigturkey | Report as abusive

So, income per capita = living standards?

No. If you have an imbalance between the rich and your average worker, you’ve proven nothing by talking about per capita income.

Take the shipping industry. It’s 15-20% of GDP. It belongs to several families. Their income is totally untaxed, as are shipping profits. But they count for GDP. Skim that untaxed amount off the per capita #, and suddenly Greece’s current $26k per capita drops to below Portugal’s. Greece would be at $21k.

Posted by DanAllen | Report as abusive

Ahhh, and yet another easy “solution” to deal with damage caused by Greece’s criminal-level of overborrowing.

Like most of the “solutions” people who have money or wealth (the savers) will see it confiscated in one form or another be it by taxes, inflation, forced drachmatisation or some other sly mechanism.

Abuse the rich, abuse the savers, abuse productive citizens — and there will be no one left who will want to work, invest, take risk or save. And then everyone suffers.

Like the article implies, one poor Greek will then cut the hair of the other poor Greek who cooks his Moussaka. Greece will return to a quaint and cheap destinations for vacationers from northern Europe.

Posted by Anthonykovic | Report as abusive

Negitive on the Euro rise. T

Posted by Intriped | Report as abusive

The Euro dollar would crumble over night.

Posted by Intriped | Report as abusive

Seems to make sense. What is the probability of this being implemented anyway? How would the Europe banks do if Greece defaults this way, compared to Argentina experience?

Posted by Bensony | Report as abusive

This crisis bears similarities to the 1998 Asian financial crisis. The cause seems to some nations living beyond their means by taking on debt. In Europe now you have the PIIGS. In Asia in 1998, you have Malaysia, Thailand, Indonesia and South Korea among them. Hong Kong was having problems with its US$ peg, something like the current Euro trouble. Speculators were trying to bring down the HK$ just like speculators now are trying to bring down the Euro. In the end, Thailand, Indonesia and Korea had to opt for IMF aid while China saved the day for HK from currency speculators. Greece case now is somewhat similar to Malaysia. Like Greece, Malaysia had rampant corruption and a massive public sector. Malaysia’s case was mitigated in having a huge pension fund which managed to escape plundering by politicians. In the end, Malaysia turned down IMF aid, devalued its currency and slashed interest rates instead of raising them as told by IMF. Trying to avoid painful restructuring, it also opted for capital controls. It obtained some short-term relief. But without restructuring it resulted in a subsequent decade of economic stagnation. Today the country is still mired in the same problems it faced in 1998. Are there lessons for Greece?

Posted by Bensony | Report as abusive

This article is right and we need to get on with it. I would argue that Portugal, Ireland and probably Spain are in the same boat and also need to cut loose. I just wish that policy makers would get on with it – it is inevitable so the sooner the better.

Posted by pavlaki | Report as abusive

The problem lies in defining in what currency debts and loans are to be collected. New statutes/laws can force all transactions to be completed in the new currency if the two parties are subject to Greek jurisdiction. However where international companies/banks or residents outside Greece are involved, the loan agreement may be vague as to whether the loan is to be repaid in Euros or not. A huge surge in litigation will arise to sort this out. Your columnist is strangely silent to these practical problems!

Posted by robinson99 | Report as abusive

Austerity is a wonderful thing. It’s almost like magic, or God. It works because someone else is feeling deprived and humiliated. As soon as the Greeks have less, the rest of us will automatically feel better about ourselves. With that change, everything becomes fair. As for the wealthy of the world, if we are lucky, they will continue to manage our little pensions for the good of all.

Posted by Ralphooo | Report as abusive