Welcome to European Tribune. It's gone a bit quiet around here these days, but it's still going.
The ECB managed to coerce Ireland into not defaulting on a much more obviously unfair debt, even after the newly elected government promised otherwise.

Actually, the jury was still out on that last time I checked. Now, admittedly that was shortly before the latest Irish bank audits so my information may not be up to date here.

Obviously it has some leverage on peripheral EU governments and economies. What is the nature of this blackmail and how can it be overcome?

We do not quite know at this point. Mig has floated the possibility that the ECB has threatened to withdraw liquidity from the Irish banking system. Another possibility is that it is simply the weight of Seriousness and appeal to the putative authority of the ECB's "experts."

But note that Ireland is not Greece. The Irish have a long-term interest in remaining within the Eurozone under the present rules, because Ireland has an intra-Eurozone trade surplus. Greece has no economic interest in remaining in the Euro unless the rules are changed in a way that treats positive and negative intra-Eurozone current account positions in a balanced manner. So exclusion from the Eurozone - either de jure or de facto - is a credible threat to Ireland's livelihood in a way it is not to Greece's.

Given that the circulation (legal or not) of two currencies: the new currency - let's call it the Drachma - and the Euro is certain, won't this create a "black market" currency rate, as in the former USSR, that will undermine the drachma


That's a feature, not a bug. You'll convert your liabilities into Drachma when you switch, so the people holding Greek debt will get to take haircuts in direct proportion to the lack of confidence in the Greek recovery. This is the whole point of the exercise.

Hyperinflation threats: "Jake is underestimating the degree to which the Greek economy is dependent on imports" - that would include fossil fuels and basic foodstuffs, especially since it would make business sense for producers to export food at international market rates. That would mean that food would still be traded abroad in Euros and barring a government forced requisition, their prices would skyrocket in drachmas...

Greece is a net exporter of food.

Fuel would be a serious problem.

Almost everything else is stuff you won't be able to afford anyway if present economic trends continue.

And this wouldn't just affect oil and food, but basic capital goods, especially machinery of all sorts etc. Greece was driven to become a service economy over the past 20 years and that means it doesn't have the (short-term at least) ability to support its basic economic and vital needs.

That is not the question. The question is whether essential imports exceed total exports. If they do, you need to revise your definition of "essential." If they still do after the revision, then you're fucked. If they don't, then sufficiently harsh capital controls will enable you to pull through.

[If someone who can read Greek could dig up some import and export data, it would help to qualify this discussion.]

The Greek people may decide, in the end, that it does not believe that it can muster the necessary political strength to see the proposed strategy through. The Greek people may also decide that the objective economic conditions make the risks of leaving the Euro large enough that austerity is preferable. That is, ultimately, a political decision, and as a foreigner I have very little standing in that discussion (both because I lack sufficient depth of knowledge about the subjective conditions in Greece and because it is not my livelihood that is being decided upon).

My agenda here is to make it clear that there is an alternative, and that Greece has no duty to refrain from that alternative out of loyalty to a European Union that appears to be run of, by and for Bild Zeitung and Deutche Bank.

The government and people of Greece may decide to decline that alternative. And while I might personally have decided differently in their position, it is their prerogative to make that decision. I only ask that the decision is made with full knowledge that there are alternatives to AusterityTM.

Even if feasible in principle: Does Greece (or other EU countries I should add) have a political personnel capable to organize the subtle and difficult political maneuvers required to fight off ECB blackmail and find solutions for the host of problems such a bold move would entail?

Presumably not at present. But such political organisation and determination will not appear unless somebody pushes the idea into public discourse. The political will and organisation needed may not appear even if the idea is pushed forcefully in public discourse, but if it is not pushed then they certainly will not.

Isn't it impossible in practice to default and leave the eurozone while staying in the EU at the same time?

Hard to tell ahead of time. It would provoke a constitutional crisis, which means that we're in uncharted waters here. My belief is that the powers that be would want to contain the damage to the Union. But that is, at the end of the day, tea-leaf reading.

Wouldn't this sort of blackmail incur the wrath of the powers that be in the EU so that there would be a backlash in terms, say, of EU funds being withheld and general economic sabotage, by the "big" EU countries whose banks would be the main victims of such a default?

Of course. But as economic sabotage goes, AusterityTM is a pretty high bar to clear.

Again, as an outsider I cannot completely appreciate whether the real gains from EU regional development and CAP money outweighs the loss to deficit terrorism. And it is even possible that there is no objectively clear answer, because it is such a close call that the answer depends on which economic-political groups one favours.

If we switch back to the drachma would the currency devaluation reduce the buying power of wages and salaries even more than austerity is doing now?

That is unlikely. Suppose that Greece has 25 % higher unit labour costs than Germany, and an import quota (imports divided by total GDP) of 1/3. Assume that total unit costs are also 25 % above German total unit costs. In that case, achieving parity through wage cuts would cut a wage earner's purchasing power by 20 %, whereas depreciation to achieve parity will reduce the purchasing power of the average Greek by 1/15, or just a hair under 7 %.

The general expression for the zeroth-order income reduction from restoring unit labour cost parity through a wage cut is

[domestic unit labour costs]:[foreign unit labour costs] - 1

The general expression for the income reduction from depreciation to restore total unit cost parity is

(1 - [domestic unit costs]:[foreign unit costs])x[import quota]x[foreign unit costs]:[domestic unit costs]

I encourage you to play around with these equations a bit to get a feel for them.

Additionally, and not captured in these simple formula, getting rid of the debt burden would remove the single greatest current impediment to Greek recovery. On the other hand, if essential imports exceed total exports, you may find yourselves in a situation where you cannot obtain the capital goods and raw materials to sustain a recovery.

Why is a devaluation of local currency less painful for the mass of working people than a direct wage reduction? (The price of oil and its prospects should be taken into account in answering this question)

Because it is harder for the wealthy to escape paying their fair share. A currency depreciation redistributes from net importers to net exporters, while a wage reduction redistributes from wage earners to employers. There are more wealthy people among the net importers than among the wage earners, and more poor people among the wage earners than among the net importers. Especially when weighted for import volume, as the rich typically have a higher import quota in economies that do not have a structural import dependency on food and fuel. However the Greek import dependency on fuel complicates the latter point, as a previous comment notes.

If local loans are converted to drachmas wouldn't that mean that the Greek banking system will in large part collapse,

Not if their liabilities are similarly converted to Drachmas.

And if they are not doesn't that mean that, say, housing loans would become impossible to repay for the vast majority of debtors?

Yes. Which is why you convert them.

For a devaluation to foster growth two things are needed: a. A tight fiscal policy: otherwise the inflationary pressures will keep increasing, leading to serial devaluations and hyperinflation.

Not due to devaluation itself. Devaluation does cause increased inflation, but as long as the economy's import quota is below 1, this increase eventually converges.

Unless you believe in rational expectations "theory," which is a neo-classical fairy tale.

Now, the ability to print your own money may cause the Greek government to go overboard and create excess inflation. If you believe that this is likely, then you have sound reason to want to stay in the Eurozone. But that would be a consequence of a Greek government failure to conduct responsible macroeconomic policy, not a consequence of leaving the Eurozone per se.

b. Excess potential in export industries: that means factories that are underfunctioning and can hire people as soon as competitiveness increases, or companies that can expand their potential as conditions improve. This sort of productive base doesn't exist in Greece and new businesses and jobs have to be created ab nihilio - something that would be made more difficult in a climate of devaluation and instability.

I am aware of that. But the objective of this exercise is not to increase capacity - at least not in the short term. It is to stop the loss of capacity that AusterityTM imposes.

How credible could Greece's "bluff" be? Wouldn't it be called as soon as it was on the table?

I am not suggesting that you bluff. I am suggesting that you threaten. If you are not prepared to carry out the threat, you should not make it.

Does a Greek solution to the crisis even exist? Isn't Greece too small a player to be able to pull itself out of the hole it is in without the EU?

No, size does not have anything to do with it. In fact it is easier for a comparatively small economy to devalue itself out of a crisis. A devaluation strategy depends on everybody else to consider the loss of trade surplus less important than the added inflation from a competitive devaluation. Obviously, the chances of this are better if you are small.

(On the other hand, the amount of underhanded mischief other people can get away with increases the smaller you are.)

Wouldn't the primary beneficiaries of a return to a (devalued) drachma be the corrupt elites that have already moved their wealth to foreign tax havens?

Inasmuch as they have moved physical wealth, yes. However, if they have only moved bank deposits, a total conversion to Drachma will actually repatriate wealth, since the process of moving bank deposits abroad involves a domestic bank borrowing money from a foreign bank. Since this foreign interbank debt will diminish in value with a conversion, it will diminish the stolen wealth.

It is possible that the corrupt elites will be made whole out of other countries depositor guarantees, but that is not your problem.

Wouldn't this tactic be more successful if it was used not by Greece alone but concertedly by all the IMFed countries?

Yes. Assembling a coalition is always preferable to fighting alone.

How does the population survive the first few months after the currency change? Rationing?

Yes. The rationing does not need to take the form of rationing stamps. It may take the form of capital controls (which is a form of import rationing, in which you restrict the use of scarce hard currency to those imports which are important to the continued functioning of society and your economy). But there will be some sort of rationing while you rebalance your current accounts.

On the other hand, AusterityTM also entails rationing. It just does its rationing in a somewhat sloppier and more capricious manner.

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Mon Apr 4th, 2011 at 11:24:26 PM EST

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