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Greece should quit the Euro and remark its debt

By Peter Morici
web posted June 20, 2011

Greece does not have a liquidity problem -- it is insolvent. Without transfers of wealth from richer states like Germany and France to retire significant amounts of its sovereign debt, Athens must restructure its bonds -- essentially default on significant portions of its obligations to bondholders.

Germany and France are at wits' ends, because their banks hold a good deal of that debt and would take big losses, and other poor EU governments would likely follow Greece's lead. Paying off Greek creditors may be distasteful, but covering the problems of all the EU governments in trouble is beyond the capacity of Germany and the other richer EU states.

To patch things over for another year, Berlin and other rich governments want Athens to impose more cuts in government benefits and wages in exchange for more loans and relatively small private creditor haircuts. And they want Athens to sell off valuable state-owned assets to help lubricate the deal.

The Greek people have already taken major cuts in benefits and salaries, and they understand gradualism is not solving the problem. They shouldn't want their economy bought up by the Germans and others, and they are correct to expect their government to consider other, more reasonable solutions.

The amount of aid the Greek government will receive through current negotiations will likely result in another crisis next year or the year after, and then more cuts in benefits and wages. Importantly, these deals do nothing about private debt -- the mortgages, auto loans, and credit card balances Greek citizens are expected to pay as their salaries are cut and cut.

As European integration progressed -- for example, with the 1992 Maastricht Treaty that harmonized taxes and product standards, and the 1999 introduction of the euro -- European voters in poorer states increasingly expected health care, job security and retirement benefits on a par with the richer states. Civil servants expected to be more adequately compensated -- yes "adequately" because examination of Greek salaries does not reveal payments that are very generous by German or French standards.

Sadly, these efforts at deeper market integration did not give Brussels the power to tax richer Germany to subsidize Greek social services in the way that Washington taxes New York to subsidize health care and retirement benefits in Mississippi.

Over the decades, poorer countries have borrowed too much to keep up, and now without continuous EU bailouts, they will default on their debts.

Prior to the euro, as poorer countries approached such crises they could let their individual currencies fall in value against the German mark to make their exports more competitive, grow more rapidly and boost debt payment capacity. It meant retirees and tourists from Germany and other rich countries could more easily afford to live in or visit poorer countries than the reverse -- a small price to pay for keeping the ship of state from capsizing.

When countries are broke and locked into the same currency area with their major export customers -- presently the condition of Portugal, Ireland, Greece, Spain, and Belgium -- their only option is deflation -- cuts in government spending, wages and ultimately prices that make their exports more competitive and boost debt service capacity.

Essentially, this is what Germany is imposing on Greece, but citizens have mortgages and other debts to pay just as the government have bonds to service. Deflation makes private debt nearly impossible to honor, and many Greeks will lose their homes and just about everything else to foreign creditors before the madness ends.

The only real option is to drop the euro and resurrect the drachma, unilaterally remark public and private debt into drachma, and let the drachma float to a value on currency markets that balances Greece's export revenues against its imports and debt servicing obligations.

Abandoning the euro for the drachma would cause Greek GDP and debt servicing capacity to grow more rapidly. Whatever losses imposed on private creditors, richer EU governments and Greek citizens, those would be smaller than the total losses imposed through an annual ritual of crises, aid packages and debt rollovers -- conditioned on ever more draconian austerity -- and the ultimate absolute default when the final charade ends. ESR

Peter Morici is a professor at the Smith School of Business, University of Maryland School, and former Chief Economist at the U.S. International Trade Commission.

 

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