Thursday 16 June 2011

Returning To The Drachma Is Not The Answer

Writing about the Greek economy is like trying to catch a ball rolling rapidly away from you down a steep hill. The moment you write something, that ‘something’ becomes outdated by yet more very strange behaviour by Greece’s juvenile political class.


As the country stands on the brink of bankruptcy the major political parties still cannot work together on a common solution. My favourite comment comes from a former cabinet minister who loudly proclaimed he was against the structural reforms required for the country’s financial life line. “Our economic policy has failed, and we are putting the achievements of the last 25 years on the auction block,” George Lianis said today in the Financial Times. Achievements?! What achievements is he possibly talking about?

Does he mean the bloated state payrolls with an unrealistic retirement age and pension benefits? Or possibly he is referring to the rampant corruption in many sectors of the Greek economy. Maybe he is referring to the highly efficient, competitive state run companies. Just possibly he means the very effective barriers that the state has placed in the way of anyone trying to build a business, employ people and increase productivity. Please, Mr. Lianis could you be a little more specific? Unfortunately his comments are typical of the nonsense that passes for mature political and economic debate in Athens these days.

There is, unfortunately, no easy way out of this very deep hole that Greek politicians have dug for themselves over the last several decades. Anyone who thinks the solution would be to drop out of the Euro and adopt the old national currency, drachma, should think again. Far from helping Greece such a move would make any lasting reform and recovery even more difficult. To see the folly of such a move without fundamental economic reforms people should simply look across the Aegean at the experience of Turkey during the ‘lost’ decade of the 1990s when runaway inflation and a disappearing currency were the order of the day.

I remember those days very well when annual inflation averaged 60% - 70% and it took more than 1,000,000 Turkish lira to buy one U.S. dollar. There was a daily race to see if the pace of the currency depreciation could keep up with the inflation. One time I was giving a presentation in Switzerland, where they take currency stability very seriously indeed, and was asked an embarrassing question at the end of my talk. One disbelieving Zurich banker stood, checked his notes, and asked if it was true that the currency had depreciated 5% during my talk. Alas, I had to tell him that was very possibly the case.

The disappearing currency really didn’t benefit anyone because merchants would rapidly adjust their prices or simply list the prices in a hard currency. Prices in the Grand Bazaar, for example, were almost always in U.S. dollars, and now they are in Euros. Tourism prices like hotels were always listed in hard currency. What was worse was that much of the country’s mounting sovereign debt was also denominated in hard currency, and that meant that more and more Turkish Lira had to be printed to meet the interest and principal payments.

The corrosive nature of this condition was temporarily obscured by bursts of high growth and very, very high corporate profit margins. Companies would adjust prices upward much faster than they would increase wages, pay taxes, or contribute to the social security fund that was always in large deficit. Lending by banks was much less important than their buying and trading government securities. The government needed the banks to buy this paper when not many other people would touch it, and the banks loved the high interest rates.

The music to this mad dance finally stopped in February 2001. The day that Turkey was facing one the largest bond redemptions in history the prime minister got into a hissy fit with the president and went on television to announce that he could no longer work with him. We all watched horrified as interest rates soared to near 1,000% and the currency lost more than 50% by the close of trading. The long-running financial charade quickly unravelled, and 20 banks went out of business in the aftermath of this mess.

The time for gimmicks and covering bad management by printing more money was over. As a Turkish saying puts it, “The sea ended.” This time it ended on the rocks and not a nice smooth beach. What saved Turkey and put it on the road to sustainable growth, a solid financial system, and more transparent public finances was a rigorous reform program prepared by the International Monetary Fund and administered by serious Turkish officials.

The current ruling Justice and Development Party (AKP) swept into power in the 2002 elections on a wave of voter disgust at the failures of the previous regimes and the promise of continuing economic reforms. To a large degree AKP’s electoral success ever since 2002 is due to the country’s continuing economic success story. Yes, there are weaknesses in this story, but no one can deny the vast improvement over the economic management of previous governments. The improvement was so great that the currency is no longer a national embarrassment since the government removed six zeros from the denominations a few years ago.

The recovery in Greece will be long and painful in the best case, and the current behaviour of the political class only means that it will be longer and more painful than it has to be. Turkey showed that old economic taboos like fighting privatisation can be broken and that government finances can be made more transparent. Greece could do worse than to look across the Aegean for the model of how to do this.

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