Monday, July 6, 2015

Can Greece Leave?

Is Grexit even possible?

It strikes me that the best Greece can do with a Drachma is to create a two-currency system, sort of like Cuba or Venezuela, or at best Argentina; countries whose politics the Greek government seems to admire, and whose economies its may soon resemble.

If the government brings back the Drachma  as a way to pay pensions, government salaries, and bank accounts, Euros will still circulate in Greece.

18% of Greek GDP is tourism. That number may be understated -- I don't know if it includes tourist spending at restaurants, stores, transport, and other places that mix tourists and locals. Tourists will spend Euros, not Drachmas. So hotels, gas stations, restaurants, grocery stores, clothes stores, airlines, car rentals, etc. will likely still gladly take euros and euro credit cards, and from locals as well as tourists.

I looked up Greek GDP at the OECD.  Of 157 billion euros value added, agriculture is a tiny 6, industry 18, of which manufacturing 13.  However, services are 130, 80% of the total.  Here, the big items are  "distribution, trade, repairs, transportation accommodation and food" 41, real estate activities 34, and public administration 39.   Exports and imports are each about 60 out of 180 billion euros.

Now, anyone exporting -- 60 out of 157 -- has access to euros and likely invoice in euros thank you very much. Anyone importing will need to get their hands on those euros.

(Interestingly most exports are services, most imports are goods. I can't get a handle on what services Greece exports, and thus whether devaluation would make much difference.)

The 41 billion of "distribution, trade, repairs, transportation accommodation and food" services will surely take euros as above, to convenience the tourist trade.  I can't fathom how 34 billion euros are real estate services -- not construction -- so I can't guess really if that is euros or Drachmas.  The 39 billion of public administration gets Drachmas.

So, the Drachmaized Greece that I see is not the cleanly devalued newly competitive powerhouse that some on the left seem to envision.  Instead I see a two-currency economy. Pensioners and government workers and anyone unlucky enough to still have a Greek bank account get Drachmas. Hotel owners, restaurant owners, and exporters get euros, above or under the table.

In this scenario, I can't imagine a freely convertible currency. Will the government really give 100 Drachmas to someone who used to get 100 Euros, with an exchange rate below half? The point of not cutting salaries was political. So we are almost sure to see capital controls, exchange controls, and a fictional overvalued exchange rate, so Greece can pretend to pay pensioners and government workers.

It's not a pretty thought. Sticking with the euro seems a far better option, just like sticking with the meter.


  1. (Interestingly most exports are services, most imports are goods. I can't get a handle on what services Greece exports, and thus whether devaluation would make much difference.)

    I presume the exports are mainly in the form of tourism services, no?

    1. That's what I'd guess, too. The World Bank classification seems to point in that direction, although in their data only 24% (16bn) of Greek exports are related to tourism

    2. and shipping services, anecdotally

    3. I live in Bulgaria, which is just north of Greece, and I believe I can venture an explanation for the large share of services in total exports.

      In the last 15 years, Bulgarian taxes have been consistently lower than taxes in Greece. Corporate tax and income tax in BG are 10% flat, and there is a further 5% divident tax over redistributed taxed company profit. In Greece, the corporate tax rate is I believe fixed at 26%, but income tax is progressive (22% up to 25 kEUR, 32% up to 42 kEUR and 42% on income above 42 kEUR).

      There are many Greek businessmen who own companies registered in Bulgaria, and I believe it would be tempting for all of them to try and save some income tax by offloading profits, and it so happens that the easiest way is to invoice services.

      The issue is so evident to Greek government that in February Tsipras proposesed legislation according to which Bulgaria, Ireland and Cyprus were to be treated as offshore zones due to their low tax rates, and that an advance 26% tax was to be levied on all outgoing payments towards these countries. The tax was to be returned within 3 months, after the business owner provided substantial evidence that the deal was factual and not made for the sole purpose of tax evasion. (The proposal was never voted as it clearly violated the EC common market laws.)

  2. "It strikes me that the best Greece can do with a Drachma is to create a two-currency system, sort of like Cuba or Venezuela, or at best Argentina."

    Or China and most of any successful country in East Asia, bar Japan (which also made foreign currencies inconvertible domestically until it was in a sufficiently strong position to withstand globalisation).

  3. Good you looked up the figures. As made in previous comments on your blog, a devaluation is unlikely to pay for stuff it will have to purchase in US dollars and Euros (eg oil for oil refining). Tourism and shipping services are major parts of its exports.

    The best guide to whether a devaluation will make much difference is to look at pre-Euro Greece. No, it did not do much for its growth or development. It was a continuous story of devaluation, balance of payments crises, defaults and inflation. Actually devaluations in cases such as Greece increase the trade imbalance by raising the prices of imports. That is why they want the Euro.

  4. Since Greece imports a lot more than it exports, isn't it obvious that a devaluation would be a very bad thing for Greece? This is not meant as a polemic question, I'm just trying to understand.

    1. Yes you are spot on, a few people have tried to point this out in vain in comments in various blogs, and it is now at last starting to catch on among US economists:

    2. Andreas,

      Your claim that devaluation is harmful where a country imports more than it exports is an odd one. The WHOLE POINT of devaluation is that it is supposed to rectify an external deficit. To say devaluation does not cure external deficits is a bit like saying that aspirin doesn’t cure head aches.

      However, it’s true that devaluation is not absolutely GUARANTEED TO WORK, just as there are people for whom aspirin is no use. The crucial question in the case of devaluation is the ELASTICITY of supply and demand for exports and imports: e.g. if loads more people take their holidays in Greece when Greece devalues by a small amount (i.e. if supply and demand for Greek holidays is elastic) then devaluation will work.

    3. If I pay with a credit card when I am on vacation in Greece, I pay in drachmas, not in Euro. If I take money from ATMs, I will receive drachma. I really do not see the whole point of this post. Inventing scenarios for defending a prejudice?

    4. The fact is that Greece imports so much more than it exports that I doubt that the elasticity of supply and demand will make a difference.

    5. "The crucial question in the case of devaluation is the ELASTICITY of supply and demand for exports and imports."

      Obviously, and that is the precisely the point being made. The point is there are no substitutes for Greek imports, including those needed to produce exports. Therefore the price elasticity of imports is very low. Tourism may benefit, but I would not put too much faith in that preventing a deterioration in the balance of payments.

    6. Ralph Musgrave, you sound like an open economy ISLM convert, but I suggest you google the Marshall-Lerner condition. There is a very strong possibility given Greece's production structure that a devaluation would worsen Greece's balance of payments position.

  5. I think it is mainly tourism and transports.

  6. I wonder what would happen if the Bank of Greece went rogue and started acting without the authorization of the ECB (for example, providing Emergency Liquidity Assistance above the allowed amount). How would the ECB retaliate? Would Greek euros start trading at a discount to non-Greek euros?

    1. I mentioned this in a previous discussion: If you're to break bad, break big. Theoretically Greece could invoke certain emergency provisions in the Lisbon Treaty and print euros. They could also sue the ECB for failure to fulfill one of its stated purposes - to maintain economic stability. Wouldn't you love to sit through a few years of drama as the case winds its way through the European Court of Justice?

      Realistically, I don't know how Greece could afford the paper and ink to print a lot of physical euros. Their printing facility only handles 10 euro notes. Secondly, all Greek-issued euros start with the letter Y and the ECB could just invalidate any note that starts with Y (first they would allow a brief window to allow people to turn in their Y notes and then shut the door to the newly-printed notes). Of course electronic euros would be another thing entirely. Thirdly, if you think the referendum threw a hand grenade into the mix, wait til you see Greece start printing euros.

    2. That's exactly what Greece did last time it joined a currency union (in the 1800s).

    3. It's actually very difficult to see how the Greek government could possibly issue a replacement for the Euro in the time available, even if they wanted to. The new currency notes would have to be designed pretty much from scratch; ATMs rebuilt, and then papers, inks, dies, stamps, and plates modeled, sourced, produced and tested, all with state of the art security and anti-counterfeiting devices (visible and invisible) embedded. This is a monumentally complex process, and would take many, many weeks at best, while the replacement currency is potentially needed this month (or next week even).

      In terms of 'new' banknotes, I can't really see what else Greece could do other than to continue, pro tem, to print their own 'unauthorised' Euros, possibly with a "Hellas" overprint. This would drive the ECB nuts of course, as machine readers probably wouldn't pick up the overprint, or people would miss it, or get confused or something.

      What a nightmare!

      But, ultimately, in a democracy, a government's first duty is always to its own citizens and not to its foreign creditors (something we seem to have forgotten).

    4. Member countries are allowed to mint commemorative coins, but these are not legal tender outside the issuing country. Not sure if there is a limit on how many can be minted.

  7. The benefits of becaming part of the EU for Greece surpassed the costs, they gave up of monetary independence but they had access to lower credit rates. I had been reading german sources on the matter in order to seize a better understanding of Greece. Also some french journals, even spanish media, there is no way one can avoid CNN. Its imposible to not have been aware of what was going on this days, a common element is that none of them assuming they represent an impartial opinion, seem to believe in Grexit. Not even former minister Vourafakis gave any signal of doing so. As you rightly describe, its difficult to imagine a Greek economy with two currencies given the current scenario, Euros as the refugee of prudent citizens trying to avoid lost of value in their savings and a legal tender for their everyday lives. With capital controls still in place, a banking system on life support, market confidence at its lowest and sovereign Greek debt rated at its worst (18.246% for its 10 year bond), what else can be seen? For now one thing is sure, its going to be bumpy ride, people are shortselling euros, it might be time to considering debt relief. Which is amazing! Nobody saw Greece's economy equivalent to the size of current GDP of Alabama could create so much noise.

    1. One shoul also consider all EU transfer to Greece along all membership i.e. from 1982 onwards. I cannot find data right now, but I remember they have been substantial.

  8. John,

    If you are a Greek citizen, would you pay your taxes in Drachmas or Euros?

    Using Drachmas to pay government employees will stop the bleeding (no more Euro denominated debt), but the question still remains - how will the Greek government obtain Euros to retire it's existing Euro denominated debt?

    1. "how will the Greek government obtain Euros to retire it's existing Euro denominated debt?"

      It is not going to pay the debt for a long time. What are the creditors going to do?

      It would be cheaper and faster if Greece simply legislated across the board pay cuts and cuts to rents and public (including state owned companies) pensions and let the market sort it out from there than to go to its own currency.

    2. Absalon,

      "It is not going to pay the debt for a long time."

      That is a political decision, not an economic one.

      The United States ran into this after the Civil War. Section 4 of the 14th amendment to the U. S. Constitution was borne of this concern:

      "What are the creditors going to do?"

      In the extreme? Pick up guns and liquidate Greece. Not that I am recommending it, but since you asked, that is one conceivable route.

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    1. Good grief.


      Stiglitz is a hack.

    2. I can't say I've seen a lot of criticism of his academic work, so I assume his Nobel Prize was well deserved. I have to agree that Stiglitz the mainstream commentator comes across as being more interested in political pandering than anything- see his book The Price of Inequality.

      I have to say though, The Renegade Economist does sound a little cooler than The Grumpy Economist.

  10. The main lesson is that there's no escaping cuts in wages and pensions. The Greeks didn't want nominal cuts as part of a deal with the troika, but they'll get them with inflated drachmas, IOUs, or whatever else comes along. Sorry Wimpy, your hamburger Tuesdays are gone. They were eliminated by an acute attack of mathematical reality.

    If they go the drachma route I completely concur with what's been said above about capital and exchange controls a la Argentina.

    "Greece can pretend to pay pensioners and government workers". Reminiscent of the old Soviet joke, "We pretend to work and they pretend to pay us."

    Since we're advertising, I would like to announce the IPO of my new Gambling Debt Backed Securities Fund. I guarantee a 50% return in 6 months. You buy shares of my fund and in 6 months I will return half of your money.

  11. Anat Admati points to this fascinating piece by George Kintis of Alcimos
    "Our Heretic (And Not-So-Simple) Views On The Greek Referendum" which explains a few things from the inside of Greece. Such as the huge exports of gasoline "....According to the UN comtrade database, supplies of bunker fuel to ships in Greece went from $25m in 2008 to $1.72bn in 2014. Exports of fuel to Turkey went from $204m in 2007 to $3.2bn in 2014. Exports of fuel to FYR of Macedonia in the same timeframe went from $72m to $614m (for comparison purposes, Greece’s GDP in 2014 was $238bn). Either Greek refineries got very efficient during the crisis, or other refineries in the region got very inefficient. Or it could be that the cleptocrats, hit by the crisis in their other half-way legit businesses, had to supplement their income with other, far more lucrative ventures.....There are similar tales to be told in natural gas, energy and practically every sector that has to do with the state...."
    This about supply side issues... But what is more interesting is this:

    ".... Tsipras expected a YES,,,He would likely to pay a visit to Ms. Merkel, with the results of the referendum at hand and tell Ms. Merkel, all your requests have been granted, now show us the money—save Greece. Now, Ms. Merkel will have no option but to oblige—how on earth can one say no to a nation which has overwhelmingly accepted everything requested of it? However, Ms. Merkel has repeatedly insisted that there is no deal without the IMF. She always wanted this, as she is afraid that a political decision at EU-level may force Germany to provide financing on concessionary terms to Greece and other potential laggards. But, horror-of-horrors, the IMF in so many words asks for the dreaded haircut. Can you kick out of the Eurozone (assuming, for a moment, this can happen) a country which has just yielded to all your demands? Can you accept a haircut, thus setting a precedent that, whenever a Eurozone country can’t service its debt, Germany will pay up? Ms. Merkel would be cornered, no? Under this scenario, Tsipras would be likely to get his debt relief.

    Unfortunately Tsipras won....

    In that case though..."...All that Greece would need is a €1.5bn loan from a friend (the US perhaps?) to make good on the IMF. The IMF could provide the entire €52bn that Greece needs over the medium term. Add that to the €32bn already lent by the IMF (and a bit more to support the banks, if needed) and now the IMF’s exposure to Greece becomes eminently serviceable—or “sustainable”, as they say. Why? Because the IMF has super-senior status, which means it gets repaid before anyone else—including the European bilateral loans of around €53bn, the €142bn lent by the EFSF, the €27bn in bonds held by the ECB and the €39bn in private debt. In other words, Germany would risk seeing its entire exposure to Greece subordinated to that of the IMF, with little leverage in case Greece does not pay up...."
    In both cases the IMF and tha US would box Germany

  12. There is a very simple way for Greece to stay in the EZ at the same time as dealing with its external deficit, which is the source of its debt, and that’s to impose import tariffs. The latter comes to much the same thing as devaluation.

    Of course tariffs break the spirit of the EU, but desperate times call for desperate measures. There’s also the problem that Greeks are a nation of cheats: half of them would then turn to smuggling. Nevertheless, import tariffs WOULD IN THEORY be a solution, yet the idea has not been mentioned at all, far as I know.

    1. Ralph,

      Actually, in one important way an import tariff is better than a devaluation.

      With a devaluation, the relative price of all goods potentially sold by Greekds to foreigners becomes cheaper - including stocks, land, buildings, and any existing goods.

      With a tariff directed at imported goods, only those goods are affected.

    2. Tariffs would be great right up to the point where your trading partners retaliate.

      If the currency devaluates in response to market forces isn't that better than the government trying figure out the right tariff? Who's better at determining the best prices?

    3. Okay, but who does overall reduced trade from a trade war hurt more - the net exporter or the net importer?

      There are lots of problems with tariffs (namely the political football they can become), and retaliatory trade policies tend to make both countries worse off, but as far as measures directly aimed at trade imbalance, they are probably your best bet.

      "If the currency devaluates in response to market forces isn't that better than the government trying figure out the right tariff?"

      The problem is that most currencies are government sponsored. A TRULY independent central bank does not exist. And so you are given the choice of a government choosing the right tariff or a government sponsored central bank choosing the right monetary / credit policy.

      Have you really eliminated government interference by introducing a central bank?

    4. JB,

      And really would the Germans mind much if Greece put a tax on imports from Germany to acquire Euros from German exporters to pay back Greek debt denominated in Euros and owned by Germans?

      Obviously there are a lot of what if's to consider - would German exporters be willing to take the hit to appease German bond holders? Would the Greek government turn around and spend the proceeds of a tariff to boost domestic demand or would it commit to reducing external debt?

      I think that a tariff where the proceeds of the tariff are explicitly allocated to external debt service could be stomachable to both parties (Greeks and Germans) and could probably pass muster under an amended Maastricht_Treaty.

      An added benefit of this is that with spending controls, domestic taxation can be lower to spur domestic production.

  13. Why can't Greece require that all domestic commerce be in drachma? This is required by many monetary sovereigns, which Greece would become if they also formed a state owned central bank. China's currency does not trade in currency markets so China pegs its currency to the dollar this way--the bank dictates how many yuan equals a dollar. You in China to do business, you do it in yuan. Works there. Why not in Greece?

    1. You are right. Cochrane is a little bit confused. He haven't heard of credit cards and ATMs probably. If I go on vacation in Greece, I for sure won't take cash with me apart from few euros.

    2. And when you go to Cuba, don't bother packing dollars either.

      You are envisioning a freely convertible Drachma. I doubt it.

    3. Anonymous,

      Actually it is a bilateral arrangement between the United States and China. The U. S. central bank could through U. S. banking interests in China attempt to unpeg the Chinese Yuan through open market operations of it's own. It choses not to.

  14. Well, the lawsuit against the ECB has begun.

    And one of the early opponents to the euro, William Hague, had this to say:

    "Economics has few laws, which is why economic forecasts are so maddeningly unreliable. If it has one law, it is this: that if you fix together some things which naturally vary, such as interest rates and exchange rates, other things, such as unemployment and wages, will vary more instead. And in a single currency zone, which has exactly this effect, you can only get around these problems by paying big subsidies to poorly performing areas, and expecting workers to move in large numbers to better performing ones."

    Currency, labor, fiscal transfers. Peg one and the others have to change.

  15. 2 currency systems lasted for several years in Balkan countries after communism. The local currency and the Mark.

    Most businesses preferred to be paid in Marks of course, and there was a quite large black-market currency exchange.


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