A way out for Greece
But since becoming a currency union in 1999, its popularity dropped. One reason is that under monetary union, the principle of ‘close friends with separated budgets’ was abandoned. Budget deficits of Greece were financed by issuing government bonds, which were accumulated in the portfolios of other member states’ banks, especially French banks. Once they realised they had gotten themselves into a mess, concerned French bankers began to ask themselves how they could get out of it again, and so they turned to president Sarkozy for help. Sarkozy proposed a plan to Chancellor Merkel and Finance Minister Schäuble, which foresaw the pooling of Greek bonds in a common fund in Luxembourg. Merkel and Schäuble agreed, and at the European summit of 7/8 of May 2010, the plan was accepted.
Merkel and Schäuble recognised too late that they had been lured into a trap. They had not ‘saved’ the currency union, they had just changed the rules of the game. From now on, every member state became effectively liable for the debt of every other member state. Inter alia, Germany became liable for Greek debt held by the Luxembourg fund. Formerly separate national budgets became socialised Eurozone budgets. Once the distinction between ‘mine’ and ‘thine’ was ended, everybody began to suspect everybody else of free-riding, either by passing on too much debt to the community, or by contributing too little to the joint efforts of debt relief. Distrust, even hatred spread. Friends in a free trade union became foes in a monetary union. The former peace project, which the economic union was, became a project of mistrust under the euro. This loss of amicability is not displayed in any statistic. But it weighs more heavily than all the billions of euros spent.
In order to save what was still saveable, Merkel and Schäuble invented the concept of ‘financial aid in exchange for reforms’. Member states with excessive debt were to receive loans from the community fund, if in return, they declared to implement reforms and put their house back in order again. But this was never going to happen. Why would the Greek government get serious about reform, knowing that, under conditions of joint liability, they would receive financial aid anyway, even in the absence of reforms? What is more, the Greek government argues that reforms were not even necessary: All it would take was to send more money to Greece. This would trigger the ‘multiplier effect’, which, by increasing aggregate demand, would automatically lead to full employment, and the country’s crisis would solve itself. What the Greek government did not mention is that at a consumption-to-GDP ratio of 120%, there clearly is sufficient demand in Greece – it is just not a demand for Greek products.
Greece cannot be saved by the Merkel-Schäuble-Plan. Why don’t the economists in Berlin and Brussels simply pull their rescue plans out of the drawers? Because they don’t have any such plans. For years, and until very recently, thinking about alternatives has been a taboo. Monetary union had to be preserved as a whole, and at any cost. Monetary union became a holy grail that nobody was allowed to touch. What is being overlooked is the simple insight that the only way to save the holy grail is to abandon the principle of pooled budgets.
Greece does not need a European Commission to save it, it needs an arrangement under which it can save itself. This arrangement has to be as simple and as robust as the former EU-as-free-trade-zone once was. It is not necessary to demand that Greece pays back its debts to the Luxembourg fund (which, given the Greek state has experienced five sovereign defaults in its existence, seems illusory anyway). All it takes is that Greece should be fully responsible for any future debt, which should be incentive enough to avoid it.
As a first step, it is important that Berlin and Brussels stop payments to Greece (or at least decrease them drastically). This need not result in a Greek default. If the Greek government wants to pay its bills, it will need money. But the euro cannot be that money, because the Greek government does not have enough of it. Thus, the Greek government will have to create a parallel currency, the new Drachma (‘NDr’), as legal tender. Even euro-denominated claims held by foreign vendors will now have to be paid in NDr. With that conversion, the depreciation risk that any foreign vendor faces comes into play. Even with the NDr as the legal tender, competitive producers will still be able to trade in euro. For those who are not sufficiently competitive, choosing the NDr as a contract currency will be preferable to foregoing the contract (i.e. not getting paid in any currency). That is the reason why the NDr will prevail and dominate the euro in Greece after a while. Only sight deposits at Greek banks will be still denominated in Euro. This is necessary to prevent a bank run after the currency conversion. The costs will be less than €20bn.
Next to the official currency NDr the euro remains as a parallel currency at a flexible exchange rate. The euro will play a role comparable to the US Dollar, which, as part of many people’s portfolios, can be seen as a second currency in Switzerland as well. The exchange rate between NDr and the euro is determined by the market, especially by the import propensity of the Greek and the competitiveness of Greek products on the world market. The import propensity will decline and competitiveness will increase, working towards an equilibrium.
Greek bonds will be issued in NDr. Thus, they will not be as safe from depreciation and default as euro bonds. The depreciation and default risk has to be borne by Greek government (like in the ‘old EU’, when it was little else than a free trade area). This is what the principle of ‘good friends, separate budgets’ demands.
Parallel currencies are a common practice around the whole world, and they have proven successful. Under a parallel currency regime, governments have every reason to reform, to avoid default in their own currency. Even the euro had been introduced as a parallel currency next to the existing currencies in its first year 1999. Whether the concept of the NDr as a parallel currency obtains approval by the Troika, is less a matter of practicability. It is a matter of reluctance, on the side of EU politicians and the ECB, to delegate power.
This article first appeared as “Ein Weg für Griechenland” in “Finanz und Wirtschaft”, 16 May 2015.
Prof. Dr. Charles B. Blankart is a professor of economics at the Humboldt University Berlin and the University of Lucerne.