July 20, 2015
Truthout, July 20, 2015
Like many people following the negotiations between Greece and its creditors, I was inclined to see Wolfgang Schauble, Germany’s finance minister, as the villain of the story. After all, Mr. Schauble insisted on severely punitive measures for Greece as a condition for continuing support from the European Central Bank (ECB). He appeared to be the bad cop relative to others in the negotiations, such as German Chancellor Angela Merkel, who was willing to make at least some concessions to keep Greece in the euro. But a more careful analysis arguably leads to the opposite conclusion.
Schauble did not argue for throwing Greece out of the euro simply as a punitive measure, although he quite obviously disapproved of the way Greece had run its budget and its economy. He argued, quite possibly sincerely, that at least a temporary departure from the euro zone would be the best path forward for Greece.
Schauble argued that a departure from the euro zone would have facilitated a restructuring of Greek debt. He also pointed out that a decline in the value of the new Greek currency would allow its economy to regain competitiveness. In particular, its tourism industry would suddenly be hypercompetitive as prices would possibly be 30–40 percent lower relative to other tourist spots in the region.
Schauble proposed an orderly disengagement from the euro that would allow Greece to reestablish its own currency with as little disruption as possible. He also proposed humanitarian assistance to ensure that supplies of food, medicine, and other essential items were available through the transition process.
This divorce process was clearly not the first best solution. That would have involved restructuring Greek debt while keeping Greece in the euro, but none of the major actors among the creditors seriously considered such proposals. The Schauble option looks quite good in comparison with the route Greece eventually took: a bailout with harsh terms that kept the country within the euro.
There are two major benefits from the Schauble plan. First, it would put Greece in a position to restructure its debt. While there would be many battles with creditors over the extent and conditions of any write-downs, the immediate outcome would be to free Greece from the obligation to run large primary budget surpluses to pay interest on its debt. This could provide a substantial boost to its economy as money that would be flowing out of the country for debt service could instead be used for domestic purposes like sustaining infrastructure and paying for health care and pensions.
The other major benefit would be that a lower valued currency would make Greek goods and services more competitive internationally. This should provide a substantial boost to its net exports, which would lead to growth and jobs.
The impact of a more competitive currency was hugely important in the case of Argentina, which is often viewed as a model for this sort of default/devaluation. Back in the early 1990s Argentina reached into the basket of really bad economic ideas and rigidly tied its currency to the dollar. While this put an end to the country’s problem with inflation, the tie to the dollar put Argentina into an economic straight jacket by the end of the 1990s.
Rising interest rates made its debt burden unmanageable. At the same time, a higher valued dollar made Argentina’s goods less competitive in the world economy. As a result, its trade deficit soared, pushing the country into a severe recession.
After the country finally broke with the dollar at the end of 2001 Argentina’s trade situation quickly improved. Argentina had a trade deficit of more than 4 percent of GDP before the recession began in 1998. In 2005, when it had more than recovered all the ground lost in the recession, Argentina had a trade surplus of 2.0 percent of GDP.
This shift from deficit to surplus of more than six percentage points of GDP would have add more than 9 percent to Argentina’s GDP in 2005, assuming a spending multiplier of 1.5. In the U.S. economy in 2015, this would be equivalent to $1.6 trillion in additional output. And this improvement in the trade balance was not the story of a boom in soy bean prices, Argentina’s principle export, as is often claimed. Soy bean prices in 2005 were little changed from their 1998 level.
Argentina had to go through the ordeal of a disorderly break with the dollar, which meant months of financial and economic chaos before it got its banking system back in working order. If Mr. Schauble was proposing a process that would smooth this transition for Greece, the prospects for a quick recovery and renewed growth would be hugely increased.
The Greek government had not prepared itself for the process of leaving the euro. Perhaps the world will be surprised and the deal it reached with its creditors will provide a basis for renewed growth. But if not, it may want to get back in touch with Mr. Schauble.