MAKING SENSE -- December 20, 2011 at 3:08 PM ET
Why the Euro Might Not Be Good For Greece
A Greek 500 drachma banknote sits atop euros. Photo by Peter Phipp via Getty Images.
Today's post tries to answer a number of questions that have come in over the past few weeks along the lines of, "What's going to happen to Europe?"
As I've long pointed out on this page, quoting the late liberal Harvard economist John Kenneth Galbraith, there are two kinds of economists -- those who don't know the future and those who don't know they don't know. Count me among the former though, truth to tell, I'm not even officially an economist, since I don't have a Ph.D.
That admission dispensed with, let me quote a tweet of mine from June of last year: "Ken Rogoff the other day, for upcoming piece: Greece will default, desert the euro for the drachma. Tufts' Yannis Ioannides didn't disagree."
And sure enough, from the piece that ran in July 2010:
KEN ROGOFF: "[The Greeks] are under tremendous stress. Not only do they owe a lot. They don't have a lot of ways to pay for it. The big problem with Greece was that they were borrowing in euro. They weren't borrowing in a currency they controlled.
PAUL SOLMAN: But if they had been borrowing in drachma, you mean they could have just printed more.
KEN ROGOFF: Yes. It gives them more levers, and the currency can go down, making their goods more competitive.
PAUL SOLMAN: Is it a possibility that Greece will go back to the drachma?
KEN ROGOFF: They're going to restructure their debt. They're going to default. And, once they do that, they might as well take advantage of the opportunity to go back to the drachma for a while, find a way to get their debt down."
The problem for Europe, of course, is not just that its banks hold so much Greek debt. It's that they hold the debt of Spain, Italy, Portugal, Ireland, Belgium, France -- well, you get the picture. Again, Harvard's Ken Rogoff, from our 2010 story:
KEN ROGOFF: "All of Europe is leveraged, borrowed to the hilt. If the weakest link falls, people will get scared about the others, that there will be a stampede. And it's a very legitimate concern."
It's also a perhaps unsolvable problem, as the hilarious Australian comedy duo, Clarke and Dawe, explain in a short video:
In any case, "unsolvable" seems to be the verdict of the markets at the moment. The latest rescue plan obliges member countries to stick to strict budget deficit limits. Oh, right. Those who've followed the euro-saga will remember that these were the same limits supposedly imposed when the experiment began.
As I tweeted the other day: "If investors think Greece will stick with the euro, how come Gr(eek) 10-yr bond is paying 29% while German bund pays 1.85?" In other words, investors in Greek debt are demanding an interest rate that would be considered usurious almost anywhere in the world. Or as one of my Twitter followers @leighblue sagely tweeted in response: "If you buy $100 of Greek 10-year bonds they'll pay $1276 in 2021 (minus any haircut or drachma devaluation)." He meant the total compounded until 2021 at 29 percent per year.
One inference seems easy to draw. Bond investors are betting that Greece, not be able to pay its debts, will default via a loan modification, just like an underwater homeowner, and just as Rogoff predicted a year and a half ago. But if it then sticks with the Euro, it will still have to pay back its newly modified debt in Euros. Wouldn't it be more sensible to switch back to the drachma and owe the money in its own currency instead? Then it could do what so many underwater debtors of the past have done: inflate its currency to lighten the economic load of its obligations.
The other indicator of the euro's fate is the German bond (or "bund"). If investors are willing to settle for an interest rate of only 1.88 percent to lend money to Germany for 10 years (the interest rate as I'm writing), they're obviously not worried about inflation. They're assuming that the European Central Bank won't be inundating the world economy with Euros anytime soon. From that I'm guessing that investors don't expect Greece and debtor countries of its ilk to drag down Germany. Which suggests to me an expectation that the heavily indebted will eventually be on their own.
Finally, for an enjoyable look at what's happening in Greece, let me recommend this podcast from NPR's Planet Money: How Office Politics Could Take Down Europe.