Nightmare scenario of a return to the drachma

Ms. Katerina Kapernarakou is a journalist for the Greek newspaper “Kathimerini”, and a contributor to the BusinessThinker.com covering the international business, economic, and financial issues.

In a hypothetical exit from the euro and a return to the drachma, the new Greek currency would have to be devalued by a gigantic 120 percent against the euro in order to play any part in reducing the country’s deficit, according to a study by New York-based financial analysis firm Roubini Global Economics.

The firm estimates that Greece would lag in terms of its labor cost per unit by 38 percent compared to the eurozone average and by 62 percent compared to Germany.

The analysis suggests that Greece could eliminate its current account deficit with an approximate devaluation of 50 percent, all else being equal, according to Roubini Global Economics strategist Michael Hart, who added that “markets have become less forgiving during this crisis.”

With the real exchange rate between the drachma and the euro weaker by 120 percent, the euro would become 2.2 times stronger in comparison to the original drachma-euro exchange rate (around 750 drachmas to the euro), a percentage that the analysts find neither unreasonable nor excessive, if it helps deal with the country’s deficit immediately. According to the analysts, it can also be seen as a simple starting point as an acceleration of inflation brings the original debt down to zero.

Hart invokes the most recent example, where Brazil in 1999 abandoned the dollar peg and devalued its currency by 78 percent in order to boost domestic demand and reduce inflationary pressure. Limited activity in the financial markets means that the country’s fiscal adjustment was extremely lengthy, as it took one year to balance the current account budget and two to show a surplus.

According to HSBC, the possible exit of Greece from the eurozone would also ultimately signal its exit from the European Union. The consequences of such a scenario would be devastating, according to the global banking and financial services company, which lists the most likely effects:

1. The nominal value of the assets and debts of the banking system would have to be calculated anew in order to devalue the currency.

2. There would have to be a system of capital monitoring because of the massive current exchanges deficit, but also in order to put a cap on daily withdrawals in order to protect the banking system from crashing, given that it would no longer have access to the liquidity of the European Central Bank.

3. A default would not avert the need for fiscal adjustment as the budget would continue to show a deficit, meaning that more austerity measures that are even more stringent than those required by the current Memorandum would need to be enforced. Assuming that this is politically possible, the Bank of Greece would have to be in charge of printing money.

4. The ensuing downward spiral of salaries (especially if the Bank of Greece is printing money) would kill any chance of boosting competitiveness, unless the country went ahead with radical structural reforms.

5. A return to the drachma would entail an enormous number of technical difficulties, not least of which would be rewriting all of the codes of exchange and reprogramming ATM machines.

6. Greece would be forced to exit the European Union, meaning that it would be liable to non-EU member trade regulations.

7. A Greek euro exit would spread the crisis to other countries on the periphery of the eurozone and would trigger an explosion in the spreads and massive capital flight from banks.

8. The credit crisis that would result from a Greek exit would make the 2008 crisis seem mild by comparison, as the global economy would sink into a deep recession.

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About the Author:

Ms. Katerina Kapernarakou is a journalist for the Greek newspaper “Kathimerini”, a contributor to the BusinessThinker.com, covering the international business, economic, and financial  issues. She keeps a weekly page in the Saturday edition on the “Newsmakers of the Week”. She has worked for private and public R / S, as well as for the Greek Service of BBC WORLD. She is a freelance writer for business magazines. She has served as the Chair of the Greek Section of Amnesty International

Which Europe?

Mr. Nikos Konstandaras is managing editor and a columnist of Kathimerini, the leading Greek morning daily.  He is also a contributor to The BusinessThinker.com

This editorial is also published in Kathimerini.

Many years ago, as Europe was taking its first steps toward greater unification, the French historian Fernand Braudel posed the question whether this would lead to an “inventive Europe, making for peace, or a routine Europe, still creating the kind of tensions that we know only too well?” In the years since the publication of “A History of Civilizations” (1963 and, posthumously, in 1987), Braudel would have seen reason to hope but also to fear: the European Union does express the humanistic spirit that can conquer problems at home and abroad, and is trying to show solidarity among its peoples at a time of crisis, but, at the same time, its member states remain set on serving first their own interests and satisfying their own obsessions, before considering what is good for Europe. Europe is at the crossroads that will determine the answer to Braudel’s question.

European history is an endless effort by the continent’s nations to maintain a balance between them. Whenever one entity assumed a disproportionate amount of power, it provoked the others’ reaction, leading to the formation of opposing alliances and, of course, war. Even though the EU has developed beyond the wildest dreams of the visionaries who saw unification as the only way to put an end to endless conflict, in the last two years we have seen a resurgence of the fear of imbalance. This time, though, the majority of countries are afraid not of the most powerful among them but of the weaker ones, whose failure could threaten their own well-being. Because Europe’s mission of “pacification” has succeeded so well, power and threats are today measured by each country’s economic standing, not by military might.

Consequently, Germany, which for decades was the silent worker of the unification project (demilitarized and penitent for past evils), is without doubt Europe’s greatest power. At the other end is Greece, with its heroic sacrifices of the past (when it was poor and always tied to the wagon of some greater power), which is the object of scorn for its inability to adapt politically and economically to the benefits of being an equal member of the European Union — which has lead to political and economic bankruptcy. For two years, Greece has been blamed for the harm it caused Europe’s single currency; in other words, the EU’s weakest member, and not its strongest, is perceived as the greatest danger to the rest. Greece, of course, is responsible for the mess it is in and for the halting effort to change, but the exaggerated fears of the other countries reveal a weakening of the vision of a “Europe of the peoples,” in which each nation has something to offer.

Europe’s unification was embraced by its peoples at the political level because the principles of liberal democracy took root in the major Western European countries, leading to an unprecedented rise in the quality of life and making their citizens the envy of other nations who could only dream of one day sharing their benefits. The subjects of the Soviet Bloc, for example, knew that their union (which had been imposed by force) existed mainly to serve the interests of Russia. The desire for freedom, democracy and economic benefits became the glue of unification. The cultural — or “civilizational” — identification opened the way toward stronger political union (up to the point that it did not eradicate national sovereignty), but it was in the economy where the greatest leap was taken, with the creation of the single currency. Now that confidence in the euro is shaken, the only solution appears to be greater economic — and, thereby, political — union. In the debate, however, we are forgetting the cultural closeness that inspired the whole effort. Countries are now measured solely on the basis of their economic indicators and not as members of a union that is far greater than its parts. The economic crisis, though, is not just a matter of sovereign debt; it also betrays the need for Europe as a whole to secure a dignified level of life for all its people while achieving competitiveness at a global level.

At a time when the whole planet is looking for balance and no country is a superpower, the Europeans cannot afford to question the dominance of their strongest member. But their acquiescence to Germany’s persistence with austerity programs across Europe could lead to a worsening European recession, the further shrinking of the middle class and the marginalization of society’s weakest members. In this case, the faceless, supranational forces of the global market will have won — not Europe. A “non-inventive” Europe will face the danger of a resurgence of tension among its members, but the despair of great numbers of citizens could trigger something worse: civil conflict. The end of the dream of Europe would be not just a defeat but the start of a nightmare without end.

Are Treasuries Overpriced?

Dr. H. Nejat Seyhun, contributing writer to The BusinessThinker magazine, is the Jerome B. & Eilene M. York Professor of Business Administration and professor of finance, Ross School of Business, University of Michigan. He is an internationally recognized authority on financial issues and Derivatives.

All I read these days is how much Treasuries are overpriced.  At the beginning of 2011, Bill Gross, the famous bond fund manager at Pimco, predicted serious losses for Treasury investors and he publicly announced that Pimco had sold its massive Treasury positions.  In addition to fund managers and newspaper columnists, recently some well-known economists have also joined this chorus.  Their argument is simple and appealing:  At an annual yield of 1.9%, with actual inflation running over 2%, these experts are telling everyone that expected real Treasury returns are negative and that anyone who buys Treasuries is likely to be disappointed over the next ten years or longer.

Inflation worries are certainly real.  Some suggest and worry that faced with a massive and ever-increasing debt, the U.S. Government is likely to inflate even further in the future to reduce the real debt burden similarly to what it did in the 1950s by pegging the interest rates below the inflation rate.  In fact, Charlie Plosser, president of the Philadelphia Fed, has also publicly expressed his inflation worry. If the Fed were to carry out such monetary policy, this would further erode the real returns to long-dated Treasuries.

Continue reading Are Treasuries Overpriced?