Only Drachmaization can save Greece and euro
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.