David Ignatius: Let Greece leave the eurozone

David Ignatius writes in The Washington Post:

The Greek financial crisis has eased — for now. But many skeptics share the worry of German Finance Minister Wolfgang Schäuble that the bailout plan may not work, and that the only way to restore competitiveness and growth is a Greek exit from the euro.

Schäuble was blasted as a heartless German for insisting, even after the rescue package was agreed to on July 13, that “the better solution for Greece” could be a “Grexit,” as it’s known. He had earlier proposed a five-year “timeout” for Greece from the common currency. For these heretical views, he was portrayed by a cartoonist as a black-clad terrorist with a knife at Greece’s throat.

But maybe Schäuble has a point: What’s the greater cruelty? Prolonging Greece’s agony with a plan that maintains its euro zone membership but cripples it with unpayable debts and perpetual insolvency? Or taking the painful but relatively quick cure of restoring the drachma and letting it fall to a level where Greece can again be competitive and prosperous?

The bailout plan calls for reform measures that would be difficult, even if the government and public genuinely supported them. But, in fact, Greece’s government and its people abhor the imposed terms of the bailout. That became clear in the July 5 referendum when 61 percent voted “no” on terms that were easier.

The bailout plan may rescue Europe — by restoring German-French amity and signaling that the currency union is intact. But it won’t rescue Greece. It will leave its uncompetitive economy in the financial version of an intensive care unit, surviving on the life support of new loans and fiscal transfusions.

 

The kinder approach might be to let Greece leave the euro zone, in what might be called an assisted transition. A devaluation of the drachma to, say, 50 percent of the euro’s value would make Greece instantly competitive and a magnet for investment. But the devaluation shouldn’t go too far. The European Central Bank could pledge to intervene in currency markets to support the drachma and prevent it from falling by, say, 70 percent or more.

A gentle Grexit would also include the kind of “haircut” — in debt forgiveness and rescheduling — that’s almost impossible if Greece retains the euro. This was Schäuble’s point on July 16, when he told German radio: “No one knows at the moment how this is supposed to work without a debt haircut, and everyone knows that a debt haircut is incompatible with membership in the monetary union.” This honest and probably accurate statement brought new calls for Schäuble’s resignation.

Generations of experience have taught economists that currency devaluation, though a severe shock to the system, usually produces beneficial results — and often fairly quickly. Exports become much more competitive (in the case of Greece, tourism becomes a bargain). A virtuous cycle should ensue: Revenues grow, confidence rises and, eventually, domestic demand returns. The country and some of its businesses might default on their debts, but most creditors would have no choice but to renegotiate terms if they want any repayment. It’s no panacea: Inflation often follows a devaluation; and as prices rise and the currency falls, savings can be wiped out.

But the process usually restores growth. Perhaps the best example is Argentina. Like Greece, Argentina thought in the 1990s that it could boost its weak economy by having an inflexible currency. For Argentina, it was a one-to-one peg with the dollar. Things went well until corruption and mismanagement made the peg unsustainable.

Crunch time came in 2001, when Argentina defaulted on its debts and floated its currency. Its peso fell roughly 75 percent. But recovery began in 2003, and Argentina’s real gross domestic product per capita has now roughly doubled from the crisis years. A debt haircut was part of Argentina’s rebound. It was a nasty negotiating process, but bondholders eventually accepted deals that repaid only about 30 percent of the paper value.

If Greece returned to the drachma, a similar process might occur. The country’s euro-denominated debts would roughly double, measured against the drachma. This burden would be insupportable. So creditors would have to do what the bailout so far has shielded them from — renegotiate the debt to a manageable level and put a newly competitive Greece on the path to recovery, at last.

Reforms might be easier, too, in a new Greece that had decided to set its own course. But as Schäuble discovered, Euro-correctness seems to prevent serious discussion of this option.