by Stephen Bryen
The new Greek government, mainly composed of former Communists and other leftists, with a dash of a far right political party giving Syriza enough support to form a government, faces a huge task in trying to reform Greece’s economy. The idea that it can be done in negotiations with the European Central Bank and the key economic power, Germany, is wishful thinking at best.
The German government has already made clear it is not prepared to write off Greek debts. Furthermore the Germans and the bankers expect Greece to pay back its loans and to retain an austerity program in order to squeeze enough resources out to make the required payments.
It is unlikely Greece can, or will comply. What is more certain is that the new government will raise salaries, cut some taxes (but not to the rich), and hire back many unemployed State workers. Of course this is impossible if the euro remains Greece’s currency.
Once the government gets organized and starts imposing its “cure” Greek repayments will have to cease, bond prices will escalate and will be chasing investors who will be running for cover, and the situation will rapidly become quite explosive.
At this point both the Greeks and the Europeans will have to make choices. In such an environment, the most likely result is that Greece will have to replace the euro with a local currency. For our purposes let’s call it the “New Drachma.”
Greece can get along with the New Drachma. But a better solution for Greece is a hybrid approach: if possible retaining the euro and support a New Drachma –in other words, two currencies.
There are two ways this can be done. One is a formal agreement with the European banks that will give Greece room for maneuver by stretching out loan repayments and making other credit provisions that are reasonable. With a second, “local” currency Greece can pay its civil servants and encourage private business to also use the local currency for all internal transactions. André Cabannes, a professor at Stanford University, outlined this approach for Greece a few years ago, and his proposal remains the best one for Greece and for other weak players in the euro community such as Spain and Italy.
A New Drachma will start off in parity with the euro, but won’t stay there for long. Unless the government exercises some discipline and restraint and builds confidence in the banking and business community, the New Drachma will rapidly lose value. The real challenge for a radical Greek government is whether it can come up with a program that can be managed properly, kept sensible, and will be able to have the support of the financial community.
Europe cannot really afford to write off Greece. Nor can the new Greek government survive if it is reckless or obnoxiously ideological. It would help both sides in the argument to find independent experts who can structure a workable program for a second currency while keeping the euro alive.