Friday, June 1, 2012

Economist's Haiku for Europe

A lovely letter to the Economist says it all.
Sir: 

Leaving the euro zone is no option for Greece (“Fiddling while Athens burns”, May 19th). The new drachma would be valueless, as there would be no demand for it. A country that finds it difficult to run its fiscal affairs cannot manage a national currency. The restored drachma would stay in circulation only if the Greeks were denied access to foreign exchange, preventing the informal use of the euro. That would require draconian exchange controls of the type put in place by Germany after the first world war, which ensured the circulation of the depreciating mark during a period of hyperinflation.

What can Europe do for Greece? It can provide it with a stable monetary unit: the euro. What can Europe not do for Greece? Well, it cannot give it a sound fiscal system. The Greeks have to achieve that themselves if they wish to remain a sovereign country.

Ernst Juerg Weber
Associate professor of economics
University of Western Australia
Perth  

30 comments:

  1. Oh the new Drachma would be used, because "Bad money pushes out good money". But the wiser citizens of Greece would hoard Euros and Dollars.

    Eventually they will remove more and more of their wealth from circulation, At least within Greece, and the situation will be even worse than it is now.

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    1. "Oh the new Drachma would be used, because "Bad money pushes out good money". But the wiser citizens of Greece would hoard Euros and Dollars."

      That's just the 1st round of the game. If central bank in Greece kept their independence - a big if, I know - after more rounds drachma would find its actual market value, and that would not be zero.

      e.g. Latvian lata is not worthless, it just has low exchange rate. 2nd tier currency is not "worthless" like "monopoly money".

      "Eventually they will remove more and more of their wealth from circulation, At least within Greece, and the situation will be even worse than it is now."

      That hangs on an awful lot of assumptions, key of those being behavior of Greek central bank. Typically, central banks are highly independent even in countries in low-moderate rule of law. Only a total screwup like Zimbabwe FUBR their money. Greece is bad, but not *that* bad.

      Delete
    2. I based my assumption on the way that Greece has so far handled it's finances and refused to change. There is of course always hope that they eventually come to their senses and realize that they cannot indefinitely fund a cradle to grave welfare state with high unemployment and crushing deficits.

      However the evidence is they will resist this reality until the last minute.

      Delete
    3. To KyleN:

      Well, what you write is precisely why central banks are/should be independent.

      The keyword here is "Greece". Greece meaning what? Greek nation? Of course they'd blown it all like drunk sailors. just like French voters would. Yet the ECB operated by Frenchman did not behave like French voters. That's the very point of it.

      They would all fight *tooth and nail* for welfare state and living at expense of anybody, including but not limited to Germans. I've heard Greeks fuming that it's all conspiracy of govt that they are not paid lavish subsidies to maintain their lifestyles.

      Paul Volcker received death threats and madmen attacked Fed banks thinking it's either Bilderbergers or some evil lizards trying to kill American economy.

      Do you mean politicians? Similar cloth.

      Politicians, like junkies, know they won't be able to resist the heroine of easy money: and that is precisely why in their saner moments they create independent central banks.

      The big question is whether Greeks would have what it takes to make one and let it work.

      Delete
  2. The Greeks are unwilling to do their part; as a result, this will end in tragedy. See Simon Johnson's article, which was linked earlier on this blog.

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  3. The other members of the euro would not like to let the greeks print euros anymore, so Greece will not have an alternative. The same applies for the target2 credits at 1% interest rate. Of course they still could use the euro as a kind of gold currency.

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  4. Boy a haiku is a 5:7:5...this is an ozzie bul...t

    fu-ck-you-gree-ce (five)

    ka-wa-zu-lu to-be gk (seven)

    dra-kma no dra-ma (five)

    this is an hai-ku veersteend sïe'

    alles klar?

    nein?

    ok amerikan can can't?

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  5. Keep it polite,mani pullite 5 =five

    and on topic greeks are not geeks 7=seven up

    and amerikan banks are nice (5= fünf):


    this is an Haiku...in anglo-italian

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  6. my real name is Roetia (five

    swiss bank country for american to read (seven

    JPMORGAN is great but moronic? (five

    Many analysts and investors are worried that a default in Greece will ultimately cause a contagion to the U.S. This is because American banks are said to have a large exposure to Greek bond debt. If investors were cautious several years ago, it would have been understandable, but not anymore.

    the greek problem is made in USA

    Chicago burns like Detroit?

    or is less flammable/(slash)inflammable or infame?

    the bank that rules the world...the anome...

    this is not an haiku

    reading is a falsetto..only 4
    respond is a waste of time 5

    this neiter... they are only words for rubble

    like
    Perth after the jap attack

    They sunk Perth at Banten Bay....

    but only attack Darwin in Australia

    a pity....

    Perth is only a few miles away...

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  7. the greek armada of tankships (5)

    ships unloading oil at big fat amerika (seven)

    have the real American blood (five)


    a haiku in olive oil....

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  8. "The restored drachma would stay in circulation only if the Greeks were denied access to foreign exchange, preventing the informal use of the euro. That would require draconian exchange controls..."

    Good comment.

    Also, what about the already-existing paper euros circulating in Greece? I don't see why a shopkeeper would accept drachmas when there are plenty of good euros in people's wallets.

    Gresham's law only applies when there are two circulating currencies and the authorities successfully enforce a peg such that one currency is artificially overvalued. The undervalued currency disappears from circulation as people either hoard it or send it overseas where it has more purchasing power, leaving only the overvalued (the "bad") currency to circulate.

    But in Greece, the authorities lack the authority and power to even set a peg to begin with. Rather than being expelled, already existing paper Euros will continue to circulate while new drachmas fall to a deep discount. Anticipating this fall, why would people even rationally accept drachmas to begin with? New drachmas will be valueless as good money drives out bad.

    ReplyDelete
    Replies
    1. Peg would not only be unnecessary, in fact it would be counterproductive: drachma would just have to find its actual market value. It would be low/very low, and that's precisely the attraction: to make imports expensive and exports, such as they are, cheap.

      Again, it is not guaranteed that Greece would jump into hyperinflation Zimbabwe or Weimar Republic-style.

      Delete
  9. JP Koning: “[N]ew drachmas [will? would?] fall to a deep discount. Anticipating this fall, why would people even rationally accept drachmas to begin with? New drachmas will be valueless . . . .” No, the market will anticipate the exchange rate to which new drachmas would eventually fall (once equilibrium was reached), so they would trade at this exchange rate from the start. Suppose that rate, in view of the government’s actions and statements, was 1:3 (euros:nds). The government would be decreeing that debts contracted in euros could be paid off in new drachmas; this would be equivalent to cutting all debts by two-thirds. (But would it not be simpler for the government to issue the latter decree without leaving the euro?)

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  10. "No, the market will anticipate the exchange rate to which new drachmas would eventually fall (once equilibrium was reached), so they would trade at this exchange rate from the start. Suppose that rate, in view of the government’s actions and statements, was 1:3 (euros:nds)."

    Perhaps. But you are assuming that the process of introducing a new fiat drachma always results in a monetary equilibrium (say 1:3). This sort of monetary equilibrium in turn assumes that communication among economic players is unlimited so that it allows them in advance to agree upon some positive initial exchange value for a would-be-drachma.

    But a non-monetary equilibrium in which the drachma is capable of purchasing 0 euros is also a possible solution.

    Given the inherent frictions in the real-world, a non-monetary "corner solution" is not only possible, but highly probable, especially given the rather dubious credibility of the Greek state. Far safer for a shop keeper to not accept drachmas at all and require euros than to accept drachmas at a huge discount. Outside of equilibrium models, real world shop keepers simply cannot pre-calculate the would-be equilibrium value for the soon-to-be drachma, and will assume it to be 0.

    A potential monetary equilibrium requires some sort of institutional process for generating positive expectations sufficient to achieve drachma acceptability; I doubt there is such a process I would trust if I was in Greece right now. Setting a peg to the euro would be one option for generating positive expectations, but this only works in normal situations. Right now, no one would believe a drachma peg.

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  11. "Lovely" is a bizarre descriptor for this letter.

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  12. Given the inherent frictions in the real-world, a non-monetary "corner solution" is not only possible, but highly probable,in United States....

    Good lord....

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  13. "real world shop keepers simply cannot pre-calculate the would-be equilibrium value for the soon-to-be drachma, and will assume it to be 0. "

    That is a silly argument. The drachma will have a positive value as long as the Greek government makes it the only legal tender - shopkeepers and shoppers will still have to pay taxes.

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  14. I'm sorry, but that's way oversimplistic. At fist I thought this was good summary but the more I think about it, the more wrong things I find about it.

    I'll start with the middle: drachma and Greek central bank, as this is what the rest of the issue hangs on.

    1. It is not given that Greeks would not be able to create independent or at least largely independent central bank. Just because most Greeks find paying taxes optional does not have to guarantee that their central bank would print money like newspapers. As bad as Greece is politically, it is not Latin America-style banana republic: it has strong national identity and cohesion, and Greeks might be able to get themselves politically to create tolerable central bank.

    Nation's propensity to pay taxes (fiscal matters) is not the same as single, centralized organization that is legally protected and manned by central bankers. The two are not cut using the same nation's peculiar political cookie cutter.

    2. As long as not hyperinflated, drachma would not be worthless: if stable, after some time it could gain trust proportional just like other fiat money. Low exchange rate is not "valueless". If 1 unit of national currency buys you coffee and doughnut year in, year out, that's a working currency, even if that unit is worth 5 US cents. Drachma might be comparable to Romanian leia or Ukrainian hryvna: even if rule of law in the country is relatively poor, that does not guarantee hyperinflation already.

    Bad money pushes out good money only if bad money is actually bad, and that's not proven in Greece.

    3. Currency controls would be unnecessary, as it would actually be counterproductive: faced with underground euroization/dollarization, politicians would have to back off pressure on central bank. Were it not for such underground black markets, additional pressure on politicians would not be present, and that's bad, not good.

    4. If there was moderate inflation and low exchange rate of drachma (low, but not worthless), that would actually be a great thing for Greece: tourism would become extremely cheap by foreign standards and a much bigger source of income for Greece. OTOH, imported fuels and the like would become very expensive - and that's both good and bad thing, good in the sense Greeks would actually start being thrifty with them, bad because it would add to operating costs.

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  15. "But in Greece, the authorities lack the authority and power to even set a peg to begin with. Rather than being expelled, already existing paper Euros will continue to circulate while new drachmas fall to a deep discount."

    That part is true.

    "Anticipating this fall, why would people even rationally accept drachmas to begin with? New drachmas will be valueless as good money drives out bad."

    But that part isn't.

    Low exchange rate != worthless.

    Apart from the very first weeks, initial reatction, the key here is not expectations of people, the key is if Greek central bank would do it Zimbabwe way of "printing" money like crazy.

    Consider the scenarios:

    1. If it didn't, drachma would be just as good as any other fiat money with comparable inflation. Consider it successful exit from eurozone: a gain.

    2. if it did... well people would do underground "euroization", much like Russia did underground dollarization in 1990s. Situation - Greeks would be using euros just like they are using it now. More or less: zero loss.

    Seems to me they could only gain by dropping euro.

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  16. Readers who would appreciate a non-cutesy, non-gloating, non-moralistic take on the history and current reality of the eurozone economic crisis should read George Soros:

    http://www.georgesoros.com/interviews-speeches/entry/remarks_at_the_festival_of_economics_trento_italy/

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    1. Please John, Soros!! He may be very good in betting his money against currencies, and destabilizing the monetary affairs of countries, but as an economist? My goodness, I'd rather stay with Barro, Lucas, Sargent and Prescott, from whom I can actually learn something.
      In the piece you mention, Soros says:

      "I am not well qualified to criticize the theory of rational expectations and the efficient market hypothesis because as a market participant I considered them so unrealistic that I never bothered to study them."

      So, he never bothered to study "them", but still considers "them" "so unrealistic". So excellent for a guy pontificating that we economists did everything wrong for, what, 250 years or so, but is not bothered to actually study economics?
      Pleeeeaaase....

      Delete
    2. It's interesting to contrast Soros's straightforward candor with Lucas's 1980 remark that "at research seminars, people don’t take Keynesian theorizing seriously anymore; the audience starts to whisper and giggle . . . ." Economics is a broad field where there's much disagreement as to what's worth studying. Soros is joined by many well-credentialed economists in finding unrealistic the work of those you mention.

      Delete
    3. John,
      sorry to break you this news, but Lucas' remark is true today as it was in 1980. Yes, are there people desperately looking for "alternative", "heterodox" ideas? Sure. Still today there are scientists who believe in cold fusion, and if you look hard enough, probably there are scientists who believe you can turn copper into gold.
      The problem is that those "alternative" "heterodox" economists, who desperately look for something new, they very quickly run into something called "the resource constraint" and into "opportunity costs". They run into the good old saying that "there is no such thing as a free lunch". The primitive Keynesian crowd (the Brad DeLong-Krugman-Summers axis), the "alternative" and the "heterodox" economics crowd may think that you can spend and grow your way into oblivion, without costs, without expectations changes, without behavioral changes; but, at some point, whether they like it or not, there is a resource constraint, and markets at large know this (oh, those bond vigilantes!!).
      Soros sells snake oil economics. Not in vain, over the last 30 or 40 years there has been work on expectations, rules vs discretion, opportunity costs, etc, all of which the "alternative" crowd wants to dismiss as unimportant.

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    4. I'm sure you believe this, Manfred, but I'm reminded of lines by Robert Graves, that such expressions of certainty

      . . . awaken
      The toad who dreams away the past
      Under your hearth-stone, light forsaken,

      Who knows that certitude at last
      Must melt away in vanity--
      No gate is fast, no door is fast--

      That thunder bursts from the blue sky,
      That gardens of the mind fall waste,
      That fountains of the heart run dry.

      Delete
  17. "The drachma will have a positive value as long as the Greek government makes it the only legal tender - shopkeepers and shoppers will still have to pay taxes."

    The tax-drives money theory makes sense. A government sets an obligation on its population which can only be discharged by payment of fiat money, say drachmas, therefore creating a demand for drachmas such that they have a positive value.

    But you are implicitly assuming that the Greek government has the ability to impose an obligation on its population. There is no guarantee that this obligation could be credibly imposed, especially given the mass financial and social chaos that would follow an attempted euro-exit. Why buy drachmas to pay for taxes if you don't have to pay those taxes to begin with?

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  18. "But you are implicitly assuming that the Greek government has the ability to impose an obligation on its population. There is no guarantee that this obligation could be credibly imposed, especially given the mass financial and social chaos that would follow an attempted euro-exit. Why buy drachmas to pay for taxes if you don't have to pay those taxes to begin with?"

    That is total non-sense. The Greek state will not cease to exist and will not desist from taxing its citizens.

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  19. "As bad as Greece is politically, it is not Latin America-style banana republic:"

    What do you mean Latin America-style banana republic? In Latin America, I can only think of Venezuela, and maybe Argentina, as countries with a polity as sick as Greece. I do not know if you are European, but what you just said reflects the deep gulf between European self-image and the disfunctional messes some of their countries really are.

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    1. Hmm I am European indeed although not Western one (post-Soviet democracy) and from my vantage point South America apart from Chile is absolutely horrible mess (reportedly, Uruguay is not that bad) -- you don't have dollarization, mess like Venezuela or police on the street blackmailing you to give your money or else they will "find" narcotics on you (authentic experience of one friend of mine who travelled there). Greece seemed positively Swiss in comparison, as bad as it is with tax avoidance and completely insane politics.

      Although I may be wrong as I did not study subject in depth, just relied on third-party impressions.

      2 problems:

      1. Corruption

      Transparency International rates Greece at position 80 (surprising indeed, I thought they were not as bad), but most South American countries are well below. Brazil, interestingly is higher at pos. 73.

      The big question is how much of corruption TI rate "tax avoidance" reflects. Tax avoidance is not as bad I think as outright bribing. Not that Greeks have very clean record on that reportedly.

      2. Identity

      Corruption is not everything. Political participation once the dust settles may also be important, despite propensity to argue.

      What is it that South Americans have in terms of national identity? I'd argue less than Greece.

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    2. (1)
      "you do not have dollarization"? Not sure what to say about Greek monetary history. I wonder if Greece in all its modern history had OWN monetary institutions as strong as Peru has today.

      (2)
      Greece, as you mentioned, is right along with South American countries in terms of corruption.

      (3)
      Not sure what you said about bribing. I have lived most of my life in Brazil, never paid a single bribe.

      (4)
      Identity? What are you talking about? First, you seem to assume that Greeks have more sense of national identity than, say, Brazilians. That is utter non-sense. Second, national identity is an overated concept anyway.

      Delete
    3. you never ever paid a bribe in brasil pô?
      and you have mensalão vitalicius or vitalis?
      Backchich is a universal way...ask the USA congress...

      third, national identity is an overated concept anyway in Somaliland or zimbabwebwebué...national identity is the glue that made a federal state like brasil
      (estados unidos do brasil né? xará....)
      chamegos de gato pardo num chegam a negão?

      Delete

Comments are welcome. Keep it short, polite, and on topic.

Thanks to a few abusers I am now moderating comments. I welcome thoughtful disagreement. I will block comments with insulting or abusive language. I'm also blocking totally inane comments. Try to make some sense. I am much more likely to allow critical comments if you have the honesty and courage to use your real name.