The Great Debate UK
When the Greek crisis began, there was much talk of contagion as the greatest short-term risk. In my view, this worry is almost irrelevant because bondholders are in any case facing a haircut of over 70%, so the question of default or bailout is now merely a technical detail.
From a longer term perspective, there is also little reason for the Germans to panic over a Greek default, even if it ultimately leads to the disintegration of the euro zone. The line peddled by a number of commentators and politicians that Germany has “done very well out of the euro zone” begs the question of how well it would have done without the euro zone, a question to which I do not know the answer – but nor does anyone else.
The implicit or explicit claim is that, with floating exchange rates, German trade would have suffered as the DM appreciated against the currencies of its neighbours. This is nonsense, a case of how, in the world of popular economics – what one colleague famously called D-I-Y economics – exchange rates occupy a position of exaggerated importance (If those who study the subject were given the same importance, I’d have had a peerage by now).
If exchange rate appreciation were so damaging and depreciation so beneficial to a country’s trade, the Swiss would by now be the poorest country in Europe and the Italians the richest. The reality is that, while there may be short term dislocations, the effect of changes in the value of a currency are ephemeral. Devaluations are self-defeating because they push up costs until the country’s terms of trade are back where they started, and the opposite for appreciations: a rise in the value of a country’s currency makes its imports cheaper, reducing its inflation rate and restoring its competitiveness as time passes. The process of adjustment seems to take some six or seven years, which might seem a window of opportunity worth seizing for opportunistic devaluation. The fly in the ointment, however, is that the more rapidly a currency depreciates, the more agents in the economy wise up and start anticipating the next depreciation, speeding up the adjustment and thereby narrowing the window of opportunity for exporters.
Whenever I see photos of Chancellor Merkel these days, I’m reminded of the lugubrious features of the creature in the Restaurant at the End of the World, as it recommended to guests which part of its own anatomy they should eat. The details of the “Deal to Save the Euro” are still mysterious and have been given a misleading spin in the official releases, but one or two points seem clear.
First, the package is a compromise – a little bit of default (as required by a reality check) plus assistance to Greece which looks very generous but is still not enough to give it a realistic chance of paying its remaining debts. So the can has been kicked further down the same road yet again.
-Jane Foley is research director at Forex.com. The opinions expressed are her own.-
Perhaps the oddest side-effect of the Greece debt crisis has been its ability to drag Japan’s budget into the spotlight.