David McWilliams: Greece must leave euro if it wants to halt death spiral
Published 15/08/2012 | 17:00
Now that the Olym-pics are over, let's focus on the original home of the Olym-pics, Greece, against the background of data released yesterday showing that the eurozone economy is slowing rapidly ahead of the troika's return to Athens in September.
The troika will be there to see if it will release additional tranches of funding to Greece. If the troika decides to cut the taps off -- unlikely, but not out of the question -- then Greece would default and move to exit the eurozone.
Greek industrial output is down 27pc since the depression began, youth unemployment is above 50pc and the economy is cratering. This can't go on for much longer.
After years of crises, leaving the euro may be in the best interests of both the Greek economy and its people. One way of looking at the debate about the currency is to see who wins and who loses when a weak economy adopts a hard currency and what happens when this is reversed.
History tells us that whenever a weak country adopts a strong currency, the weak country is made weaker, not stronger. Its manufacturing base can't compete and those who pay themselves in the hard currency without earning it, such as the public sector, get paid in a currency they have no ability to earn.
Therefore, these people are getting a transfer of income. If they were paid in a currency that accurately reflected the real weakness of the country in which they work, they would have much reduced purchasing power. Asset owners, too, benefit enormously because even at subdued prices, their assets are priced in a far too strong currency giving them a one-off transfer of wealth. This leads to a type of looting of national wealth through the respectable veneer of a hard currency.
The country becomes a 'Lootocracy' -- where one section of the population loots the wealth of the other.
Those who depend on exports to generate hard currency lose out enormously because it is much more difficult to compete when a currency is so strong. On the flipside, banks and financial middlemen of all stripes gain, because the only way the country can pay its way is via large scale and ongoing borrowing in the very hard currency that is causing the problem in the first place.
Devaluing the currency -- as we have seen time and again -- gives the industrial sector a chance to expand. At the same time, certain key sectors, like agriculture, will see their price in local currency fall vis-a-vis foreign competitors.
Finally, in a country like Greece with a large tourist industry, a depreciated currency makes it a more attractive place to go on holidays.
When a country devalues its currency and is carrying huge debts in a hard currency, such as the euro, it will default on everything, or at least a large proportion of its debts -- as Iceland did. But that really is a problem for the creditors, not the debtors.
The country might, until it gets its act together, be unable to borrow from the financial markets for a while -- but maybe this is necessary to wean itself off constant infusions of foreign loans to maintain a lifestyle it can't afford.
If we examine the sharp shock countries like Iceland and many Asian nations experienced in 1997, the fastest way to close a current account deficit is not to borrow.
In time, the economy recovers and investment migrates towards those businesses that can actually generate a return on equity from real business activity rather the biggest rent generator in a "lootocracy", which is what many of the banks and public sector in Greece appear to have become.
If investment decisions make sense, money will flow back into the country. If not it won't. So there will be a short recession. But it has to be better than the years of depression that the euro promises.
The battle we are seeing in Greece -- and other countries that have adopted a hard currency -- is a battle between those who are paid in the hard currency or have assets valued in that currency, who will see a dramatic fall in their standards of living (which are unsustainable anyway) and those with nothing left to lose.
Obviously most of the broad, non-productive, non-exporting middle class and the proto European elite in Greece are all hugely in support of the euro because they don't trust their own to run the place. They prefer a badly run place as long as they are paid in a German wage that prevents them having to live in Munich -- which is what their poorer, less well-connected neighbours have to do, and have done for generations.
But there comes a time when this death spiral of economy contraction becomes pointless and excessively divisive. The smart money anticipating this, leaves the country as has been the case in Greece, waiting for the moment. It won't come back until the "event". This means that the country becomes a ward of foreign largesse and even the most understanding neighbours get fed up.
The truly amazing thing about Greece is that it is still running a current account deficit, which means someone is continuing to finance its excessive lifestyle. This luxury was not afforded to the Icelanders, the Latin Americans or the Asians after their various similar crises.
The only way out for Greece, one which will ultimately give its next generation a chance, is to leave the euro. This allows the process, which would happen in a bankrupt company, to do its thing: default even more on your creditors, let your price -- that is, your exchange rate, drop -- and stop borrowing hard currency. Economically speaking, it really is that straightforward.
The losers -- there will always be losers -- would be those who don't produce anything in Greece because they would see their standards of living fall to reflect the appropriate level, and of course, the owners of assets in the country. Traditionally asset owners are very powerful and will hardly encourage such a move. But this is what should happen.
Politically, people who would lose out will try to stop this happening, but had Greece retained its own currency, it would have happened years ago.
The euro, and Greece's membership of it, is preventing normal economic adjustment in Greece, making things far, far worse for everyone.
Greeks who have savings in the euro will see those savings devalued dramatically, in the same way as the same savers saw the real value of the drachma savings in their accounts increase enormously when Greece joined the euro.
Interestingly, looking at similar examples where countries change currencies, there is a period of extreme instability when the currency falls, but ultimately the new currency finds its level and things stabilise. Iceland is only the most recent example and the IMF was only on Monday trumpeting the success of Iceland's recovery.
Greeks and Greek companies who have borrowed in foreign currency will renegotiate all these contracts. And, strange as it sounds, life will go on.