Saturday, 11 June 2011

Greece and the euro

The international banking crisis is far from over. Huge amounts of debt are owed by banks to their investors. And individual governments have courted votes by allowing themselves, their banks and their electorates to borrow, spend and gamble like there was no tomorrow.  The USA is one of the most indebted nations on the planet but has managed to defy the laws of finance because of the dollar’s status as a reserve currency and the major military power wielded by the US.

One major concern in recent months has been Greece. It, and the European community which is currently financing its debt, appears to be faced with two alternative courses of action , either of which would have major effects on international and national finance both within and outside not only the Eurozone, but Europe as a whole.

Greece and the European Central Bank have to decide between two options.

1. Greece leaves the Eurozone

Suppose Greece decided to write off its foreign debt by ceasing to use the euro as its currency. It could default on its debt by redenominating its currency, i.e. converting the euro into drachmas. How would this work?

My understanding is that it would be something like this (I’m not an expert in finance, or anything, else and I know some of the people reading this are knowledgeable in this area, so please correct me if I’ve got it wrong):

The Greek government would close its banks, probably on a Friday. While they were closed to trading all bills and invoices in euros would be re-stated in drachmas - essentially the word 'euro' would be replaced by the word 'drachma' .  This would of course include money owed to foreign firms, investment banks, hedge funds, governments and individuals.  So when the Greek banks reopened all the creditors would find they were owed in drachmas what  they had previously been owed in euros.

Why would that be a problem? The answer is that the Greek government would fix the drachma at a lower value in terms of other currencies. Probably the drachma would be worth only around 50% of a euro. Whereas before a Greek firm owed a British firm £1 million, it would now owe only £0.5 million. Similarly with all organisations and persons abroad who had lent euros, dollars, yens, yuans or any other currency to a Greek organisation or person, or had stored it there, or invested it, or had it tied up in Greece in any way. All would suddenly be out-of-pocket.. They would get back only half what they could have expected by the normal rules and ethos of trading.

A private UK company with funds saved in Greece and at the same time having a critical public service role (e.g., a large private care company looking after the elderly) could be put into debt by this and need to be rescued with UK public money.

A chocolate factory, however, would probably be allowed to go out of business, thereby adding to unemployment. Those made jobless would have to be paid benefits or job seeker’s allowance. Again, the public would pay.

A bank or other financial intitution with large amounts in, say, Greek property, might find itself defaulting. The public would then have to rescue it.

There is another kind of consequence to Greece leaving the Eurozone. Other heavily indebted countries like Ireland, Portugal and Spain would be perceived as likely to pull off the same trick.  Their economies could collapse almost overnight as creditors of all shapes and sizes suddenly removed their money. This in turn would affect all other nations with substantial investments or assets in the defaulting countries.

So if you or your country has got a lot of money tied up in Greece or any other of the countries heavily in debt, it may  be in your interest for the Eurozone to stay in tact.

2. Greece stays in the Eurozone

This too has its downside. The Greek institutions in debt are at present being lent money by the better-managed countries, mainly Germany, within the Eurozone. And because it is in few people’s interest for Greece to disengage, even countries outside of the Eurozone are under pressure to help with the financial rescue not only of Greece but of Ireland, Spain and Portugal. Again, the public in those countries would be the ones footing the bill.

Either course is likely to result in unemployment and inflation, especially so in view of the escalating costs of fuel and commodities. In my view, of the two options, the second would be the least damaging, but with one proviso. No country in the Eurozone must be allowed to get into such debt again.

The financial crisis is truly international and in the last analysis the cause is two-fold: greed and pride.  

Author, 2077 AD