Tuesday, 13 November 2012

The Greek Tragedy

What is actually a huge question as to whether any of the large economies of Italy, France and Spain can co-exist within a common currency with Germany cannot safely be asked by either side - but they can discuss the problems of Ireland, Portugal or Greece because ultimately their fate, although important to their inhabitants, can economically be a matter of indifference to the rest of Europe.

To put the matter in its proper context, think of the Greek economy as being the same size as a good growth year in Germany. There are about 11m Greeks and the GDP is about $300bn. When the rest of the EU talks about how much the debt must be cut by, or how much the government must sell off by way of assets, the debate is much wider than just Greece - and if, as grows more likely, Greece is cut adrift from the Euro it will be as a dreadful warning to others that there are no easy answers.

The reason we seem to be heading for a New Drachma is that the Greek people are strongly resisting the disciplines necessary to cure the underlying problem - which is the government spends too much, employs too many and gets too little out of both. Populism of the left panders to this failure of popular will by claiming it is possible both to carry on spending and to remain within the Euro. It could just as well be of the right, either extreme can and do claim panaceas exist very easily; the problem only comes if the voters believe them and in Greece too many do. As a consequence every agreed stage of the recovery programme has been implemented late or not at all. Banks and bond holders have suffered huge reductions in the value of their debt, voted for 'voluntary' reductions in the amounts outstanding, and international institutions have provided massive loans. Somehow in the Greek parliament this is turned into Greece being a victim - rather than the poor lenders or the taxpayers in the rest of Europe being victims. With riots outside it is difficult for sense to be debated inside parliament even by those who know where the truth lies.

The consequences of the inability to focus on and cure the real problems is inexorably leading to a loss of authority of government, a flight of capital, and a situation where it gets harder and harder for businesses to function. Even in areas where Greece has superb advantages - such as tourism and shipping - the unreliability of public services from electricity to airports makes life very hard. There is an inevitability to Greek tragedy - and this one can probably be taken all the way back to the Colonels and the removal of the Monarchy, and it is hard to see how the final tragic act - that of the introduction of the New Drachma - can be avoided.

So on Drachma Day a three day bank holiday will be declared - probably starting on Friday and finishing the following Wednesday. The ports and borders will be closed by the Greek and neighbouring armies, the Navy will patrol the shore to destroy smuggling boats and the air force will deliver about €2,000 per head of the new currency (which will have taken De La Rue about 3 months to produce) to every town and city bank branch in the country. Exchange control regulations will make it an offence, punishable by confiscation, for Greeks to hold any euros for a period of some weeks after D Day. Foreign visitors will be limited to taking out or bringing in €1,000 in cash and any surplus will have to be deposited in New Drachma. The official exchange rate will be 1 New Drachma per euro and the Central Bank of Greece and all Greek banks licenced by it will convert all balances and loans in euro accounts held in Greek branches into New Drachma on D-day. There will be a period of one month for all cash notes and coins to be exchanged, after that it will be a criminal offence for any Greek citizen to possess euros on Greek soil without proof of their having been acquired in a legitimate manner. The Central Bank will for a period intervene in the currency market to prevent the value of the New Drachma rising above 1 euro but will not support it if it falls.

There have been suggestions that instead of printing New Drachma an endorsement or stamp could be applied to existing euro notes but unless every issuing bank agreed it seems unlikely that this would work - similarly suggestions that the banknotes issued by the Greek central bank should become New Drachma seems unlikely to work. It would also be completely unenforceable to try to confiscate external assets of Greek residents (although this was done in the UK that was under war-time conditions and even then was probably not 100% enforceable). All the Greek government can try to control is Greeks in Greece at the time of the split, and that will be hard enough given the land borders and sea channels which abound with possible routes to remove cases full of cash. It will be a military operation, possibly with the declaration of martial law, and given recent history civil commotion and substantial resistance must be anticipated.


So what happens after the dawn of the New Drachma on D-day? There is an assumption that the New Drachma will fall very fast to a discount of about 30% to the euro so as to price Greeks back into world markets. Markets are funny things and nothing should be taken for granted but as the problem is caused by unsustainable levels of spending and income it seems likely that a sharp depreciation to a level where assets, income and exports all become much cheaper is inevitable. A further default on external borrowings is possible - but the possible contagion is probably containable by concerted international action to recapitalise the French, Cypriot and other European banks who would find their assets have depleted by the loss of nearly all the remaining value of their Greek lending. Greece would again be excluded from international markets and Greek government property abroad would be subject to freezing and confiscation. Greek airlines would probably be grounded by lack of credit and travel abroad for ordinary Greeks would become very different for at least a short period. Continued membership of the EU would be extremely difficult for a prolonged period - but eventually an accommodation would be reached with creditors and trading partners. If all international links were broken the consequences would be so catastrophic that some form of settlement would be reached even if extremists were in power in Athens. Eventually, no doubt, the tourists would return to the beaches and islands, the industrialists would exploit their new found competitiveness and a few years of faster than average growth would return unemployment and living standards to European levels. But this might take 5 years.


Greek tragedy is predictable - and the chorus normally tells everyone the truth but is ignored. The fact is that the euro is not the problem for the Greek nation - the tensions of today are symptoms of the underlying problem but all the actors are pretending not to know what the problem is. The government spends too much and collects too little in tax. New Drachma or not it must cut spending and increase taxes.

What Harold Wilson, the UK Prime Minister in 1967, did under similar circumstances was to carefully explain that the cuts in benefits, the reduction in subsidies and the pay freezes he imposed were the fault of the "Gnomes of Zurich". This immortal phrase was of course complete nonsense - firstly Swiss bankers, and indeed those in the City of London who then, as now, were the best analysts of government policies are no more vertically challenged than the rest of us. Secondly, like Cassandra, free markets have a disturbing tendency towards telling the truth and a government whose bond is unsalable is one whose words are worthless. But what Harold Wilson really meant, and what the Greek Government should take deeply to heart, is that financial discipline and the economic reality that in the long term a government can only spend what it can raise by taxes is much easier to impose on your population if you can blame some abstract international body or bodies over which you have no control. The Greek people do not want to hear that it is their problem, and that they cannot have state jobs for their cousins and pensions for everyone - but if you tell them that Frankfurt, Paris, London - or even Gnomes in Zurich are the reason for fiscal rectitude they are much more likely to bear the pain and vote for you again. A New Drachma identifies the problem totally with the government of Greece, and civil disorder followed by a military coup are the most likely consequences.

There is no Euro crisis, just governments who pay too many too much. The Euro is the best solution for Greece or Spain or Portugal that they could possibly hope for. Like Ireland they can find a cure tomorrow and blame it on the necessity to stay in the Euro. Gnomes in Zurich, although perhaps more picturesque than Dealing Desks in Docklands, are nowadays better replaced by the Bundesbank and the IMF, but all are much better scapegoats than your own spending ministries and inefficient tax systems. The Euro is also the solution to the endemic problem of governmental overspending which lies behind the current crisis. All that is required is a simple credible and comprehensible fiscal rule. This is that if a government has a deficit of 4% in its spending this year then the salary of every state employee, the rate of every state pension, the amount of every benefit of subsidy must fall by 4% the following year. This rule is so clear and unambiguous that voters, politicians and civil servants will all know the consequences of their failure to keep their expenditure within their means will have direct personal consequences for them next year. Strangely enough, with such a rule deficits would disappear. At the 39th Olympiad in 622 BC Athens suddenly became entirely crime free when Draco decided the time had come to impose rules of conduct with easily understood penalties for transgressors. With the 30th of the modern series so recently on our screens perhaps the Greek Government should rip up plans for a New Drachma and decide the Euro is not the problem, but the solution - and it is from Athens and the 39th Olympics they should take their lead. Tough firm rules with draconian penalties if they are flouted are the only cure, and the sooner the better. A New Drachma may be just round the corner but it will be no solution.

If you would like more information please contact us via our website at http://www.nwbrown.co.uk

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