Michael Mussa, former head of research at the IMF and presently a senior fellow at the Peterson Institute, argues that Greece ought not restructure (pdf) and definitely ought not leave the euro-area, whilst also sketching out how unwieldy are the debt dynamics with or without the IMF/EU program. It’s an example of the cognitive dissonance we’re seeing a lot lately, in discussing best strategy for Greece and Europe. The unsustainable debt dynamics are carefully acknowledged, but the usual solution (default and devaluation) is asserted to be unavailable, on circular grounds. Thus,
A number of critics of the present approach have suggested, not without reason, that a debt restructuring for Greece is probably inevitable.
Moreover, the economy will need to grow. And this raises real problems for the fiscal-probity approach:
With the exchange rate pegged within the euro area, Greece requires outright wage deflation to restore competitiveness within the area. Achieving this will not be good for nominal GDP growth and for debt dynamics.
In other words, Plan A is mission impossible. But it must be followed, because … well, just because. The alternative (default, devalue, restructure, reflate), we’re told, is Just Plain Scary. I’ll pick this point back up in a moment. But first, the Scare:
In the extreme, if Greece were to exit from the eurozone in an effort to gain international competitiveness and spur economic growth, this would undoubtedly escalate concerns about the viability of the European Monetary Union for all of its members. This means that exit of Greece from the euro area must be viewed as an extreme step that should be avoided at virtually all cost.
The functioning of the Greek financial system will be seriously impaired for some time. The whole Greek economy will suffer. Thus, looking only at Greece, there is good reason to try to avoid sovereign default and restructuring as long as there is some reasonable chance of being successful. Sovereign default is not a cheap way out. Exit from the eurozone would be even more disruptive and expensive.
We need substantiation for such categorical assertions. Perhaps Mussa and others could cite Hong Kong. Now there’s an economy that can weather a crisis — and severe currency overvaluation — without devaluing and without default. The question for the rest of us is, Is Greece more like Hong Kong or Argentina? Well, let’s start with why Hong Kong is so good at keeping a fixed currency over a business cycle and indeed in the midst of a severe regional financial crisis (1997-98). Hong Kong’s economy is the most flexible in the world, in terms of factor and product market prices. It gets top marks from the Heritage Foundation, no cream puff when it comes to matters laissez faire. Hong Kong is also more a city-state than a full economy. It’s not even a sovereign country.
What about Argentina? It’s sure sovereign. As is Greece. (Come to think of it, maybe that’s why comparing Greece to California is slightly misleading.) It’s also an example of an economy that bounced back after a sharp devaluation, having suffered years of GDP contraction under an overvalued peg. But it’s not alone. Almost everything we know about devaluation is that it begets growth. You might cite a basket-case economy to warn of the futility of devaluation, but Greece is no basket case. Forget what you’ve heard about the recklessness of the Greek government, the corruption of the elites, the avoidance of taxes. Is Greece worse than Argentina in these departments? Moreover, one should hold up a mirror when hurling accusations of malfeasance. (Note: I am very much in favor of structural and fiscal reform in Greece. I just recognise that these alone are inadequate to the larger task of revitalizing the economy and stabilising the debt load.)
If we’re willing to plunge into the memory hole (I use the term advisedly: it seems that even the leading scholarship on the period I’m about to discuss have completely lost sight of its lessons), there is a very good example for a time when Europe was confronted with a system of irrevocably fixed exchange rates and a global debt crisis. I’m referring to the Great Depression. At that time, a country’s commitment to pegging its currency to gold was irrevocable. And utter damnation would befall anyone unwise enough to reject this monetary order. (Examples of some relevant scaremongering are here, and fuller treatments of the connection between EMU today and the gold standard in 1931 are … all over the archives of this blog. Have a look.) Of course, from the safety of hindsight, we now agree that the best thing a country could do in the Great Depression was leave the gold standard: devalue the currency, even if it meant default. Not only was this best for the country, it would theoretically have been best for the global economy. The fact that it took until the 1980s before the academic scholarship settled on this view gives you some indication of the weight of orthodoxy when it comes to the monetary order. Perhaps few things inspire as much dogmatic thinking (and hence cognitive dissonance and doublespeak) as do matters of monetary order. (If you have any doubt, try suggesting to a member of the Austrian school that the gold standard exacerbated the Great Depression.)