Greece and the Great Depression
Guest contributor to Centro de Estudios Espinosa Yglesias
In the Great Depression, the prevailing wisdom argued that currency was only trustworthy if pegged to another currency — preferably, one which is pegged to gold. The idea was to limit the potential for fiscal malfeasance. The key link was the foreign-exchange market. If the government spent too much, the extra spending tries to leave the economy, via the fx market. Unless all the other governments are behaving this way, there won’t be enough foreign currency in the market, so the central bank has to supply it from its reserves. These are obviously limited, so the government has to reverse its fiscal misbehaviour and relieve the strain on the fx market.
But a government can be fiscally virtuous and still face a gaping hole in the fx market. A big trading partner might suffer a contraction and stop demanding your goods. Its price level might far so fall that your entire traded sector is uncompetitive. Either of these will create a gap in the fx market which the central bank cannot fill. To maintain the currency peg, policymakers must embrace austerity. Yet this austerity will have a knock-on effect on your other trading partners, prompting them to pursue austerity. This chain-reaction explains part of the severity of the Great Depression.
Fast forward 80 years. Greek debt is unsustainable without dramatic official support. As a result, the EU has arranged 110 billion euros in offical loans to ensure that Greece does not need to face the international capital market for the next two years. The plan calls for a resumption of Greek debt sustainability in 2014 on the basis of a growing economy and primary fiscal surplus. The recipe for both is austerity. Nowhere in the programme documents are wage cuts specified beyond the public sector. But independent analysts estimate they will need to be 20% or more, barring a surge in wage growth outside Greece.
Unsurprisingly, the market is sceptical. The plan is highly unlikely to succeed. In the meantime, it will kill GDP growth in Greece and its euro-neighbours, and necessitate a depreciation in its non-euro trading partners. The British pound is falling because of Greece, not British politics. The Turkish lira dropped 7% on May 6. At the end of all this, Greek debt will be no more sustainable than when it started, which means the sovereign debt crisis has only been postponed. And the patience of the population might well be exhausted.
To understand the pressure to follow this path, go back to the Great Depression. The prevailing wisdom which urged policymakers to pursue more and more austerity, more and more poverty was the gold standard. Its defence was likened to defending civilization itself. Monetary arrangements have a tendency to do this; Mexico’s pre-1994 experience is no exception. Yet warnings of calamity often prove unfounded, which makes their assertion an example of dogma. In the Great Depression, the gold standard dogma had the power to compel masochistic policy and a plunge in the world economy. As it turned out, to escape the downward cycle, a nation had to forget the dogma and leave the gold standard (or choose autarky).
The EU leadership portray Greek travails as an “existential” crisis for Europe. Such talk is not only unfounded but dangerous. If the Great Depression is any lesson, condemning workers to the sacred cow of a monetary order is risky business. Far more is at stake than the future of Europe’s monetary union.