Units and unities: can currency change really resolve the Greek tragedy?

June 22, 2011

As the Greek tragedy goes into what looks like its final act, there is increasing talk of the country leaving the euro zone and refloating the drachma. Perhaps the Athens street mobs favour this “solution”, but what would it involve, and would it work?

It is a bizarre situation, without precedent as far as I am aware (though I am no economic historian). Usually, new currencies are introduced to replace old ones which have become discredited (typically after hyperinflation), whereas here we are talking about the absolute opposite: abandoning the euro because it is too strong, in favour of a new drachma, which will be a weak currency by design – rather like launching a ship, in the hope it will sink!

Equally bizarre is the fact that many people seem to think this course of action will somehow be less painful for ordinary Greeks than the austerity measures being demanded by the IMF, EU and ECB. But just consider what is involved.

The immediate problem would be the changeover mechanism. New currency launches take time, normally many months or even years, so even if this reversion to the drachma can be rushed through at Olympic speed, we must surely be thinking of January 2012 at the very earliest. But what happens in the interim? The situation could be completely unmanageable.

In the first place, Greek savers are not going to wait around while their cash, bank deposits and other assets are forcibly converted into drachma (and their banks go bust too). Instead, they are going to do everything in their power to put them beyond the reach of the Greek monetary authorities, which may simply be a matter of moving their accounts to foreign banks, if they haven’t already done so, or possibly something more sophisticated or devious. (In any case, you can be sure middle-class Greeks will already have had years of practice at hiding funds from the taxman).

In fact, since, legally or illegally, euros will continue to circulate long after a new currency is launched, the only feasible way to refloat the drachma is in a dual-currency regime in which, at least initially, drachma are only used for transactions involving the government and nationalised industries. So, for example, civil service salaries and welfare payments could be paid in drachma, which would then be accepted by the government-owned utilities, and presumably by banks, which would have to be nationalised, de facto if not de jure. The private sector would then use drachma alongside euros, which would for the foreseeable future remain the currency of choice for all their big-ticket transactions.

Post-hyperinflation experience in Latin America, Israel and Eastern Europe suggests that this sort of dual-currency scenario can be as stable and durable as any other type of regime in the unstable world of international monetary arrangements.

However, refloating the drachma will make it more or less impossible to repay any of Greece’s euro-denominated debts, so we have to assume it takes place against the background of a messy, acrimonious default, imposing a haircut on bondholders so great that it will leave Greece frozen out of the credit markets for the foreseeable future  – and maybe facing reprisals from its lenders, in the form of asset seizures and legal action dragging out for years to come.

In the meantime, millions of ordinary Greeks find themselves paid in heavily-devalued (and probably highly volatile) drachma, reducing their purchasing power by (I guess) thirty or forty percent. So, for example, the fact that the electricity company will accept drachmas will be little comfort, because, unless the government follows a suicidal policy of subsidising energy prices, the cost of electricity will have risen more or less in proportion to the devaluation – its real cost cannot be reduced simply by currency manipulation – and the same applies to all other imported goods. Whether the local car dealer is posting prices in euros or drachma will make no difference, because the cost in terms of hours of work will have risen by the same percentage.

The hope will be that, with the passage of time, Greek industry will take advantage of its new competitiveness to increase its output of exportables and import substitutes. It will prove to be a forlorn hope, however, if the country remains hobbled by a network of restrictive regulations intended precisely to prevent competitive forces from operating properly. The experience of countries like India, China and Israel is a testimony to how the dead hand of socialist intervention can squeeze the life out of even the most entrepreneurial people, but also to how quickly they can revive once the economy is at last set free. In fact, I would bet on Greece being the miracle economy of the coming decade, if only it jettisons the nationalist and protectionist policies it has pursued over the last half century.

In summary, a go-it-alone strategy can certainly succeed, but only if most of the Greek workforce (especially its civil servants) accept a drastic cut in their real standard of living, government spending is slashed, the nationalised industries are privatised and the economy is deregulated.

Of course, these are exactly the things the troika is demanding in return for a bailout – which is exactly why I am so puzzled by the enthusiasm of some Greeks for quitting the euro.

The only way refloating the drachma could be advantageous for Greece would be as part of a deal with their lenders. If, instead of flouncing out of the euro zone, they are able to extract a generous parting gift as part of a multilateral agreement, then they may be able to mitigate some of the pain over the succeeding decade.

If this sounds improbable, remember that the Greeks actually hold most of the aces in this poker game, though so far they have lacked the necessary sangfroid or maybe the sheer brass-necked chutzpah to play their winning hand to a conclusion. The reality is that, if Mr Papandreou or any successor could command a secure majority at home, he would instantly become the most powerful Greek since Alexander the Great. I say this because it is now clear that both Europe and the US are so desperate that they are willing to pay almost any price to resolve the crisis. Perhaps a better comparison is with Samson threatening to bring the house down over all our heads, because the fear is that a disorderly default would be take us all right back to where we were when Lehman was allowed to fail – and this time around, with a world economy which is in a far more delicate state than it was in 2008.

You may be wondering why, if everyone is so desperate for a deal, it hasn’t been done long ago. There are, I think, two reasons. First, the situation is hideously complex, involving a tangle of issues like contagion, national sovereignty, bank solvency in both lender and borrower countries, and so forth, which mean that each country’s economists are constantly running back to their computers to update their guesstimates of how much the latest proposals will cost its own banks and/or taxpayers.

What is often forgotten in the heated atmosphere of arguments about bailouts and types of default is that at the heart of the problem stand the ordinary voters of the countries concerned, because at its simplest it is a question of how much (relatively) thrifty North European taxpayers are willing to donate to bail out the profligate consumers of South Europe. From this point of view, it is no good the Greek crowds railing against the acronyms – the IMF, the ECB and the EU are simply agents of the taxpayers who fund them. It is the taxpayers who set the limits within which the international and national lenders can wheel and deal. And where the international banks are concerned, far from being mean to Greece, they have been far too generous for far too long. In any case, since they are themselves actual or potential welfare clients of their national governments, they have no choice but to do the bidding of their paymasters, the taxpayers of Germany, Netherlands, Finland etc.

The politicians, bankers and economists running around like headless chickens in Brussels and Frankfurt are faced with the problem that, however desirable a deal may be, they dare not agree to anything they cannot sell to their voters, who cannot be expected to understand the intricacies of the situation or why the moneymen are so desperate to avoid a default, but suspect they are about to be fleeced yet again. (Of course, it does not help in this regard that, after the experience of the last few years, the public understandably has little faith in either the competence or the integrity of the international bankers who are playing the Cassandra role).

If only this drama would obey the rules, the three unities, set out by Aristotle for classical Greek tragedy: no more than a single plot unfolding at any one time, all the action in one place – and, best of all, lasting no more than 24 hours (remember, in those days the audience were sitting on stone seats…)

Comments

A problem exists with loans and liabilities to banks. Presumably an act of parliament has to state that these will be owed in the new currency. Nationalised domestic banks can be forced to accept this devaluation of their advance. However it might precipitate the bank’s insolvency. However foreign banks might demand the loans are repaid in Euros. A lot will depend on the Loan Agreement small print. It will be a nightmare for people with secondary homes in Greece mortgaged abroad in Euros. There will be court cases all over Europe to unravel the position involving both Greek and foreign law as well as involving Common Market Human Rights legislation. Greece might even have to leave the Common Market to escape these treaty obligations.

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