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Don't Blame the Euro for Greece's Woes

Author: Benn Steil, Senior Fellow and Director of International Economics
April 26, 2010
Financial News


The ongoing Greek debt crisis has revived all the old arguments from the 1990s as to why national governments, no matter how small or dependent their countries are on the outside world, need monetary sovereignty - that is, the ability to mint a national money and to control domestic interest rates.

Financial Times columnist Samuel Brittan recently took up the theme, arguing that with a reborn drachma Greece "can pursue a fiscal policy attuned to domestic needs, without being dependent on the international bond market". But can it?

History shows that such independence is chimera. In Greece's case, it has never existed.

Following its recognition as a state in 1832, Greece spent the rest of the century under varying degrees of foreign creditor control. On the heels of default on its 1832 obligations, the entire finances of the country were placed under French administration.

In order to return to the international markets after 1878, the country had to pre-commit specific revenues from customs and state monopolies to debt repayment. An 1887 loan gave its creditors the power to create a company that would supervise the revenues committed to repayment.

After a disastrous war with Turkey over Crete in 1897, Greece was obliged to accept a Control Commission comprised entirely of representatives of the major powers which had absolute power over the sources of revenue necessary to fund its war debt. Protests were raised in the Greek parliament that the commission effectively suspended the country's independence.

And this was all under the reign of the "sovereign" Greek drachma.

Fast forward to the 1980s, and Greece used its monetary sovereignty to devalue twice, in 1983 and 1985, which, as Bank of Greece governor George Provopoulos has pointed out, produced nothing but further unsustainable wage growth and inflation. The problem of so-called twin deficits (budget and current account) remained, with an Icelandic-style currency collapse prevented only by strict capital controls.

But Greece never walled itself off from the international capital markets. Far from it. Using Bloomberg data, I found that at the end of 2000, just before Greece joined the eurozone, 79% of its outstanding debt was already denominated in euros, and a mere 8% in drachmas.

Even if Greece had remained outside the eurozone, its dependence on euro borrowing would only have increased. A falling drachma would merely have brought the current crisis to a head earlier by accelerating the rise in Greece's debt-to-GDP ratio (again, think Iceland).

Greece is not a Robinson Crusoe island in the Aegean, providing itself with all the necessities of modern life. It is a small corner of the eurozone economy, with which it is significantly and increasingly enmeshed.

As such, the fact that the euro is not an "optimum currency" for Greece, or any other eurozone country for that matter, is not the main problem. That problem is excessive foreign borrowing, a problem with which Greece has struggled since the early 19th century.

And it is an irony of the growing likelihood that Greece will be forced, yet again, into the arms of a foreign creditor body that it is the International Monetary Fund which, in 2009, urged European governments to boost their deficits well beyond what would have resulted from the operation of automatic stabilisers built into their tax and spending regimes.

A final point that needs to be made is in response to those, like Harvard's Martin Feldstein, who believe that a devaluation-friendly drachma can be brought back from the dead. Samuel Brittan even suggested that a local currency "whether or not called the drachma, [could emerge] with or without the sanction of the Greek government."

But can anyone believe that shopkeepers would, without the strongest form of compulsion, accept money, new or old, conjured up for the very purpose of enabling debasement? In the face of strong public opposition, Ecuador's president Rafael Correa was obliged to abandon his 2006 plan to reintroduce local money, in place of the US dollar. Ecuadorians may have been ready for big changes in economic policy, but they were not about to dissipate their savings.

We should hardly expect otherwise from the Greeks.

This article appears in full on CFR.org by permission of its original publisher. It was originally available here (Subscription required).

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