A Plan of Hope for Greece

Both Project Syndicate and Le Figaro declined to publish the following proposal. Given the type of analysis that they use to publish I take that rejection as a compliment.

In “A plan of hope for Greece” I argue that the main cause of the present and dramatic difficulties of the Greek economy is the grossly mispriced exchange rate implicitly embedded in the euro and that, as a consequence, the return of the Greek economy to growth requires above all a return to monetary independence and a substantial devaluation of a new Drachma vis-à-vis the euro. Instead of waging a “war of secession” against Greece and try to impose further austerity to a deflationary economy, the other EU and Eurozone nations should recognize that a major debt relief is unavoidable and should be accompanied by a generous “new Marshall Plan” that would guarantee a continuing access of the Greek government to international financing during a transitional, post-Grexit, period. It must be understood as the price to pay in order to avoid a much more costlier permanent “transfer economy” from the North to the South of the EU, and the condition for a stabilization of Europe’s interests in the Balkans and the Middle East powderkeg.

A Plan of Hope for Greece

Jean-Jacques Rosa

June 27, 2015

No solution to the Greek problem is possible as long as the question is framed into a restrictive confrontation between the creditors’ injunction “commit to reform (i.e. spending cuts and tax increases) to get liquidity” and the Greek government’s rebuttal “debt relief first” and “we chose our own cuts and taxes”.

It should be recognized that a Greek recovery is possible but requires, as a sine qua non condition, an exit from the euro, and this in turn can only succeed if conceived in a spirit of European solidarity. It is imperative both to restore hope to the Greek society and to reassure other members of the EU that do not wish to shoulder the burden of a permanent transfer society, but want to preserve the political union of the continent. European leaders should offer Greece a modern Marshall Plan, which ought to be an essential element in a strategy of controlled exit of Greece from the eurozone.

Despite the previous 2012 partial defaults on external debts, the Greek economy is still mired in hopeless depression and continued deflation. While the current debt burden of about 180% of GDP, and growing, is simply not sustainable, additional spending cuts required by the creditors’ cartel will aggravate depression, and additional liquidity, if supplied, will further deteriorate the debt/income ratio, thus intensifying the debt-deflation vicious circle.

The fundamental cause of the problem is that a small, and by necessity very open, economy is easily sunk by an inadequate, mispriced, exchange rate. Since the entry in the Eurozone in 2001, the massive divergence of costs between Greece and its main partners, which are all members of the zone, has resulted in the equivalent of a massive exchange rate revaluation. Greek products (including tourism and shipping) are now priced out of foreign markets while Greek imports became relatively cheaper than local products, depressing local activity. This accumulated chasm should take several more years of deflation, depression, and misery to be breached. This is politically and humanely impossible.

The obvious and quick solution then is to devalue a new Greek currency vis-à-vis its Eurozone partners and complement that by a major debt relief. This is a classical, well known, mainstream economic solution to this type of problem. But that strategy is ruled out by the cartel of creditors and the authorities of “institutional Europe” for fear of the contagion effect that a Grexit would produce on other struggling southern economies, and of a subsequent unraveling of the euro. The Greek government, on the other hand, fears to renege on its electoral promise to stay in the euro, and also to lose access to international financing coming currently mostly from other European governments, so that an exit would mean, in the short run, an aggravated economic slump and more bankruptcies before the economy can benefit from a return to growth. 

Moreover a confrontational exit, a “war of secession”, would weaken the EU itself at a time of major political and strategic uncertainties in the Middle East and Central Europe.

A positive aspect of the problem, however, is that its magnitude is small. Greece’s GDP amounts to only about 2% of EU’s GDP, and thus its overall debt can represent no more that 4% of overall EU’s GDP. Thus, helping the Greek economy to return to growth and hope is a relatively minor task compared, for instance, to what was the European problem at hand in 1945. Currency reform and the Marshall plan aid helped devastated Germany to reconstruct its economy and return to brilliant growth, a policy that Mr. Schäuble and Ms. Merkel should remember and ponder. The reason and generosity that prevailed then should also prevail today.

Accordingly, all parties would benefit from the following strategy: complement a Grexit – a return to the Drachma with a radically lowered parity to the euro -- with a major debt relief (50% or more) and a guarantee by the creditors governments – and the so-called Eurogroup -- of a continued access by Athens to ECB’s very low interest rates borrowing during a transition period, let’s say of five years. It would be during that period that a reform and budget consolidation could take place in step with the return to positive growth rates, and not before.

The European northern creditors would thus trade the necessity of continued transfers to an ailing Greek economy for an indefinite future for a one shot temporary aid that would really restore its capacity to grow, as it clearly existed before the fateful entry into the Eurozone.

Such a strategy would rather strengthen the euro than weaken it, vindicating the commitment of the current member States that prefer a strong currency to a weaker one. It would also create a precedent for a much needed orderly, constitutional, euro exit procedure that could be elaborated for the benefit of countries that prosper more under a relatively weak currency, and would supply an alternative to the unrealistic and preposterous claim of “irreversibility” that is at the root of the present war of secession.

And if some other country then wanted to exit from the Eurozone, it would be for good, fundamental, economic reasons and without creating a political and financial crisis that would jeopardize the rest of the EU.  The survival of a euro and the return of Greece to hope, ending the rampant civil war in the EU, depend on European leaders’ generosity and breadth of vision.  The opportunity is for them to chose.

 

Grexit: A European Solidarity Solution.

In the Greek drama one thing is certain: according to the criteria of optimum currency areas (OCA) theory (the validity of which has been amply vindicated by the recent evolution of the past few years in the eurozone) Greece cannot be part of the same currency area as Germany. And since the euro has been managed as a “DM bis”, Greece cannot anymore be part of the eurozone. It never should have been admitted in the first place, a reality readily acknowledged, with a perfect logical inconsistency, by those who at the same time assure us that it is out of the question that Greece could return to monetary independence.

In reality, insofar as it is totally impossible for the Greek economy to morph into a sort of clone of the German economy, even by investing a huge amount of time and effort, there is no other way for Greece to resume a path to prosperity than by an exit from the Eurozone as soon as possible, while defaulting partially or completely on its debts in euros that the French and German bankers and the ECB detain.

A new drachma that would be devalued in the first weeks by some 30 to 50% from an initial parity definition relative to the euro and the dollar would instantaneously restore the tourist and oil industries international competitiveness. But of course such a move would raise the question of the sanctions external financial markets would apply to the defaulting borrower. That is the crux of the problem and it is the reason that prevents Greece from defaulting its way back to prosperity. This is also what prevents today the Greek government to choose the exit from the euro, for fear of inextricable financial difficulties in the near future.

It also appears that the Greek public opinion wants to keep with the euro, probably as a token of its close affiliation with the smallest inner circle of the European Union, so great is the Greek distrust of its Turkish neighbor. But it is equally clear that it is not and will not be possible in the future to simultaneously satisfy the legitimate aspirations of the Greek people to regain prosperity and its aspiration to keep the euro as its national currency. The Tsipras government thus tries to demonstrate to the voters that the northern Europe creditors, and especially German ones, allied to the IMF in the Troika, intend, by refusing to grant new payment and credit facilities, to force the country to leave the euro, against his will. The Greek government thus hopes to renege on its commitment to stay within the eurozone without suffering the political penalty that disaffected voters could impose on Syriza.

For its part, the Merkel government, the leader of the creditors and therefore a strict adherent to financial orthodoxy, which is not illegitimate, knows that his constituents want to avoid at any cost a commitment towards a federal Europe that would imply permanent transfers to southern European countries, in the same way that northern Italy subsidies on a permanent basis the Mezzogiorno , or west German Länders the eastern ones. Indeed, these transfers can be understood as palliative care but they do not effectively treat the underlying problem of inequality in economic development. It follows that, rationally, both the Tsipras government and the Merkel government have in fact to recognize that a Grexit is unavoidable. But both are trying to shift all the responsibility of the rupture to the other party, for electoral reasons: Mr. Tsipras because he promised his constituents to remain in the euro and Ms. Merkel because she promised her own electors not to grant any more aid to a Greece described as "parasitic".

The euro is the bone of contention that, instead of promoting an "ever closer union" among the member countries of the area, gradually leads to a breakup of the European Union, a trend that was perfectly understood and predicted by the American economist Martin Feldstein as early as 1992.

Can one imagine a solution that would allow both antagonistic governments to implement jointly their only common and realistic policy while substituting a real European solidarity to the destructive current confrontation within the EU? This is in my opinion a matter of positive incentives. Economic analysis and rationality leave no doubt about what the outcome will be: the Grexit must prevail. To get it by agreement between the two protagonists rather than by the use of a showdown in which each side is trying to shift to the other all the responsibility for reaching this necessary conclusion, Germany has to make the Greek exit both honorable and nontoxic for the southern economy. First it has to make clear that it is impossible to save the Greek economy from complete destruction without restoring an independent currency tailored to their specific needs, economic as well as political. But it should make this exit solution even more attractive by providing financial assistance not in the case in which Greece choses to stay in the straitjacket of the euro, but on the contrary only in case of an exit. It should be a sort of a new Marshall plan, concerted with other European countries, supplying Greece renewed funding after partial default for a limited time only. The plan should be established in liaison with the ECB that would act in the same direction.

Such an aid is justified by the fact that all the Eurozone countries that accepted the entry of Greece in the euro should share some responsibility for that major mistake and pay for it.

For its part the Greek government should, in these circumstances, speak the language of truth to his constituents, and explain clearly that the return to growth is possible and will be supported by the other European, but at the cost of exit of the euro. Such an exit would not mean leaving the European Union, on the contrary. But the positive results of such an exit coupled with a substantial devaluation and a partial erasure of its debt in euros, and of a once and for all new aid from other Europeans should lead to positive results in terms of growth in a few months, certainly enough to win most of the Hellenic voters to accept the new policy and overall situation.

Instead of escalating towards an acute crisis in a confrontation of two governments that in fact basically agree on the only possible solution, a constructive agreement of European solidarity would satisfy both the legitimate aspirations of the German people and the Greek one.

But this requires a little more realism and high mindedness in Athens, Berlin and Frankfurt.

Grexit : une solution de solidarité européenne.

Dans le feuilleton grec une chose est certaine : selon les critères des zones monétaires optimales (qui ont largement démontré leur validité dans l’explication du réel au cours des dernières années) la Grèce ne peut faire partie de la même zone monétaire que l’Allemagne. Et comme l’euro était jusqu’ici défini comme un DM bis la Grèce ne peut donc faire partie de la zone euro. Elle n’aurait jamais dû y être admise en premier lieu, ce que reconnaissent volontiers, avec une parfaite inconséquence logique, ceux qui en même temps nous assurent qu’il ne saurait être question que la même Grèce puisse reprendre son indépendance monétaire.

En réalité dans la mesure où il est totalement exclu que l’économie grecque puisse se muer en une sorte de clone de l’économie allemande, même en y consacrant beaucoup de temps et d’efforts, il n’y a aucun autre moyen pour la Grèce de retrouver la voie de la prospérité que de sortir au plus vite de l’euro, quitte à faire défaut partiellement ou totalement sur ses dettes en euros détenues par les banquiers français et allemands ainsi que par la BCE.

Une nouvelle drachme qui serait dévaluée dès les premières semaines de quelques 30 à 50% par rapport à une parité de définition initiale vis-à-vis de l’euro et du dollar, rendrait aux industries touristiques et pétrolières hellènes leur compétitivité perdue. Mais se poserait bien entendu la question de savoir quelles sanctions les marchés financiers extérieurs appliqueraient alors à l’emprunteur défaillant. Là est le nœud du problème et c’est ce qui pourrait empêcher une Grèce défaillante de retrouver la prospérité. C’est aussi ce qui empêche aujourd’hui le gouvernement grec de choisir la sortie de l’euro par crainte de difficultés financières inextricables dans un proche avenir.

Certes il apparaît que l’opinion publique grecque souhaite conserver l’euro, sans doute comme gage de son appartenance étroite au cercle interne le plus restreint de l’Union Européenne, tant est grande la défiance à l’égard du voisin turc. Mais il est tout aussi clair qu’il n’est pas et ne sera pas possible à l’avenir de donner simultanément satisfaction à l’aspiration légitime du peuple grec de retrouver la prospérité et à son aspiration à conserver l’euro comme monnaie nationale. Le jeu du gouvernement Tsipras consiste alors à démontrer à ses électeurs que ce sont les créanciers du nord de l’Europe, alliés au FMI, qui en refusant de consentir de nouvelles facilités de paiement et de crédit obligent le pays à quitter l’euro, contre son grès. Le gouvernement grec espère ainsi revenir sur son engagement de rester dans l’euro sans pour autant subir la sanction que risquent de lui infliger les électeurs.

De son coté le gouvernement de Mme Merkel, chef de file des créanciers et donc de la rigueur comptable, qui n’est pas illégitime, sait très bien que ses électeurs ne veulent à aucun prix s’engager dans la voie d’une Europe fédérale qui impliquerait des transferts permanents à perte de vue pour les pays d’Europe du sud, à la façon de ce que fait l’Italie du Nord pour le Mezzogiorno ou encore l’Allemagne de l’ouest pour les Länders de l’est. Ces transferts sont des soins palliatifs mais ils ne soignent pas utilement le problème sous-jacent de l’inégalité du développement économique. Il s’ensuit que rationnellement, tant le gouvernement Tsipras que le gouvernement Merkel sont en réalité d’accord pour un Grexit, une sortie de la Grèce de l’euro. Mais chacun tente de faire porter à l’autre toute la responsabilité de la rupture, pour des raisons électorales : M. Tsipras parce qu’il a promis à ses électeurs de rester dans l’euro et Mme Merkel parce qu’elle a promis aux siens de ne plus accorder la moindre aide à fonds perdus à une Grèce décrite comme « parasitaire ».  

L’euro est bien la pomme de discorde qui, au lieu de favorise une « union toujours plus proche » entre les pays membres de la zone pousse progressivement à un éclatement de l’Union Européenne comme l’avait parfaitement prévu l’économiste Martin Feldstein dès 1992.

Peut-on alors imaginer une solution qui puisse à la fois permettre aux deux gouvernements antagonistes d’appliquer la politique qu’ils souhaitent tout en substituant une réelle solidarité européenne au conflit actuel destructeur de l’Union. C’est à mon sens une question d’incitations positives. L’analyse économique et la rationalité ne laissent pas d’ambiguïté sur l’issue : c’est le Grexit qui doit s’imposer. Pour l’obtenir par accord entre les deux protagonistes plutôt que par recours au bras de fer dans lequel chacun tente de faire porter à l’autre toute la responsabilité de cette issue nécessaire, il faut que l’Allemagne rende la sortie grecque à la fois honorable et non toxique. Elle peut le faire en partant du constat d’impossibilité de sauver l’économie grecque sans la doter d’une monnaie indépendante et adaptée à ses besoins, économiques comme politiques. Mais elle doit rendre cette sortie plus attractive en prévoyant une aide financière non plus en cas de maintien de la Grèce dans le carcan de l’euro mais au contraire en cas de sortie. Ce devrait être un nouveau plan Marshall assorti de crédits renouvelés, pour un temps limité, qui seraient consentis à la Grèce et à sa nouvelle monnaie, en liaison avec la BCE pilotée par M. Draghi dans le même sens. Et de son coté le gouvernement grec doit tenir, dans ces conditions, un langage de vérité à ses électeurs en leur expliquant que le retour à la croissance est possible et qu’il sera soutenu par les autres européens, mais au prix d’une sortie de l’euro qui ne signifie pas pour autant la sortie de l’Union européenne, bien au contraire. Les résultats positifs d’une telle sortie assortie d’une dévaluation substantielle, d’un effacement partiel de sa dette en euros et d’une nouvelle aide des autres européens devrait entraîner des résultats encourageants en termes de croissance à horizons de quelques mois, ce qui suffirait certainement à rallier la plupart des électeurs hellènes à cette nouvelle donne.

Au lieu d’aller droit à la crise par confrontation de deux gouvernements qui sont au fond d’accord sur la seule solution possible, un accord constructif de solidarité européenne permettrait à la fois de satisfaire les aspirations toutes deux légitimes du peuple allemand et du peuple grec.

Mais il faut pour cela un peu plus de réalisme et de hauteur de vues tant à Athènes qu’à Berlin et à Francfort.

Whither the Euro?

An excellent paper by Kevin O’Rourke (All Souls College, Oxford) in Finance and Development (IMF, March 2014).

Excerpts:

“Historians may wonder how it came to be introduced in the first place.

The euro area economy is in a terrible mess.”

Indeed, the eurozone GDP still 3 percent lower in 2013 than in the first quarter of 2008 while in the United States it was 6 percent higher, and the zone unemployment exceeding 12 percent, “are not minor details, blemishing an otherwise impeccable record, but evidence of a dismal policy failure.

The euro is a bad idea, which was pointed out two decades ago when the currency was being devised. The currency area is too large and diverse – and given the need for periodic real exchange rate adjustments, the anti-inflation mandate of the European Central Bank (ECB) is too restrictive. Labor mobility between member countries is too limited to make migration from bust to boom regions a viable adjustment option. And there are virtually no fiscal mechanisms to transfer resources across regions in the event of shocks that hit part of the currency area harder than others.

 Problems foretold

All these difficulties were properly pinpointed by traditional optimal currency area theory.”

Readers please note: it was “the theory” that predicted these difficulties before the fact, not individual economists! So judgment and clear understanding of theory and facts count for nothing … What about the (majority of) economists who neglected the teachings of OCA theory?

Maybe this curious conception of economic analysis has something to do with the author’s confession, later in the paper, that:

“I and many others have made such arguments (for “more Europe” rather than less) over the past five years. But as time goes on, it becomes more and more difficult to do so with conviction.”

His confession of guilt is welcome. But he could add the few names (there weren’t many!) of the economists who were right from the start, Martin Feldstein for example. And one that, spectacularly, had his theory right from the start but his analysis dead wrong, Robert Mundell!

Fortunately O’Rourke has some interesting things to add:

“..it is becoming increasingly clear that a meaningful banking union, let alone a fiscal union or a safe euro area asset, is not coming anytime soon. For years economists have argued that Europe must make up its mind: move in a more federal direction, as seems required by the logic of a single currency, or move backward? It is now 2014: at what stage do we conclude that Europe has indeed made up its mind, and that a deeper union is off the table? The longer this crisis continues, the greater the anti-European political backlash will be, and understandably so: waiting will not help the federalists. We should give the new German government a few months to surprise us all, and when it doesn’t, draw the logical conclusion. With forward movement excluded, retreat from the EMU may become both inevitable and desirable.”

O’Rourke however relapses in “eurospeak” when he concludes that the demise of the euro “would be a major crisis” and would require “capital controls, default in several countries, (and) measures to deal with the ensuing financial crisis.”

This standard pessimistic outlook has been repeatedly made by euro sectarians, including Barry Eichengreen who has even claimed that while it was possible to become a member of the Eurozone, it was radically impossible to get out (despite abundant contrary evidence on a number of exits from fixed exchange rates arrangements, as well as currency zone dissolutions) because it would create “the mother of all financial crises” – whatever that means!

Common sense, on the contrary, tells us that if the real exchange rates are deeply misaligned within the shared currency (because of implied nominal exchange rates fixed “forever”) and since the misaligned exchange rates are the cause of deep structural imbalances in the national economies of the area, a return to equilibrium exchange rates should favor a resumption of growth an prosperity. Once this burdensome handicap is removed, the economy should return to a “natural rate of growth”, especially so because of the accumulated slowdowns of the past two decades.

A final interesting consideration. Since our techno-monetaro-economists are so deeply ignorant of political realities and public choice theory, they should read the following sentence of O’Rourke:

“During the interwar period, voters flocked to political parties that promised to tame the market and make it serve the interests of ordinary people rather tha the other way around. Where Democratic parties, such as Sweden’s Social Democrats, offered these policies, they reaped the electoral reward. Where Democrats allowed themselves to be constrained by golden fetters and an ideology of austerity, as in Germany, voters eventually abandoned them.”

Politicians beware ...