The end of the Greek bailout and how Greece could end up with two currencies.

By October 8th of this year, the European Finance ministers must decide whether or not to send Greece 11.5 billion Euros in bailout funds, based on the report of the ‘Troika’ (the EU, ECB, and IMF) as to whether Greece is holding up its end of the bailout conditions.

If the Troika and the European Finance ministers stick to the letter of the bailout agreement, then it is the end of the line for the Greek bailout: the bailout agreement, signed by the major political parties currently in power, forces Greece to do things like cut pensions, public wages, procurement spending, and privatise government property. What did the same political parties promise the Greek voters before the June elections? Well…. no pension cuts and no public wage cuts. And what about privatisation of things like government land? Well, the privatisation program has been conveniently derailed on legal grounds for years already with no end in sight, so forget about that one. Worse: the value of government property has plummeted since the assets have effectively been given to cronies, such as when parliament approved a bill allowing property developers to build on nature reserves reducing their value as assets.

In short, there is no way Greece will live up to the letter of its agreement.

It is thus a golden opportunity to reduce the damage of the bailout mistake. That damage has been severe enough already: it has lead to the impossible situation that domestic Greek economic policy is now portrayed by all major Greek political parties as dictated by outside forces, allowing all of them to shirk responsibility for real reforms.

Worse, despite the dire situation Greece is in, outside money has allowed the Greek politicians to simply not reform at all when it comes to improving economic dynamism. No reform to the constitution which outlaws the sacking of any public sector worker! No sacking of public employees and non-implementation of plans to do so in the last 3 years! No opening up of professions or reduction in the red tape that allows public servants to demand bribes! In essence, no improvement in public administration at all.

In case you might think I am exaggerating about this point, let us mull this crucial point over more carefully, starting with some of the stories of corruption that have come out just the last 3 months.

Take the case of Byron Polydoras, an MP for the same party as the current prime minister who is currently on a begging tour through Europe promising to do in future years what he doesn’t want to do now. Byron was parliamentary speaker for just a single day just before the last election. How did he spend that faithful day? Well, he gave his daughter a permanent job in his office. She now has a job for life on a good salary, protected by the constitution that does not allow her to be sacked! Whoever said that Greeks politicians are incapable of organising anything on short-term notice? I suspect Byron of having had the large amounts of paperwork that needed to be filled in ready in his desk for when an opportunity like this came along!

Not just is Byron still an MP, but quite defiant about his actions too, clearly expecting other Greeks to agree that nepotism is the whole point of being a politician. If you can’t help your family, even if it’s at the expense of others, why even bother running for office?

Nor is Byron an isolated case. Bribes are a normal part of life for people wanting a life-saving operation or the tax collector to pass them by. Transparency International in its 2012 report on Greece documents many cases, including a fascinating table on what the going bribe is for several services. Want a construction license? That’s up to 8000 Euro! Want to move up a surgery waiting list? That’s up to 20,000 Euro! Want you driving license (private sector)? That’s up to 500 Euro! Greece is thus currently 80th on its corruption index, leaving only Bulgaria behind it within the EU, and notably slipping from its already low 57th place in 2008.

Greece is thus a place with ‘corrupted legality’, where many anti-corruption laws are not enforced and some laws actively promote corruption (like illegal buildings that can be approved later). And it is not getting better in Greece, but worse. From an economic point of view, the deterioration is entirely to be expected and partially the fault of other European countries: corruption is foremost about insiders with political power squeezing outsiders and the Financial Crisis has empowered the insiders more than the outsiders. The EU has actively helped corruption by channeling all the bailout money through the Greek insiders whilst the outsiders in Greece have seen their businesses suffer from reduced market demand. The EU has thus been systematically rewarding the wrong people for the wrong things.

Are Greek politicians and the bureaucracies they head then not capable of decisive action at all? Oh yes they are, but only on matters that motivate them, such as picking on the politically weak. This for instance includes the recent pogromesque round-up of 6000 migrants in Athens during a massive police operation that swept through whole neighbourhoods. Bribes will of course be collected as we speak to determine who of these migrants stays and who doesn’t but it was a remarkably efficient and well-planned operation from a political system that always needs more time to do things it doesn’t want to!

There are thus plenty of economic and moral excuses for the EU finance ministers to pull the plug on Greece and let it decide its future by itself without EU funds keeping an impossible situation afloat. Better for Greece in the longer run and certainly better for Germany which has so far failed to appreciate the disastrous effect of its generosity.

Would Greek leave the Euro without the bailout money? Well, that depends entirely on Greece and no-one else. There is nothing inevitable about it, nor is there the legal apparatus for others in the EU to ‘force’ Greece out of the Euro.

But, I hear you ask, if the Greek government cannot pay its bills in Euros then surely it must introduce some form of other currency to pay its bills, effectively leaving the Euro? This logic, which you sadly see all the time in newspapers, is plain wrong on two counts. First of all, a Greek government can overnight decide to simply pay only part of its bills with however many Euros it has, which is a form of bankruptcy without Euro-exit.

More fundamentally, the re-introduction of a second currency (the Drachma) in no way forces Greece to abandon the Euro. As long as Greece does not declare the Euro illegal tender on its territory, it can without major consequences start paying bills to other Greeks in new Drachmas, declaring that second currency to also be legal tender within Greece. You would then have one country and two currencies, something that is a bit cumbersome but not unique at all. Hong Kong has had two currencies for over a decade now and it works fine (the Hong Kong dollar and the Chinese Yuan). Until the old currencies were abandoned, the EU had two currencies inside each Eurozone country too, albeit for a short transition period. If Greece opts for this, there is no mechanism for the other Eurozone countries to kick it out of the Eurozone.

There are many advantages to Greece for having two currencies instead of abandoning the Euro: it doesn’t involve capital flight and thus hard-to-police capital controls. It doesn’t need banks changing the tellers and it doesn’t require a huge pile of Drachma’s to be distributed all at once but can be done gradually. There would simply be a Drachma paid to civil servants and all others dependent on the government, as well as the Euro in general circulation, leaving it to companies to decide how to pay its employees. It also would make it far easier for Greece to return to a single currency and hence can be politically motivated as a ‘time out’ period.

Having two currencies is also good for the rest of the EU: it leaves the Eurozone intact; it leaves the Greek government visibly bankrupt and thus introduces a threat-point to back up real fiscal discipline in the Eurozone; and it allows the Greek government to overnight pay its creditors only a fraction of the previous value (since the new Drachma would probably only be worth about half a Euro).

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Rex Ringschott
Rex Ringschott(@rex-ringschott)
9 years ago

Fascinating post Paul.

Stephen Bounds
9 years ago

I’m actually wondering why the option of reverting to two currencies hasn’t been raised earlier … it seems like such an obvious plan.

I mean, I presume the drachma would be at risk of hyperinflation and so forth, but at least this would effectively achieve the pay cuts needed for government staff … right?

JC
JC
9 years ago

More fundamentally, the re-introduction of a second currency (the Drachma) in no way forces Greece to abandon the Euro.

Well it does really. The market’s concern has always been about Greece being able to meet its liabilities in euros and the purpose of the second currency is to renominate most of those liabilities in a currency that is expected to drop precipitously once it is introduced. So Greece would be leaving the euro if not formally.
Paul, you need to get your head around the fact that Greece leaving is a costly and risky action. The loss alone to the EU would possibly total E400 billion. It would theoretically bankrupt the ECB as they have paid in capital of around E6 billion. It would also pressure the weaker members as the euro no longer is a roach motel that was promised.

Greece should never have been allowed into the Euro and now it’s very expensive to throw them out.

What’s the solution? Dunno.

derrida derider
derrida derider
9 years ago
Reply to  JC

“So Greece would be leaving the euro if not formally.”
You say that like it’s a bad thing. Leaving the Euro INformally has three big advantages – it can be done in a relatively gradual and orderly way, it avoids the legal problems and most of the immediate losers are Greek rather than German.

Debts that cannot be paid will not be paid. The only thing to be decided is how not to pay them – and this is a relatively elegant way to do so.

James A
James A
9 years ago

And also who not to pay – government employees being a good example for those who should be paid in Drachmas.

Paul Frijters
Paul Frijters
9 years ago

Stephen,

after posting I learned the option has indeed been raised, but not discussed widely. An FT article talked about it 2 months ago though much less with the political economy angle I am taking. Yes, it would definitely be the easy way to reduce the size of the public sector very quickly.

JC,

Greece is not going to pay its loans back whether it is in, out, alongside, underneath, or right on top of the Euro. It simply doesnt have the economy to do it. So the question is not whether the rest of the EU is gonig to lose money, the only question is when and how.

Q
Q
9 years ago

Greece’s underlying primary budget balance according to the OECD has been and going to
-10,1 2009, -4.2 2010, 0.4 2011,3.2 2012, 5.5 2013
This has led naturally to a lengthy recession.

It will not escaped any greek politician’s notice that advocating austerity measures has not helped win votes as Pasok’s fortunes has shown.

I do not know why Paul think the Greeks or any other nation would be enthusiastically endorsing labour market reforms.
It doesn’t win votes. Ask Gerard Schroeder!!!

The Germans have been hypocrites abut this in many areas. this is just one.

As for Greece, I agree with Paul Krugman

A greek anecdote from a friend of mine. his brother works for a french bank in Greece where he tries to gain new loans but as the Bank is not lending at all he has no work to do. He can be made redundant but it is far too expensive so he goes to work each day and does nothing fr the bank!!

Tel
Tel
9 years ago
Reply to  Q

You agree with Paul Krugman’s comment, “Greek euro exit, very possibly next month,” which he came out with several months ago?

Supposedly finishing up with, “End of the euro,” any minute now.

What no one can explain to me is, if the Greek govt can’t collect taxes in Euros, how are they going to collect more tax in Drachma?

Gavin R Putland
Gavin R Putland
9 years ago

How can Greece restore some approximation of full employment? By getting rid of taxes that cause the price of labour as paid by employers to exceed the price as received by employees. The same reform, among others, would reduce the cost base of trade-exposed industries, helping the country to trade its way out of trouble – like a devaluation. Here’s how to apply the same logic in Australia: http://t.co/P7ANmUTU .

Bill Posters
Bill Posters
9 years ago

Hong Kong has had two currencies for over a decade now and it works fine (the Hong Kong dollar and the Chinese Yuan)

Not quite; the HK dollar is pegged to the US dollar, and so is the RMB. This effectively pegs them against each other, so the effect is not the same as introducing a free-floating currency (which would surely be the point of reintroducing the drachma).

Paul Frijters
Paul Frijters
9 years ago

Q,

much of what you said, such as the reasons why Greek politicians dont want to reform (and even the reference to the Hartz reforms), I agree with and have written much the same in my previous posts (follow links in article).
Yet, on the crucial point of leaving the Euro, I do not agree that a Euro exit is imminent or unavoidable. Its all up to the Greeks. If they do not want to leave, it wont happen, even if they default. And since the Euro is very popular there…

Also, dont believe the OECD forecasts on Greek primary budgets. If I could bet against those forecasts, I would.

Bill,

the RMB and the HK dollar have varied a lot against each other, as well as against the US dollar. See eg all the historical tables at
http://www.hkab.org.hk/ExchangeRateDisplayAction.do

Labor Outsider
Labor Outsider
9 years ago

Over the decade, the HKD, USD and RMB may have varied but it would be nothing in comparison to the the fluctuations in the Drachma that would ensue. It is also manifestly untrue that there wouldn’t be capital flight if such an arrangement were introduced as many investors would view the inital introduction of the Drachma as a prelude to getting rid of the Euro altogether. Moreover, the government may well say that the new currency would only be used for certain purposes (i.e. paying government employees) but it wouldn’t be a particularly credible promise in my view. Finally, the post doesn’t really consider the potential contagion effects to other peripheral countries. This current crisis is many thing, including the re-emergence of convertability risk. That would only increase if Greece took the step that you are advocating.

I realise that you have the strong view that Greece is insolvent and so the status quo, including existing proposals on the table, isn’t sustainable. However, it would be nice to see some discussion of the potential costs / problems with such a move as well.