Talk of Euro abandonment would trigger an immediate run on Greek banks, sending the country into an even deeper hole. Who wants a Euro deposit to be converted into a drachma deposit?
You could imagine keeping current Euro-denominated deposits and adding new drachmas to the system, circulating at a flexible exchange rate. That still might trigger a bank run (who expects the parallel currencies to last forever?). Furthermore the new drachmas would bring seigniorage only if the law forces their overvaluation in some manner; refer back to the earlier discussion of the bank run.
Read the rest at Marginal Revolution -->
Why it's hard for Greece to back out of the Euro
Talk of Euro abandonment would trigger an immediate run on Greek banks, sending the country into an even deeper hole. Who wants a Euro deposit to be converted into a drachma deposit?
You could imagine keeping current Euro-denominated deposits and adding new drachmas to the system, circulating at a flexible exchange rate. That still might trigger a bank run (who expects the parallel currencies to last forever?). Furthermore the new drachmas would bring seigniorage only if the law forces their overvaluation in some manner; refer back to the earlier discussion of the bank run.
You could imagine a surprise freeze on all bank deposits, thereby preventing an immediate bank run but leading to a later bank run. Plus in the meantime there is no working banking system. And if this doesn't come as a true surprise, you end up with the immediate bank run.
What is the chance of a bank run very soon -- if only driven by "sunspots" -- thereby forcing the Greek government to suspend redemption and devalue those deposits, effectively turning them back into drachmas?
Looking to history, there are plenty of countries which break pegs or leave currency zones. But they all seem poor enough, banana republic enough, or insulated from "currency competition" more than a new Greek drachma would be insulated from competition with Euro-denominated banking.
Have I mentioned that currency substitution models do not in general imply stability or well-behaved quantity theory relations?
Can you see any coherent scenarios in which Greece (or other EU countries) can leave the Eurozone? The forcing, immediate bank run is the only option I see and that is not a pretty one. It also implies that the "policy decision" is up to Greek account holders and not up to the Greek government. At best, the Greek government is making decisions about the fiscal side of the equation.
Are the nominal interest rates rising on Euro-denominated accounts in Greek banks? (Are they allowed to rise?) That is one good barometer for Greek depositor discontent.
Posted by Tyler Cowen on February 8, 2010 at 10:29 AM in Economics | Permalink
Comments Tyler, you don't say how Greece would benefit from abandoning the Euro. Actually, given the openness of the Greek economy and the fact that Greece's sources of foreign exchange are diversified, Greece cannot solve its fiscal problem with a devaluation as Argentina did at the end of 2001. In Argentina, the devaluation was necessary for the government to tax the main exports and therefore to reduce significantly the fiscal deficit. Since Greece faces a serious fiscal problem, it needs a fiscal adjustment that cannot rely on an increase in tax revenues from a devaluation (directly as in Argentina or indirectly as a result of a large increase in exports). The fiscal adjustment will have to be negotiated between the government and the unions of civil servants, and it is a distraction to talk about the abandonment of the Euro. And as long as there is no agreement, the government will have no choice but first to delay payment of the servants' wages and then to cut temporarily their wages by issuing a fake currency.
Posted by: E. Barandiaran at Feb 8, 2010 11:57:16 AM
The coherent scenario for a country leaving the eurozone is exactly the opposite: it is Germany leaving because it doesn't want to support countries like Spain and Greece. It could cause a flooding *to* their banking system as everyone would know what that means for the euro.
Posted by: Matt L at Feb 8, 2010 12:01:58 PM
Whatever happened to gold? In the days of my youth any rumour of financial instability caused a parade from the bank to the jewelry stores.
Posted by: Ed at Feb 8, 2010 12:10:40 PM
Greece would certainly lose out from leaving the euro and this is therefore unlikely to happen. However, there's an alternative scenario. If the southern Mediterranean countries continue to stall and expect to be bailed out by the Germans, could we see a new euro (with the North Europeans) or a new Deutsche Mark? This would end up with the same result as the Southern Europeans leaving the euro, but in a back door kind of way.
Posted by: jpf at Feb 8, 2010 12:26:29 PM
Isn't the solution for the Greek government to pay its employees in neodrachmas, but leave the euro in place for everything else?
Posted by: dearieme at Feb 8, 2010 12:31:04 PM
Have I mentioned that currency substitution models do not in general imply stability or well-behaved quantity theory relations?
A point covered nicely by Scott Sumner not too long ago.
Posted by: Michael F. Martin at Feb 8, 2010 12:50:11 PM
Germany does not mind some devaluation of the Euro because it is an export economy. France would also enjoy a devaluation of the Euro. The Greek crisis is driving this devaluation and the bigger economies have no incentive to pay dearly to save Greece from default. Germany and France have to make sure that Spain and Italy stay afloat.
Posted by: londenio at Feb 8, 2010 12:53:23 PM
the greek debt (and the spanish one, the italian, and so on) is denominated in euro.
which is the point of switching currency if you cannot devaluate that one the debt is denominated in?
you switch from euro to the new dracma. but the previous debt?
so only defaulting on the previous debt can be a solution.
God forgive them.
Posted by: Kerub at Feb 8, 2010 2:31:30 PM
Kerub, you're right and your point further highlights that the discussion of Greece abandoning the Euro deflects attention from the serious fiscal adjustment that Greece must undertake. As serious as the one that California must undertake.
Posted by: E. Barandiaran at Feb 8, 2010 3:12:21 PM
I don't understand why other Eurozone members care whether Greece defaults on its sovereign debt. How does that harm the Euro itself? Would other organizations that borrow in dollars somehow suffer if California defaulted on its dollar-denominated debts?
Posted by: Richard at Feb 8, 2010 3:49:21 PM
I asked this question about Spain to Edward Hugh, and here's his reply:
"@ Don,
I hope, in passing, I have answered your question. Basically, getting its own curerncy back wouldn’t help at this point, since all the debts would need to be repaid in another currency, or you default, and become a cross between Argentina, Cuba and Serbia.
Flat broke, and no one willing to lend you any money."
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