“Beware of Greeks Bearing Debt: Will Greece Go Off the Euro Standard?” – David Kessler


I am pleased to announce that Dave Kessler has agreed to join The Brooklyn Diplomat team. This operation is now a two-man wolfpack! Dave’s a fellow Loyola grad and loves reading and writing about global affairs. He’s taken a few more economics courses (ok, maybe a lot more) so he will be able to offer more geoeconomic analysis than I am comfortable dealing with. That hasn’t stopped us from having intellectually stimulating conversations on things like the eurozone crisis and the rise of China though. In his spare time, Dave loves thinking big thoughts with his Jesuit educated bretheren, and hitting the gym with some of them (me included). Welcome Dave! Now without further ado, David’s first piece!

Greece is the posterboy for the “European Sovereign Debt Crisis.”  In the media there is always talk of a new “Greek Bailout.”  Academics, officials, panelists and the average Joe all debate about where Greece went wrong and how it can fix itself.  The fiscal conservatives point to all that is wrong with “big government.”  The socialists blame the “draconian” austerity measures forced upon Greece and her people by foreign financiers.  Others point to pervasive corruption, Southern European culture, and further variables to attribute to Greece’s disastrous state of affairs.  Any and all of these things may be to blame, but perhaps Greece’s currency is the foremost problem causing such misery.

With one out of every four laborers out of work and youth unemployment at more than 60% this year, Greece’s situation (as well as Spain’s) has nearly reached Great Depression proportions. This is further disturbing when one considers that the entire economy of Greece has contracted from a high of $341.6 billion in 2008 to $289.6 billion for last year representing a GDP decline of roughly 15% in just four years. To exacerbate the financial troubles facing Greece, prices have risen steadily as the crisis has worsened! The trouble is that the most attractive method by which Greece can become competitive again is through consumer price deflation; this is due to the fact that as part of the Eurozone, Greece, although a soverign nation, cannot control the value of its own currency.  As for the Euro, it has fluctuated against the USD from   €1.6 : $1.0 to €1.2 : $1.0 from 2008 – 2013. Currently estimates stand at €1.3 : $1.0. Because the supply of Euros is controlled by an independent institution, the European Central Bank (ECB), Greece cannot engage in recession countermeasures such as “Quantitative Easing” (“QE) as is currently being mobilized in the US. QE is a tool whereby a central bank increases the money supply by purchasing securities.  Therefore, Greece has solely fiscal alternatives to control the collapse of its economy such as deficit spending (a method John Maynard Keynes suggested in his work, The General Theory of Employment, Interest and Money, to alleviate the Great Depression.)

Sadly, these options are also compromised due to the austerity measures placed upon Greece as a precondition for bailout loans.  These bailout packages have come with serious public spending reductions, including the slashing of 150,000 jobs from 2010 to 2013.  Thus, austerity creates more unemployment and reduces short-term growth potential. Moreover, the growth potential in many countries facing similar situations like Greece is challenged by the need to acquire capital in order to repay loans. As a result, instead of tax reduction, which aids growth, tax increases often occur during austerity in many debt-stricken countries.  Thus, countries such as Greece are forced into a corner where they can engage in neither monetary nor fiscal expansion to stimulate their economies.  But Greece’s situation is not news to historians. Although the “Greek Question” is unique in its specifics, it is strangely familiar to another such situation that occurred in 1920s Britain.

Following the First World War, the great nations of the world returned to the monetary system known as the “Gold Standard.”  For decades before World War I, the Gold Standard played its part as the rock upon which a nation’s currency could rest.  Due to the heavy debt burdens during the War, countries left the gold standard as they printed new money to pay for the war.  After the war, nations thought it best to return to the former gold standard.  With a percentage of a nation’s currency directly underwritten by an amount of gold, nations could trust in the sable value of each another’s currency.  An exchange rate would be determined for a specific currency to gold and an individual could go to a bank and exchange his/her currency for that amount of gold.  All currencies pegged to gold were considered “reserve currencies” as was gold itself.  In the 1920’s, this gold standard began to unravel.  One of the key reasons for this dramatic change was the reality that, because a specific percentage of a nation’s currency was underwritten by Gold, the amount of liquid money in an economy was restricted by how much gold was in circulation.  The positive end of that system was the low level of inflation experienced by a country on the gold standard, making a safe investment for other nations.  Conversely, the key negative end of this system was the inability for that currency to depreciate in times of recession.  This was due to the fact that the amount of money in a society was regulated by the supply of gold.  Moreover, domestic prices of goods and services are slow to adjust to an overvalued currency.  As a result, prices of export goods and services may be compromised due to a currency that is too expensive during times of economic recession.  This could, and did, lead to high levels of long-term unemployment for countries like Britain during the 1920’s (Pg. 218).  To counter the high price of the British Pound Sterling, the British authorities and Bank of England attempted to deflate prices within the economy. They achieved some success, albeit failing to bring prices to a competitive level (Pg. 220). (Liaquat Ahamed brilliantly describes the whole gold standard failure in his book Lords of Finance: The Bankers Who Broke The World.)

The straw that broke the camel’s back was the beginning of the US Stock Market Crash of 1929 that sent shockwaves across already weak world markets.  By 1931 Britain became one of the first major industrial powers to abandon (Pg. 479) the gold standard; following this Britain began to recover that same year. This was a result of a depreciation that followed their departure from the gold standard.  Once sterling was allowed to depreciate, it could compete with other competitive nations’ currencies as British goods became less expensive.  Thus, by departing from Gold, the British Pound Sterling was revalued in monetary markets while simultaneously giving the British government and the central bank more control over their money.  The Pound Sterling was no longer pegged to gold.  (Soon after Britain, almost every other nation left the gold standard and few have ever returned.)

The Nobel-Winning economist Milton Freidman once wrote,

“The argument for a flexible exchange rate is, strange to say, very nearly identical with the argument for daylight savings time. Isn’t it absurd to change the clock in summer when exactly the same result could be achieved by having each individual change his habits? All that is required is that everyone decide to come to his office an hour earlier, have lunch an hour earlier, etc. But obviously it is much simpler to change the clock that guides all than to have each individual separately change his pattern of reaction to the clock, even though all want to do so. The situation is exactly the same in the exchange market. It is far simpler to allow one price to change, namely, the price of foreign exchange, than to rely upon changes in the multitude of prices that together constitute the internal price structure.”  (Although today currencies fixed to precious metals such as gold are not common, there are many currencies that are pegged in much the same manner to other currencies such as the USD.)

Right now the Euro is a freely floating currency however its valuation represents the currencies of 17 states with total financial disunity.  Without a united fiscal policy, the Euro and its value simply cannot represent the individual needs of each economy.  The belief in establishing the single currency represents ideas that a European currency would work very similar to the US Dollar.  Let’s address this point further.  Though the US Dollar represents 50 individual states, the comparison stops there.  Firstly, if prices are too high in one state, one can much more easily move to another state because English is generally spoken throughout the country.  Secondly, the federal government provides financial unity that European Union lacks; If a certain state is in financial difficulty, the federal government can supply it with aid (the recent American Recovery and Reinvestment Act of 2009 is an example).  Finally, the most profound difference in the examples lies in the political structure of the Eurozone.  In the US, the federal government is incentivized to help states out because its representatives in key leadership positions (Congress/President) are elected by the whole population of the country.  In Europe, a German MP is not elected by Greek citizens; therefore to the German MP there may be much less incentive to approve an aid package to Greece.  Conversely, because Greece does not add to Germany’s economy, a German taxpayer should be skeptical about paying for a Greek bailout.

Due to these inhibitors, Greece is using a virtually fixed currency.  Greece must now seriously weigh its options in regards to the single European currency.  As observed, Greece can’t seem to stop the hemorrhaging of its economy despite its attempts at reform.  Both its monetary and its fiscal instruments are currently unavailable and it has very few options.  Its options are: A) wait until the depression passes and remain on the Euro or B) leave the single currency and risk the return to the Drachma.

This is no easy choice. The single currency has indeed brought some clear advantages, none the least of which is political unity with its Western and Northern European neighbors who now have a vested interest in its survival.  Furthermore several transaction costs of doing international business within the Eurozone have been completely eliminated due to a common currency, not to mention also the relative stability of possessing a hard currency (a currency that is accepted almost anywhere in the world).  Finally, there is now even hope that certain other notoriously recessed economies such as Spain are finally returning to growth in the near future.  For Greece however, there are signs that the worst has yet to come.  In May of this year, the Organization for Economic Cooperation and Development (OECD) forecast did not expect the economy to improve in Greece until 2014 at the earliest.  Furthermore, it stated that improvement would result, “…if export demand strengthens, competitiveness improves further and investment returns.”  All three of these factors are heavily influenced by the value of the Euro and can be undermined if the Euro appreciates before then.

What Greece needs now is a serious assessment of the risks and benefits of being on the “Euro Standard” and take it from there.  Perhaps, like Britain in 1931, Greece will leave the fixed currency model and adopt a currency that can represent only its economy. Britain did not join the Euro yet still reaps the benefits of being in the European Union, perhaps Greece could follow suit.


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