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Monday, July 13, 2015

Impending disaster in Greece

Paul Krugman analyzes the debacle in Greece. Although Greeks voted barely a week ago to reject the bailout terms offered by the EU, which called for uninterrupted austerity, Prime Minister Alexis Tsipras proposed to the EU to accept almost all of the terms if there was some true financial relief. Instead, what the European Union, spurred by Germany, proposed today demanded all of the pain, and none of the gain that Tsipras sought. Indeed, Germany has essentially demanded regime change in Greece, even though Tsipras only came to office in January. As Krugman says, "It is, presumably, meant to be an offer Greece can’t accept."

The Germans, it would appear, have decided to push Greece from the eurozone. But demanding an end to Greek sovereignty and austerity as far as the eye can see is simply evil. Moreover, it negates the long-successful stand of European Central Bank (ECB) president Mario Draghi that the ECB would do "whatever it takes" to keep the eurozone intact. The ECB's reputation would be damaged greatly should crisis recur in Spain, Portugal, Ireland, etc., now that the world knows the ECB will not do "whatever it takes." This is a recipe for a new recession in Europe spreading from the EU periphery. The German demands are particularly "grotesque," as Krugman says, when you consider that Greece has already endured 25+% unemployment for three years (see chart). This is an unemployment rate that the United States never saw even at the height of the Great Depression in 1933, when it peaked at 24.9%.

However, I believe Krugman's argument actually overlooks an important point. He writes:
But still, let’s be clear: what we’ve learned these past couple of weeks is that being a member of the eurozone means that the creditors can destroy your economy if you step out of line.
His point is that eurozone membership has removed Greece's ability to exercise monetary policy autonomy and respond to its specific conditions, including via currency devaluation. Indeed, there can be no doubt that monetary union was flawed from the start. But Krugman overestimates the ability of devaluation to fix an economic crisis. At the same time, he underestimates the ability of creditors to destroy a government whose economic policies they disapprove of.

 The mega-example of this, of course, is the Latin American debt crisis of the 1980s. Mexico, Brazil, and all the other victims of this crisis (caused primarily by the U.S. Federal Reserve cranking up interest rates to astronomical levels in the late 1970s and early 1980s, which in turn caused an unprecedented rise in the value of the U.S. dollar and a global recession) were "bailed out" by the International Monetary Fund (IMF) in order to prevent the collapse of creditor banks in the United States, but were subject to strict austerity, with the same results we've seen in the EU. Indeed, in virtually every Latin American country income per capita was lower in 1990 than at the start of the crisis in 1982, giving rise to the term "lost decade of development" to describe these events. Supposedly, the IMF learned its lesson after the Asian financial crisis that austerity packages didn't work. Krugman has argued this many times (one example here). Indeed, the IMF has seemed to be more of a voice of sanity in the current crisis than in either the Latin American or Asian crises. Yet, in the endgame of the Greek crisis, this seems to have fallen away, with the IMF going along with the EU on Greek austerity. Something is seriously wrong here.

But there is another important example to mention, where the IMF was not involved. This, too, was a result of the Fed-caused global recession, this time in France. After Francois Mitterrand and the Socialist Party swept to power in 1981, among the government's many policy changes was an attempt at Keynesian stimulus. However, this was met by massive capital flight. The problem was that the French franc was losing so much value that the government had to reverse its policies. For example, the franc was 4.6453 to the dollar in January 1981, but fell to 8.0442 by August 1983, 9.3041 by September 1984, and 10.0933 in February 1985. The takeaway is that even having floating exchange rates does not guarantee that you can maintain your policy independence.

Events are moving very rapidly; perhaps the EU will find a way to prevent this disaster. But at the moment, things look very grim.


  1. I'm not sure I understand the worry about currency devaluation ("For example, the franc was 4.6453 to the dollar in January 1981, but fell to 8.0442 by August 1983, 9.3041 by September 1984, and 10.0933 in February 1985"). It was my understanding that devaluation was not a danger to avoid but rather a goal to achieve. Are you suggesting that there could be *too much* devaluation?

    1. According to David Andrews (in my co-edited book *Structure and Agency in International Capital Mobility), France's foreign exchange reserves came within days of being exhausted and the country was facing an immediate plunge in the value of the franc of more than 20%. The government's assessment (which, of course, could have been wrong, but I'm not in a position to judge) was that the immediate inflationary consequences could not be dealt with. Hence, the retreat from unilateral expansion.

      At the same time, these events motivated the French to seek the creation of the euro, as a way of not being beholden to the German Bundesbank's monetary policy. But as we have seen, in the negotiations creating the euro, the Germans were successful at creating a European Central Bank that maintained the Bundesbank's singular responsibility of preventing inflation with the US Fed's dual mission of reducing unemployment. Talk about locking in a deflationary bias!

  2. France did not have a floating exchange rate under Mitterrand. It had joined the European Exchange Rate Mechanism in 1979, and Mitterrand's decision to keep the franc in the ERM led to the u-turn and austerity starting in 1984.

    1. Indeed. The full story serves as a milder foretaste of what has just happened, in much more brutal fashion, to Syriza supporters' hopes for a genuine (anti-austerian) solution to the Greek crisis:

  3. What is the alternative to "austerity"?

    Greece has been overspending for years, and piling up debt. If the debt is cancelled so that Greece can make the new, lower payments, who will lend them more money? No-one. The result will still be "austerity" (i.e., living within their means).

  4. Greece has been reducing its GDP faster than its debt, which is why the debt/GDP ratio keeps growing. The alternative to austerity is growth.

    As for your second question, even within the flawed lens of "country as family," if you declare bankruptcy it's actually quite easy to find credit card offers. They'll have crappy terms at first, but get better over time. So you should not be surprised that after a debt writedown, Greece can borrow. Iceland is a perfect example of this. It can now borrow at very low rates.

    1. Sounds like bad money after good.