What History Can Explain About Greek Crisis

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Correction Appended

FLORENCE -- The decision to suspend Greece from the common currency became inevitable when it emerged that Athens had fiddled with the accounts yet again amid chronic economic weakness, forfeiting what credibility in the international arena it still had left.

That was in 1908.

After diluting the gold content in its coins, Greece left the Latin Monetary Union, whose founding members included France, Italy, Belgium and Switzerland. More than a century later, history may repeat itself, albeit in vastly different circumstances.

From the dual currency economy of 14th-century Florence to the monetary union of Austria-Hungary and Argentina's abandoned dollar peg, the past is littered with examples of countries' weighing the costs and benefits of different monetary regimes.

What can history teach us about the options still left for a euro zone pulled apart by divergence between a competitive core and an uncompetitive periphery; arguments about austerity versus stimulus; and the increasing gulf between those advocating to keep Greece inside the club at all costs and those lobbying for an exit?

If Greece makes it through the current political crisis and stays in the euro zone, one useful case study is Germany's reunification, which suggests that the adjustment could take decades, not years, and involve mass emigration, billions of euros more in fiscal transfers and the rise of fringe parties in Greece as well as in the countries that have to foot the bill.

Like the former East Germany, Greece suffers from a crippling competitiveness gap and is locked into the euro. East Germans were priced out of the labor market because the value of the Deutsche mark reflected Western, not Eastern, productivity levels. About 14,000 businesses were shut down and four million jobs lost in the first five years after formal reunification, in 1990. Unemployment eventually peaked at more than 20 percent in 2005.

Since the fall of the Berlin Wall, in 1989, more than 2 million of the 16 million people living in the East have moved West. Long-term unemployment and wage depression bolstered xenophobic parties and the Left Party, which grew from the former East German Communist Party and hopes to reach the national government in 2013.

More than two decades later, living standards have converged, although they remain about 20 percent lower in the East with unemployment in the Eastern part at nearly twice the Western average.

And this was within one nation with the same language, perfect mobility and the fiscal transfers missing in the euro zone: German taxpayers financed more than €1.7 trillion, or about $2.17 trillion, at current exchange rates, with the "solidarity surcharge" to pay for modernizing the former East Germany.

"If Europe does for Greece and potentially other peripheral countries what West Germany did for East Germany, it will cost dearly, politically and economically," a senior European diplomat said, speaking on the condition of anonymity because of the sensitivity of the issue.

But if it does not and Greece leaves the euro zone, the diplomat added, the cost could be even higher. Past breakups of currency regimes led to messy transitions, often involving bank runs, capital flight, emigration and some measure of default.

When Austria-Hungary collapsed in 1918, after World War I, and with it a currency zone covering part of today's euro zone, the new governments of the region created national currencies by simply stamping the Austro-Hungarian krones circulating in their country with a national marking. Armed troops patrolled the borders to stop people from ferrying krones to the country they thought would have the strongest currency to get the most valuable stamp.

In 2012, much of the conversion back to Greek currency, the drachma, would happen electronically, during a banking holiday that would temporarily freeze online transfers out of the country, but the borders would still have to be sealed to prevent people from smuggling euros out of Greece after the devaluation has taken place, an awkward undertaking in postwar Europe. A substantial default on Greece's public and private debt would almost inevitably follow: the value of Greek liabilities would surge overnight as the revived currency would trade at an estimated 50 percent to 80 percent discount to the euro, economists say.

The lesson from the United States' moving away from the gold standard in 1933 and from Argentina's abandoning its dollar-peg in 2001, said Nouriel Roubini, a professor of economics at New York University, is that Greece's euro debts -- public and private -- would have to be "drachmatized."

After depreciating the dollar by 69 percent, the U.S. Congress voted to invalidate any promise to pay debt in a unit referenced in gold. Argentina "peso-fied" not just the government's dollar liabilities but also those of banks and companies, in effect decreeing a private sector default, without which much of the economy would have been bankrupted.

Another lesson from the Argentine case, said Simon Johnson, a professor of economics at the Massachusetts Institute of Technology, is that if you're planning to leave a currency regime do it sooner rather than later because the costs are likely going to rise.

"Argentina's case shows that years of austerity are pointless; they just destroy companies and create a political backlash," said Mr. Johnson, a former chief economist of the International Monetary Fund.

Argentine growth eventually bounced back helped by an increase in exports.

"Once you change the value of your currency, it's amazing what you can sell," Mr. Johnson said, adding that even Greece, with no obvious competitive export industries, might surprise skeptics once devaluation had gone far enough. "Make them cheap enough and they will export."

The wild card, and this is where history offers virtually no guidance, said Barry Eichengreen, a professor of economics at the University of California, Berkeley, is that Europe's modern and interlinked financial system might buckle under the contagion of a Greek default.

"There is a very severe risk of banking collapse," said Mr. Eichengreen, who has been urging for an aggressive recapitalization of banks in the euro zone even if Greece stays.

One thing history does teach us is that whether Greece stays or goes, it will be costly, said Carmen M. Reinhart, a senior fellow at the Peterson Institute for International Economics. "Neither scenario is pretty," she said.

As Europe and the rest of the world search for clues as to whether Greece's future will be measured in euros or drachmas, the answer might be both, at least for a while, according to economic historians like Ms. Reinhart and Harold James of Princeton.

"A solution with a parallel currency that falls short of a complete exit is less radical and would inject a measure of flexibility into the system," said Mr. James, a professor of history and international affairs and one of a number of economic experts who debated the future of the euro zone at a conference in Florence organized by the European University Institute this month.

Dual currency regimes go back a long way; in 14th-century Florence, international trade was counted in florins, which were gold based, but domestic transactions took place in silver-based coins.

A more recent example is Panama, which like Greece is a big state employer and adopted the dollar as its currency in 1904. When four U.S. banks froze Panamanian government assets in 1988, and refused to pay the annual payment for the Panama canal, effectively cutting off the dollar supply, Panama paid its civil servants in government checks that were divided up in small denominations, were accepted to pay taxes and soon circulated more widely as a quasi-currency at varying discounts.

In the year before Argentina's default, a handful such quasi-currencies could be found in different parts of the country, said Ms. Reinhart, Peterson Institute senior fellow. "This may well have begun in Greece," she said. "In Argentina it went on long before it was onto people's radar."

If there is no perfect historical precedent that shows the way out of the current crisis, one thing is shown time and time again: without a political union that allows for fiscal redistribution and a degree of economic convergence, currency unions tend to fail.

Some point to the United States as a blueprint for an overhauled euro zone. Key to the success of monetary union in the United States was an agreement negotiated by Alexander Hamilton, the first Treasury secretary, for the federal government to assume high levels of state debt in 1790, after the War of Independence, said Mr. James, the Princeton economic historian.

But the agreement came at a price: the common liability of Virginia, the most powerful state, was limited by a ceiling.

"Perhaps this would be a way of persuading Germany of signing up to common European bonds," Mr. James said.

Others said the lack of economic convergence would inevitably lead to failure. The Soviet Union, rather than the United States, comes to mind when assessing Europe's hope of maintaining its single currency in the long term, said Mr. Johnson, the M.I.T. economics professor.

Long committed to maintaining a ruble zone among the Soviet republics, Russia's central bank eventually pulled the plug. "The lesson is, it's time to go your own way," Mr. Johnson's said. "The euro has failed. It's over."

Correction: May 22, 2012, Tuesday

This article has been revised to reflect the following correction: An earlier version of this article mischaracterized Greece's membership in the Latin Monetary Union. Greece was not a founding member of the union.

world

This article originally appeared in The New York Times.


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