By Jan Toporowski for Greek Left Review – #glrsi
Since the Greek crisis broke out in the Spring of 2010, many on the Left, their imaginations inflamed by the evident suffering of the Greek people and comment in the financial media, have taken up the theme common on the Right that the solution to the crisis lies in default by the over-indebted governments on their debts and withdrawal from the European Monetary Union. In this, those sections of the Left and the Right have misunderstood the significance of the case for default and withdrawal, and the way in which it is supposed to improve the situation for their countries. Insofar as there is a theory behind this, it is the old commodity money theory, which is also behind the mainstream optimal currency area theory, and that puts forwards the exchange rate as a substitute for real wages in maintaining trade competitiveness. The theory need not detain us here beyond observing that it does not work in a credit economy and, even if it did, Greece in particular is so dependent on imports that no devaluation of a ‘new drachma’, even on the most dramatic scale, could increase employment. The more important policy inspiration is the example of Argentina, which left its currency board with the U.S. dollar in December 2001, and rapidly came out of its economic crisis following a substantial depreciation of the Argentine Peso. The currency board, being a fixed exchange rate, is deemed to be similar to the European Monetary Union, in having a number of countries for which the exchange rate at which they entered the Union is now considered inappropriate.
The focus on the exchange rate peg that Argentina abandoned and its similarity with the European Monetary Union is, however, misleading. Much more important for policy is what the exchange rate peg does for the banking system. The Argentine crisis was precipitated by a banking crisis, rather than a crisis of government indebtedness (although that Argentina had too, but of foreign indebtedness, rather than in its domestic currency, as is the case for the indebted countries of the Eurozone). The banking crisis hinged upon the requirement, under the currency board, for the Argentine central bank to issue only banknotes that were backed by holdings of U.S. dollars. This limited the amount of domestic Argentine credit that could be converted into cash. When doubts about the viability of the currency board emerged, a run on Argentine commercial banks started, as their depositors sought to withdraw their deposits in cash in order to convert them into dollars before the peso depreciated. The run was stopped by coming off the currency board with a massive devaluation of the peso. The devaluation also allowed Argentine commodity exporters to win back markets that had been lost to Brazil and Uruguay, whose currencies had previously depreciated.
The situation in the Eurozone is fundamentally different. There is a crisis of government indebtedness, because the financial markets have been led by European policy-makers into something of a Ricardian funk, requiring sovereign debt to be much more readily repayable than it normally is. But the debt is in the domestic currency of the country and therefore, in principle, should be rather more easy to manage than foreign debt. Moreover, the Greek and Italian banks are not in crisis and are supporting their respective governments through buying government securities, with money borrowed from the European Central Bank. By the beginning of July 2011, the ECB had lent the Greek banks some €100bn, equivalent to some 27% of total outstanding Greek Government debt. (Incidentally, the tactic of the central bank lending money to commercial banks to buy government securities, which the central bank cannot or will not hold, was suggested for Germany back in the 1930s by Kalecki as a way of getting around the Reichsbank’s restrictions on holding German government paper).
In the Greek situation, default on the Greek government debt would have catastrophic consequences. The most direct effect would be on the finances of the Greek government. Despite commitments to its European partners and the International Monetary Fund to balance its budget by June 2011, the government still has a primary deficit in its budget, that is, it has a deficit even if it makes no debt or interest payments. Default would leave the government in the pathetic position of refusing to make debt payments to its bankers, and then coming back to them to ask to borrow more money. The consequence for Greek banks would be to make them insolvent, as the value of their government bonds is wiped out. Moreover, once withdrawal from the European Monetary Union came onto the public agenda, those same banks would be faced with a run on them by their customers, seeking to withdraw their deposits in Euros before those deposits are redenominated into to-be-depreciated ‘new drachmas’. Any surviving banks would then be pushed even further into insolvency with the depreciation of the ‘new drachma’ inflating the value of their Euro liabilities, including their borrowing from the European Central Bank. Similarly, the Greek government too would find that its Euro debts would increase relative to the depreciating ‘new drachmas’ in which it would now collect taxes. The same is true in the case of Italy.
In Argentina, default on the Government’s external debt and abandonment of the currency board revived the Argentine banking system. In the Eurozone, default and exit would destroy large parts of the defaulting government’s respective national banking system and, because of cross-border integration of banks in Europe, large parts of the German, French and even British banking systems too. The Left will end up politically compromised as financially incompetent, leaving the Right to take and hold power for a generation at least with a regressive economic reconstruction.
The recent debacle in Greece over the referendum on the latest agreement with the troika (the IMF, the EU and the ECB) does not change the politics of this situation. The threat of default and exit plays its part in this drama not as a realistic possibility but as the nuclear option of the Greek Government. The threat to default and exit is a threat to force the collapse of the banking system. The indebted governments, and the financial markets, know that there is one thing that the troika fear even more than inflation, or infringing the Stability and Growth Pact, and that is the failure of the banking system. Talk of default and exit is the government’s and the financial markets’ way of encouraging the troika to continue to refinance that Government. Refinancing the Government reinforces the debt servitude of the Greek people. Papandreou’s demand for a referendum was a tactic to ease the terms of that servitude: a tactic that unfortunately backfired.
There are other options for reducing the debts of indebted governments in the Euro-zone. A default, or a partial default, would have to be made up by a recapitalisation of the banks. As indicated above, this would be catastrophic for the banking system, and for the governments defaulting on their debts. The crisis would spread further through the exercise of credit default swaps and the reining of bank lending to the rest of the economy. Virtually the same effect on the aggregate balance sheets of the European banking system, and without any catastrophic consequences, could be obtained by levying a tax on the balance sheets of all European banks, and using the proceeds to repay in part the debts of the indebted governments. A tax of 1%, for example, used to repay Greek government debts, would be sufficient to halve the total of those debts in one year. Within five years the debts of the most indebted governments could be reduced to Maastricht-compliant levels. Such a tax would in no way diminish expenditure in the economy and leave banks and governments with much healthier balance sheets. If the European Union can agree a financial transaction tax, it can surely agree a tax on bank balance sheets that would save the banks and the public finances of Europe. Then we can get down to the real issues of political economy: rebuilding our economies, reviving democracy, and making our societies fairer and more prosperous.