By Detlev Schlichter On June 23, 2011
The New Drachma? (photo by Swiss Banker)Fallacies and Misconceptions about the Greek Crisis
One frequently gets the impression from reading the mainstream media that Greece has a monetary policy problem and not a fiscal problem. This is incorrect. Yet many commentators seem to argue along the following lines: This crisis is due to the straitjacket of the single currency with its one-size-fits-all monetary policy, or at least aggravated by the constraints of this system. Greece would have more “policy options” in dealing with its troubles if it had control of its own national currency.
Then there is, connected to this, an underlying – and not very flattering – notion that the Greeks are somewhat unfit to live and work in a ‘hard money system’, which presumably the euro is. The Greeks, this seems to be the allegation, like borrowing and spending too much. I am paraphrasing here but this is certainly the underlying tone of the narrative. The Germans and Dutch and French can live without the constant aid of conveniently cheap national money – but the Greeks can’t.
This is nonsense, and dangerous nonsense at that. Let’s first look at what Greece’s alleged “options” would look like if the country suddenly had the drachma back. The idea in the mainstream media seems to be that they could have lower rates and an even easier monetary policy than they have today under the ECB, and that such a policy would be suitable to the country as a whole. We have to remember that the ECB is already running an ultra-expansionary monetary policy, that the ECB is already the single biggest owner of Greek government debt, and that the ECB is very generously funding all euro banks (including the Greek banks) under lending programs that allow a lot of toxic waste to be used as collateral. But, I guess, a newly independent drachma-central bank could print even more money, hand that money to the Greek banks and the Greek government to allow them to stagger on, and then have a go at – what’s that pernicious phrase, again? – “inflating the debt away”. Well, good luck – we will debunk this shortly.
But there is another, slightly more sophisticated sounding argument out there. According to this ingenious interpretation, the Greek government is insolvent not because it habitually spends more than it takes in but because the Greek economy is not growing fast enough. If only the Greeks were more competitive and could sell more stuff abroad, then their government could happily continue spending! So again, the problem is with the inappropriately “hard money” of the Eurozone when what is needed is “soft money” — a super-easy monetary framework, in which the currency can be debased and international competitiveness and government solvency be restored with cheap money and low rates.
Photo by M. BartoschLuckily, I have never needed the help of any of those debt advisory services for consumers who face personal bankruptcy, so I am not speaking from experience here. Yet, I very much doubt that the first advice these services give to individuals at risk of getting crushed under mountains of credit card debt, is that they should get better jobs so their income rises. Yet, this seems to be the standard advice from mainstream economists for governments. Governments are expected to manipulate the economy via their paper money monopolies in order to generate the economic growth they need in order to sustain their lavish spending. Economic reality has to be made to perform to the demands of state largesse.
Also, I wonder, if soft money is such a great idea, why should we confine it to Greece? Should we then not all ask our central banks to run an even easier policy to “stimulate” growth? Well, most central banks are already trying this without much success. Could it be that there is something fundamentally wrong with fighting a crisis that is the result of too much debt and cheap credit with yet more debt and even cheaper credit?
I am not quite sure what is scarier, the present crisis or the fact that such economic nonsense is widely considered accepted wisdom.
A soft drachma would be of no benefit
But back to Greece. First of all, it should be clear, that a reintroduction of national paper money in Greece and the subsequent debasement of this money would not prevent bankruptcy. It would accelerate it, as the original debt was contracted in euros, and any attempt to repay it in debased “new drachmas” would constitute a default. (Of course, the Eurocracy may try and label it “restructuring” or “re-profiling”, but the rest of us have to live in the real world.) And even if repayment in new and debased drachmas was finally agreed, it would still constitute a massive loss to euro-area lenders such as the reckless German and French banks that foolishly lent to Greek politicians with blissful abandon and that are really the designated beneficiaries of the bailouts. They might as well write-off the Greek euro debt now.
Reality is not optional. The Greek government is bust, which means it cannot and will not repay its debt in anything of material value. Introducing a soft drachma doesn’t change anything.
However, many commentators suggest that even after default and substantial write-downs at the banks and pension funds, Greece should still leave the euro. Why? First of all, there is no need for an exit. The euro is a form of paper money, and paper money is not debt. The euro, just like the dollar, pound and yen, is an irredeemable piece of paper. The governments that issue it promise to exchange these notes for – nothing! The creditworthiness of these states is immaterial. The Eurozone is a currency union, not a credit union or fiscal union. I explained this here.
But I suppose the argument for post-default exit is essentially the one I cited above, namely that a soft national currency is more in character with the Greek’s alleged tendency to financial extravagance. Even if we accepted the distasteful national stereotype behind this, this argument would still be nonsense.
Debasing the currency can never be in the interest of Greek society – or any other society for that matter. Of course, weakening the exchange value of the new drachma would be a temporary shot in the arm to the export industry. As Jamie Whyte explained so lucidly here, and using the UK to illustrate the point, a weak currency is a subsidy to exporters funded by a tax on importers. Debasing the currency never furthers overall prosperity. In terms of access to internationally traded goods and services, the Greek population would get instantly poorer.
Additionally, easy money is a subsidy to the banks and the borrowers, and a de-facto tax on savers, who – contrary to the caricature in the media- do in fact exist in Greece. The recommended soft money policy for Greece would mean that savers lose purchasing power via a combination of artificially low interest rates, international currency depreciation, and rising domestic inflation. But sadly, savers do not count for much in today’s macro-economic debates, which are all geared toward borrowers and dominated by Keynesian ideas of boosting the growth statistics and generating artificial “aggregate demand”. Such a policy bias has far-reaching and long-lasting consequences. Saving and the accumulation of real capital are the backbone of any economy and the only method we have for increasing productivity and thus generating lasting prosperity. It is the savers who put the capital into capitalism.
Currency debasement is never in the national interest
Savers are presently taking their money out of the Greek banks and the Greek economy and, together with the productive elements of society in Portugal and Spain, put their money into real assets overseas (such as property here in London), thus making a mockery of the notion that the adoption of soft national paper monies would be in the national interest. In fact, as the Financial Times reported yesterday, many Greek savers are currently rushing into the eternal form of money, gold, the sale of which is rising sharply in Greece. These people choose the hardest form of money for their savings. They fear bank runs and financial collapse but also exit from the euro and subsequent currency debasement as all of these are damaging to their wealth. They are certainly part of the nation but debasement is certainly not in their interest.
National Bank of Greece in Athens (Photo by Michalis Famelis)And there is a further problem. Even for the supposed beneficiaries of these policy recommendations – the local export industry, the borrowers, the government and the moochers and freeloaders who cling onto the state like a nasty skin rash– the benefits would be fleeting. They would only last a second or two, then the benefits of currency debasement would turn into disadvantages – and disadvantages for everybody. Savers and creditors, whether domestic or foreign, would demand higher yields for keeping their money in the country or putting new money into it. Gains in the exporting industries would not only be offset by losses in the importing industries but the overall wealth would diminish through higher inflation and reduced capital accumulation. No society has ever enhanced lasting prosperity through a weak currency.
The notion that a debt problem can be solved or alleviated via inflation is a misconception. The cost is only socialized and spread across all holders of the domestic paper money. This policy is not only immoral as it burdens innocent bystanders – people who never contracted for that debt as I explained here – it is also ineffective. The holders of domestic bank deposits and domestic bonds are not simply going to sit tight and let their wealth evaporate. They either get out or demand a risk premium for staying in.
The idea that states that owe money in their own paper currency cannot default is wrong. Once the markets sense that the government or its central bank tries to “inflate the debt away”, the currency and the domestic debt get sold and real interest rates shoot up. This quickly worsens the debt dynamics for domestic borrowers, most importantly the government itself. In the end you get both, hyperinflation and sovereign default, as has happened numerous times before.
The problem is not that the euro was too much of a straitjacket for Greece but that it was too little of a straitjacket. The lenders to Greece probably knew very well that the Greek government was overspending but still funded it generously. Consciously or subconsciously, they must have thought that the euro-area is still a paper money arrangement, and therefore they never expected that the question of sovereign solvency would even arise. They were wrong. They should now take the losses.
The widespread idea that diverse countries cannot share the same currency is evidently wrong. They have done so in a stable and mutually beneficial way under the international gold standard. A proper commodity money system is, of course, a straitjacket for states and banks. As the present crisis shows, such a straitjacket is urgently needed. The excesses of ever-expanding paper money, which the world suffers from today – unsustainable debt levels, weak banks, and distorted asset markets –, are inconceivable under a real gold standard.
Greece is not the only country that will default. It is simply the first. Portugal, Spain and Italy will follow in due course. By then the ECB will have printed trillions of new euros to keep German, French and other banks in business. If the Greeks really wanted a weak currency, they should stay in the euro. The euro – like the dollar, pound and yen – is already on a slippery slope of irreversible decline.
A gold standard for Greece?
But the Greeks are now the first to take the pain. They are the first to hit rock bottom, so they should be the first to be able to rethink the situation and look at other options. As soft money is not in the interest of any society, why not be the first to go for hard money? Money that is harder and more trustworthy than any politicized national fiat money which the authorities can print without limit? Greece should allow the full and painful liquidation of the paper money excesses, it should let the government default, exit the euro and be the first to reintroduce a proper gold standard. This would give the country instantly much needed credibility. It would not only keep Greek savings in the country, it would attract savings from around the world, potentially making the country a magnet for savers everywhere who are increasingly concerned about aggressive monetary policy and are desperately looking for safe places to park their cash.
I have no doubt that the most important economic event of the coming decade will be the demise of the global paper money system. We live in the twilight of the fiat money era. A return to apolitical, international, commodity-based media of exchange is inevitable. Why not start with Greece? The transition would be painful but there are no painless options available anyway.
I am convinced this would be a sensible strategy but I also think it is unlikely. The state and the banks benefitted from the paper money franchise, and they are now addicted to cheap credit and unwillingly to check into rehab. The establishment will continue to fight a return to sound money.
In the meantime, the debasement of paper money continues.