Exit of Greece from the euro is collective suicide

2012-01-08

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The voices calling for an exit of Greece from the euro are increasing exponentially. They see it as a panacea to the maladies of the country and the difficulties the eurozone is facing, allegedly because of Greece. Among them are key figures of the business/investor community such as George Soros, prolific economists such as Nobel Laureate, Paul Krugman, or the latest “pop-star” of the field Nouriel Roubini; and of course a diverse europhobic spectrum of Greek political powers that wish to reconstitute the national currency, the drachma, either because that is “patriotic”, or it is “social”. They tell us that exit from the euro and reconstitution of the drachma will repatriate monetary policy powers, thus allowing Greece to depreciate its currency in order to become much more “competitive”, thus inflating its way out of the crisis, so that the Greek people will have to “suffer less”. Such rhetoric is both theoretically and empirically completely detached from reality as it sees only one side of the much broader issue, namely that of Greek exports.

First of all the facts about previous depreciations of currency do not align with the argument about increased competitiveness. The currency history from 1980 to 2000, before Greece joined the euro, shows no correlation between depreciation and the so-called competitiveness. In 1980 the exchange rate in dollars was $1 = 42.46 drachmas, in 1987 $1 = 135,18 dr., in 2000 $1 = 308.93 dr. It is clear that the drachma was massively depreciated with respect to the dollar, meanwhile Greek exports roughly doubled over the same period, from $5.1 bn to $10.8 bn. [Data taken from express.gr]. This increase in exports is not analogous to the rate of depreciation, suggesting that other reasons led to the increase in exports such as the improvements in technology, the accumulation of more human capital, the accession to the European Economic Community (which later on became the European Union) in 1981 and many others. On the other hand the amount of exports more than doubled once the country entered the euro, even though the trade balance continued to remain negative because of further increased imports. The gist is that no correlation between depreciation and “competitiveness” exists, at least not in the case of Greece in its recent past.

Next one needs to consider the import side, in order to realize the real impact of an exit from the euro. According to data from the Bank of Greece the value of imports is 2.6 times more than the exports. In other words Greece imports much more than it exports. A massive depreciation of national currency, should the drachma be reconstituted, would imply that all those firms that rely on imported goods, will suffer greatly given that the price of imports will rise as much as the value of drachma falls. In practice this means that a big portion of the business community will have to go bankrupt, effectively wiping out half the foundations of the real economy. If more than half of the businesses are worse off, any argument in favor of “competitiveness” is nonsense – as for aggregate indices, such as GDP per capita etc. these tell us little and mislead a lot. The real goods and services will decrease considerably depriving the economy of much of its wealth and growth capacities.

The only way for Greece to become competitive is to eliminate all those bureaucratic barriers and perverse incentives that restrain investment. Exports are improved by real changes, in how the economy functions, not with nominal currency depreciations and inflation-led “growth”. Speaking of inflation, it is preposterous to say that an economy can escape from a crisis through inflation, since in the long run, that will eat in the profits of entrepreneurs, effectively making them less competitive, depriving them from the ability to employ people, leading to a suboptimal level for all. When real profit margins reduce, people lose their jobs.

Another issue that is being raised, is that all of the above can be tackled through the injection of low interest rate loans from private banks, who will only be subject to the Central Bank of Greece, in case the drachma is reconstituted. All the Central Bank will have to do is produce money out of thin air and give it to banks so that they can supply it to the economy. This argument is complete nonsense for three reasons (1) banks will still have the incentive to use that money in all sorts of activities that are not related to the real economy, (2) banks will never give out money at negative real interest rates (because of high inflation and the need for low interest rate loans) – if inflation is for example 3% and the nominal interest rate is 4%, then the real interest is 1%, similarly if inflation is 6% and the nominal interest rate is 1% then the real interest is -5% meaning that a bank gives out 100 to get back 95 – no bank will do that, (3) artificially low interest rates will distort the capital structure leading to large-scale malinvestments, which will in the long run damage the growth capacities of the economy, while leading to serious shocks.

Again one could argue that banks will be forced to do as the state commands, since the state will nationalize them. Assuming that the Greek state has the money to do that, which it does not, a simple question is enough to counter that argument: is there any serious investor out there that will trust banks who are owned by a bankrupt and unreliable state? None is the answer and I do not think I need to theorize on that. In addition that uncertainty will effectively avert any foreign direct investment, thus leading Greece to a de facto quarantine from the rest of the world for many years.

Lastly the supporters of the drachma make mention to Argentina and how the Latin American country managed to “successfully” escape from the fixed exchange rate with the dollar. The problem with that view is that the cases of Greece and Argentina are not directly comparable, as the latter was under the status of a fixed exchange rate, while the former is part of a currency union (the euro) which is profoundly different. In practical terms, the people in Argentina used the national currency as money, while its exchange rate vis a vis the dollar was held constant. In Greece, people do not use drachmas who have a constant exchange rate with euro. They have abolished drachmas and only use euro. In case the new devalued drachma is introduced, because of the negative expectations people will have towards it and the greater value they will show in “harder” currencies like the euro, a black market for currencies will definitely emerge. In short another adverse effect will result in the quest for “competitiveness” through currency depreciation.

Finally, if gaps in competitiveness could be covered by currency depreciations, then why not have a different currency for each region separately? For instance Mykonos, Santorini or Crete that attract millions of tourists every year thanks to their majestic beaches (among others) should have a different currency from the mountainous regions of Heperus, that are much less attractive to tourists. Wouldn’t that make sense to tackle the gap in “competitiveness”? I am not searching for an answer along these lines, I am just leading the currency depreciation argument to its logical conclusion, to destroy it.

Based on all of the above, I say that an exit from the euro is disastrous for the economy of Greece. I could have also added the fact that the euro-denominated debts, would skyrocket in case of a currency depreciation, thus making the bankruptcy even worse, while also referring to the externalities that such a euro exit would create on the rest of the euro area, which will again harm Greece. Instead I preferred to focus on the internal aspect of the matter, with emphasis on the fallacy about “competitiveness”. The purpose here was not to argue against the intentions or motives of each supporter of a Greek euro exit, but to demonstrate how such a move would be tantamount to collective suicide, causing much more harm than good. The pro-drachma rhetoric is completely detached from reality as it is founded on a series of false assumptions and ill advised theories. Greece has to be part of the euro, for as long as it exists, either we like it or not. Search for solutions elsewhere as currencies have none.