After setting out on a grand political project of closer integration it turned out that the debt owed and austerity required to maintain the project led to it's inevitable end.
The Euro starring Greece? Actually I am referring to the Gold Standard starring the U.K. Winston Churchill in typically eloquent fashion proclaimed in September 1925 that, “a rising tide lifts all ships” and that Britain’s adoption of the Gold Standard would, “boost international trade and give Britain a seat at the top table”. This may have been so, but some issues unfortunately came up.
Firstly, I should explain what the Gold Standard is. Essentially all countries ‘peg’ their respective currencies to gold. So, if you needed $10 to purchase some gold where as you only needed £5 to get the same amount; then it follows that £1 is worth $2. Get it?
Like all economic problems there is usually some political issue at their heart; Britain, in one of it's more arrogant moments, decided to enter the Gold Standard at a high exchange rate. This was presumably done for political and psychological reasons; (it looks kind of bad if your currency isn’t worth much gold relative to your rivals’).
Unfortunately, this had some unexpected and unwanted consequences for Britain; as the pound was strong relative to it's main trading partners, exports started to lose competitiveness and the economy moved towards domestic consumption and non-tradable goods (i.e instead of selling cars we switched to cutting hair). This led to a consumption boom as borrowing and spending became easier due to the pound’s strength and the economy expanded, though unsurprisingly this turned out to be quite unsustainable.
1929 came along and the Wall Street crash leads to the end of easy credit and the onset of the great depression. Now Britain faced a dilemma, the Gold Standard had made Britain’s goods expensive and now the recession was hitting, domestic consumers couldn’t pick up the slack, Britain started to lose its tax revenues as the economy started to spiral downwards. In this situation it would be a good idea to lower one’s interest rate as this allows business to start borrowing and thus invest again, but it also lowers the price of the currency as lower interest rates lead to more money sloshing around in the economy. This is obviously incompatible with a set exchange rate, as was the case with the Gold Standard, thus all Britain could do was grin and bear it.
Everyone knew that Britain wanted to drop the interest rate and devalue, but they couldn’t without leaving the Gold Standard which would make the country’s leaders look like, well, chumps. This was especially true of Montague Norman the Head of the Bank of England, the George Papandreou (Greece's Prime minister) character of his day. Norman had to put up with intense public anger over the whole saga especially as he was credited with being the one responsible for the somewhat peculiar name of ‘austerity measures’; incredulously Norman would often go away for five or six weeks on yachting holidays to escape from it all. One wonders what would happen to Mr Papandreou if he did something similar today.
In September 1931 the inevitable occurred and Britain left the Gold Standard. Sterling fell by 30% which instantly made Britain’s exports more competitive and led to its debt to fall substantially. The great political win was that although wages had fallen by 30% relative to other currencies, the political fallout was nowhere near as big as it would have been had Britain tried an actual wage cut. (It is a lot easier to devalue your currency to make your workforce more competitive than it is by cutting 30% of wages; even if this is essentially the same thing.)
Unfortunately, there wasn’t much planning to this or to the U.S leaving the Gold Standard under Roosevelt not long after. Germany obsessed with inflation control unsurprisingly stuck with the Gold Standard. This created a sort of two tier system in world trade and when those trade disputes turned ugly, well we all know what happened next.
So what can Greece and Mr Papandreou learn from today’s history lesson? If leaving the Euro leads to currency devaluation and a decrease in debt, whereas staying in it condemns the country to austerity measures such as cuts in wages (rather than the somewhat cheekier and less politically hostile way touched upon earlier of devaluation) then maybe accepting the inevitable return to the drachma isn’t such a bad idea. Hell, maybe if it all gets too much, he could take Norman’s advice and take a 6 week yachting holiday.
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| A bad graph, an even worse situation, Greece owes 120% of what it makes! |
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| Not as bad as Japan, but still bad |
Those interested in the comparison can get more on Radio 4
To those of you wondering how the debt to GDP ratio in Japan can be so high without there being some kind of crisis.
ReplyDeleteJapanese people save A LOT, to the point in which the government has to borrow their money to spend for them. They do this by selling government bonds to the prudent public who want a safe asset for old age.
This is sustainable as long as Japanese people and not foreign creditors hold the debt. Italy is a whole other kettle of fish.
Oh and if you would like to comment you must have a google email account. This takes literally two minutes to do. Comments would be welcome!
ReplyDeleteIt is quite wrong to encourage Greece to leave the Eurozone. Indeed, whether the greeks had this crazy idea, the greek currency first would loose much more than 30% of its value. Secondly, it absolutely wouldn't lead to a fall of the debt as the debts Greece incured were in €. In and of itself, the national debt value wouldn't decrease then and Greece would have a weaker currency, that is to say more difficulties than today to even think about beggining to repay...
ReplyDeleteDear Coemgen_T,
ReplyDeleteThank you for your comment I look forward to more.
If Greece where to leave the Euro, it would no longer pay its Euro debts and would therefore default. I admit that this is different to comparison drawn as the U.K had a reduction in debt due to devaluation, but the concept is the same. Of course if Greece were to leave the Euro but carry on paying it's Euro debts then there would be no reason to leave the Euro; however, I do not imagine that the Greeks would carry on servicing Euro debt upon leaving the Euro.
Furthermore, a comparison to Argentina shows that although, as you rightly pointed out, a substantial devaluation can lead to inflation, it does allow the economy in question to re-balance and get back on track.
I believe given the debt burden and Greek economy's lack of competitiveness and thus ability to grow, without substantial fiscal transfers and the will to reform, neither of which seem forthcoming, a return to the Dracma and whence default seem inevitable and recommendable.
Greece can't leave the Eurozone simply because the EU would prevent them from doing it. Beyond the economical implications it would have, the political ones are much too heavy to allow such a scenario.
ReplyDeleteI personally find the quest for a deeper european economic integration more relevant and the last ambitious European Summit agreements - even if we still have much work to do - is the first step towards this integration.
Dear Coemgen_T,
ReplyDeleteI merely draw similarities between the gold standard crisis of 1931 and the Euro crisis today.
I have not put forward an opinion on whether Greece should be in the Euro or otherwise; however, with regards to whether Greece should be in the Euro, one should consider whether or not fiscal transfer will be put in place to help peripheral nations. If such help is forth coming then the Euro will be sustainable, however without this the Euro in its current form is unsustainable.
I thank you for your comments and look forward to further debate on forthcoming articles on the Euro crisis as this is something I find of interest.
Your articles bring out well the issues you choose to discuss to the point that I would consider coming back for more of this expert views. Thanks for sharing. Keep up.
ReplyDelete