The ECB decision to limit liquidity to Greek banks was the nail in the coffin. Rumors of a “Grexit” caused bank withdrawals to accelerate. Over €25bn have been withdrawn from Greek banks since the end of November. The problem is that fractional reserve Greek banks do not have these funds. Current non-performing bank loans in Greece are close to 40% and banks hold large amounts of high risk Greek government debt.
The current Greek crisis is actually exposing the elephant in the room – a worldwide problem getting progressively worse by the day. A problem that has plagued developed economies for the last two centuries – a problem currently metastasising into a full blow cancer before our eyes – fraudulent fractional reserve banking.
Despite rumours in the press, there are no European mechanisms to force Greece out of the euro. Greece would have to be the one to decide to leave. Current wisdom is that a bank run would force Greece to return to the drachma. Although this is a possibility, it is not a foregone conclusion. Even if Greece defaulted, it would still probably have a large euro-denominated debt. Greece needs a plan to stay in the eurozone, at least in the short term, but it also needs significant debt relief.
What should Greece do? Sometimes you have to consider the impossible to make the possible evident. Greece should default on as much debt as possible. There is no benefit to meeting the EU halfway. Greece is currently running a primary surplus (or very close) so it does not need EU funds to cover government expenses. However, it does not have funds to cover withdrawals from Greek banks – an indirect liability – once the ECB and the EU cut off funds. Greece could impose capital controls and bail-ins, but most deposits are from Greeks whose average monthly income is less than €780 – the electoral foundation of the new government’s popularity. In 2013, the Cypriot government quickly backtracked on its attempt to bail in small deposits once the population rose up in widespread anger over the measure.
If it wants to survive politically, the new government must find a way to meet this extra funding necessity. The first step would be for Greece to take total control of its few remaining banks – a minor change since the Greek state already owns large parts of these technically bankrupt banks. To find funds to meet growing withdrawals from Greek banks – now a direct government liability – the Greek government could drastically reduce excessive government salaries by reducing payments over €1,500 per month by 50%. For example, a parliament employee in 2011 received an average of €3,000 net per month, not counting the bonuses and allowances on top of wages. According to the budget of the National Assembly, the 15th and 16th month salaries of these employees alone cost taxpayers €16.9bn in 2011. A socialist government could easily get away with such a manoeuvre.
The next step would be for Greece to convert banks into deposit institutions. Assets currently held by banks would be sold off. The model of such institutions would be like storage facilities, were you pay a fee for the storage of items such as furniture. Ultimately, these deposit banks should be sold to the private sector but with strict rules on property rights. A deposit is a bailment, not a loan, and any sleight of hand to convert a deposit into a loan should be considered fraud.
However, 100% equity-financed loan banking should be open to competition. Putting money in a loan bank should be like putting money in the stock market. You know you risk losing everything. Such banks, or investment trusts, would be like any other business and would not need any more special regulation than the makers of potato chips.
Greece should consider leaving the euro. Current monetary policy in the eurozone is reckless, and a storm is brewing increasing the likelihood that Europe will try to print its way out of trouble. We have been down this path many times before. History is littered with examples of countries trying to defy the law of scarcity by printing intrinsically worthless pieces of paper. As Voltaire once said, “paper money eventually returns to its intrinsic value – zero”. It took France forty years to recover from the hyperinflation of 1790-1797. The German hyperinflation of 1921-1923 created a political vacuum that gave us mankind’s worst nightmare.
The new drachma and the euro could trade side by side as legal tender. Greece would benefit from competing currencies. Yet government revenues and payments should be in new drachmas. The government must sever its link with the inflationary irresponsible monetary policies currently being followed by the ECB.
Greece should then fix its new currency to gold. In 1923, Germany returned to a gold standard with essentially no gold.
Few economists understand why some advocate a return to the gold standard. Keynes called gold a “barbaric relic”. It is not because gold is somehow special. Gold has many drawbacks, but its primary advantage makes all of these drawbacks moot. The most important aspect of a gold standard is that it constrains current and future governments from using the printing press to finance government expenditure. This struggle between governments and their people has been going on for millenniums. Kings, during the middle ages, would regularly debase their currency, but even the Kings were limited in the amount of debasement they could get away with. In today’s fiat currency world, the debasement possibilities are endless.
In a relatively short period of time, Greece could go from being the example to avoid to an example to emulate. With such a financial structure, Greece would benefit from long term financial and economic stability. It would force Greece to make hard choices up front, thus avoiding getting into trouble in the first place.