Thursday 16 February 2012

Greece - a welcome back for the Drachma?

Greece is once again on the brink.  The latest tranche of bailout money - €130bn - from the EU and the IMF needs to be transferred shortly.  Greece has to repay loan repayments to private lenders of €14.4bn on 20 March.  Without the new bailout money Greece will not be able to pay this money.   This has in time honoured fashion led to a stand-off between Greece and the EU/IMF.  The latter do not want to lend this money without cast-iron guarantees from the Greek government that it will this time around actually deliver on the austerity and reforms which they have signed up to.  The Greeks naturally are not too keen on ever more austerity and suffering.  While it is tempting to reduce this to a morality play with goodies and baddies, the reality is a bit more complex.  I have previously posted about Greece’s woes, here, and the situation has not changed much.
The kernel of the situation remains the same.  Greece needs to get rid of its debt.  A haircut will no longer do.  If a voluntary agreement cannot be reached to write off all of Greece’s debt, the country will almost certainly have to default.  It is probably just a matter of when.  This is when things become really interesting.  For Greece will then face a choice of whether to remain within the Eurozone or whether to exit the euro and re-introduce the Drachma.  Lots of commentators, particularly those of a eurosceptic persuasion hope that Greece exits the euro.  Not doubt as a precursor to the collapse of the whole Eurozone.  I will leave this speculation to others.  What interests me just now is how certain is it that exiting the euro would be of much help to Greece and its long suffering citizens.
Before that a brief word on the implications of a forced default by Greece.  This would likely be catastrophic for Greeks, individuals and companies.  By defaulting Greece would be unable to borrow any more money.  To regain access to borrowing the conditions would be likely to be even more severe than those on offer at present.  Short of any new money, the Greek government would have to balance its books immediately.  Which could lead to even greater redundancies than planned.  Default is an extreme measure and not to be undertaken lightly.  All of this is to emphasize that Greece is in an incredibly difficult situation from which there is no easy or painless way out.
Exiting the euro and re-instating the drachma is of course equivalent to a devaluation.  In the case of Greece this is likely to be a substantial devaluation.  And in the past, devaluations have worked for some countries.  The example most frequently presented is Argentina which defaulted in the early 2000s, left the dollar peg and re-instated the peso as its own currency.  And relatively quickly recovered economically to become once again a relatively successful and prosperous country.  However there are two key differences between Argentina in 2001 and Greece in 2012.  The first is that Argentina had and has enormous natural resources, which the rest of the world wanted.  Secondly the rest of the world, and in particular, Argentina’s key export markets were booming in the early 2000s.  Neither is alas true for Greece now.  Greece has no great natural resources and worst of all, most of the rest of the world is either in recession or suffering very, very weak growth.   So, even with a large devaluation there is little prospect of a significant improvement in exports.  As Ricardo Hausmann in an article for the FT puts it: “Here’s the bad news for Greece: in our sample of 128 countries, it had the biggest gap between its current recorded level of income and the knowledge content of its exports. Greece owes its income to borrowed foreign spending it cannot pay back. It produces no machines, no electronics and no chemicals. Of every 10 US dollars of worldwide trade in information technology, it accounts for one cent.”  There is only so much that an increase in the numbers of tourists can contribute to reviving the Greek economy.  So it would seem that the key advantage of a devaluation - a sharp increase in export income - may not be easy for Greece to achieve.
The downside to a devaluation is of course that it makes imports a lot more expensive.  Depending on how much the new drachma is worth, imports are likely to cost Greece anything between three and four times more than now.  And here is the biggy.  At present, Greece imports around three times as much as she gains from her exports.  Now with a devaluation some of this will change.  Greece will export more and import less.  But without its own industrial or energy base, Greece will have to spend more and more of its new drachma on imported manufactured goods and on oil and gas.  Without a good and reliable transport system for example there is little prospect of increasing the number of tourists nor of increasing exports.  And transport will largely depend on imports.
The upshot of all this is that a devaluation in current circumstances will make most Greeks poorer.  More of them may be in work, which will be a good thing, but their earnings will be in drachma and these drachma will buy them very little in the way of imported goods.  Just about everything will become much more expensive.  But then things are very, very bad just now and will only get worse whatever happens.  This post is not an argument for or against devaluation for Greece.  This is a matter for Greeks.  I just want to emphasize that it is not a pain free choice.  Greeks face a most unenviable series of choices and whatever they decide or is decided for them, the short and medium term future does not look good.  As the old Irish saying has it, I wouldn’t start from here.

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