If SYRIZA-EU negotiations break down: two views on what Grexit means for Greece

by Jehu

kick-outThings don’t look very promising for those who hoped Germany would give in to pressure and accept a write down or delay of Greece debt obligations. With that in mind I decided to look at the most likely outcome of a collapse of negotiation: Greece’s voluntary or forced exit from the euro and European Union.

Of course this post is highly speculative and not to be taken as a prediction.

What Grexit looks like to SYRIZA

It appears SYRIZA’s opposition to leaving the euro common currency may not be an expression either of its commitment to neoliberal principles nor the impact Grexit would have on the living standards of the working class. Its commitment to staying in the euro may actually be based on a more mundane consideration: simple pragmatism.

This is my take away from this paper written by Yannis Varoufakis in 2012: “Weisbrot and Krugman are wrong”. In the paper, Varoufakis address the argument by Mark Weisbrot and Paul Krugman that SYRIZA follow Argentina by repudiating its debts and devaluing its currency:

“Mark Weisbrot has been arguing, for some time now, that Greece must try to emulate Argentina; that is, to default on its debts not as a bargaining strategy that yields a New Deal within the Eurozone but, rather, in the context of exiting the Eurozone altogether and going it alone.”

This tells me one important thing: in Varoufakis’s thinking, default is aimed at exerting pressure for reform of the European Union along Keynesian lines. Threatening to drop the euro and go back to a national currency does not fit into the strategy because, in his thinking, it probably won’t work as a bargaining weapon.

Which means, in principle, Varoufakis is not against employing currency devaluation as a tool of economic policy.

I find this particularly interesting because it means, in the paper, Varoufakis does not make the connection between the devaluation of a currency and devaluation of wages denominated in that currency. He actually describes currency devaluation as a means to avoid “the clutches of the poisonous austerity (and internal devaluation) that the IMF had imposed upon the country”

Since both internal and currency devaluation are devaluations of the living standards of the working class, what benefit does currency devaluation have over the IMF’s and European Union’s preferred method of internal devaluation?

In either case, the wages of the working class will be cut; the only distinction to be made between the two is that an internal devaluation requires a granular approach: the troika identifies specific rules, regulations and labor forces that must be eliminated. Currency devaluation, on the other hand, simply lops off some portion of real wages of all workers by depreciating the purchasing power of the nominal wages.

Three reasons why Grexit may not work for Greece

First, Argentina could use devaluation to boost its exports sector, while Greece does not have this option. Certain industries in Argentina had underutilized productive capacity and for this reason exports could be stimulated by slashing nominal prices for these goods relative to other currencies. Moreover, Varoufakis notes, potential markets for Argentina exports (China, Brazil) were experiencing robust expansion and needed many of the products Argentina could produce. By contrast, in Greece’s case, industries which are valuable to it in terms of export earnings are suffering the effects of Europe’s recession and a longer term decline.

The example Varoufakis gives for why currency devaluation will not work for Greece is important because it shows why and how currency devaluation works: Currency devaluation can be successful if, as a result of reducing the wages, it is possible to increase sales of goods outside the country. This is just another way of saying that if a way could be found to reduce the subsistence of the working class all at once, the additional surplus value can be exported to new markets, raising profits.

The practical argument Varoufakis is making here is that even if SYRIZA reduces the wages of the working class through currency devaluation, it is not clear there will be export markets for the increased Greece production. Europe is, after all, experiencing a recession caused by overproduction.

Thus, Varoufakis is not against reducing the living standards of the working class by means of currency devaluation, he just doesn’t think it will work in Greece’s specific case. His argument is, “Yes, we can slash the wages of cabana boys and housekeepers, but who will send us the additional tourists?” The argument has the virtue of being purely pragmatic — in no way based in principle against cutting the wages of cabana boys and housekeepers. At no point does Varoufakis say, “Listen, we communists aren’t supposed to be trying to expand the economy by cutting the wages of cabana boys and housekeepers in our tourist industry in order to increase profits.”

Since cutting wages through currency devaluation will not drive new customers to Greece resorts, why threaten to devalue your currency and cut the wages of cabana boys and housekeepers. If you make this sort of threat and Merkel calls your bluff, introducing a new drachma to cut the wages of cabana boys and housekeepers won’t create more jobs in Greece’s tourism industry, just more poverty.

Who determines what is money?

The working class in Greece already suspects the Left intends to Grexit and they have been stocking up on euros and dollars. This means, within the country and even in banks in other countries, they have amassed a huge store of currencies to cushion themselves.

SYRIZA can introduce a new drachma (or whatever you want to call it) to replace the euro, but society can just as easily pour billions of saved euros and dollars into the black market. In any case, what serves as money in an economy is not determined by the laws of the state, but by society.

Anyone who wants to know how this works need only look at Zimbabwe’s experience with hyperinflation: Zimbabwe had a law that recognized the Zim dollar as the legal currency. However, when people lost faith in the Zim dollar, they very quickly replaced Zim dollars with euros and US dollars in their commercial transactions. Ultimately the Zimbabwe government was forced to recognize its currency was worthless and accept euros and US dollars. In the final analysis, society, not government taxes, determines what is money. There are a lot of misguided people on the Left who think the state can determine what is money by insisting on its own currency as taxes. Zimbabwe showed just how wrong and silly this idea is.

Varoufakis rightly explains that any attempt to introduce a new drachma would rapidly decay into hyperinflation:

“This means that, by the time we come to an exit from the euro, the stock of savings will be in euros and the flow of incomes and pensions (once the banks re-open) will be in drachmas. So, unlike in Argentina, a Greek euro-exit will drive a wedge between stocks and flows, savings and incomes; with the former revaluing massively relative to the latter. Moreover, the very availability of such large quantities of ‘hard’ currency savings, in the hands of the average Dimitri and Kiki on the street, will ensure that the decline in the value of the new drachma will be precipitous”.

An exit from the euro means an exit from the European Union

For his third reason why Grexit cannot work, Varoufakis argues that any attempt to leave the euro must also mean Greece leaves the EU. The matter here is Greece’s sovereignty and the limits placed on it by treaty:

“For if the Greek state is effectively to confiscate the few euros a citizen has in her bank account and turn them into drachmas of diminishing value, she will be able to take the Greek government to the European Courts and win outright.  Additionally, the Greek state will have to introduce border and capital controls to prevent the export of its citizens euro-savings.”

Leaving the European Union means loss of subsidies and funds, as well as the imposition of trade barriers. This will also have an effect on the euro itself, which will appreciate; seriously undermining the European economy and producing another leg down on the depression.

I don’t insist Varoufakis’s reasons are above dispute; rather, I want to point to the pragmatic nature of his reasons. Nothing in Varoufakis’s argument suggests SYRIZA will not turn on the working class an impose a new austerity via currency devaluation. All his argument says is that he does not think this will work as it did for Argentina.

What should be clear from this examination is that SYRIZA does not on principle oppose policies that ultimately reimpose a ruthless austerity on the working class. It may be that they just do not realize Grexit has can have this this impact on real wages any more than the rest of the Left — like KKE and ANTARSYA — realizes it. Or it may be that they just don’t care.

As a result, I would not rule out the possibility these folks take a wrong step and create a disaster for the working class.

What if Greece is forced out of the euro?

Varoufakis might believe leaving the euro would not work for Greece in the way it “worked” for Argentina — by spurring exports — but what if Greece has no say in the matter? What if Greece is forced to leave? Would this necessarily be a disaster for Greece?

A few days ago, Zero Hedge reposted an interesting paper by Citi’s chief economist, Willem Buiter, on what a Grexit would look like. The gist of Buiter’s argument can be found here: “If Greece Exits, Here Is What Happens”.

What I find so interesting about this paper it that it assumes Greece is somehow forced out of the euro, rather than leaving voluntarily. In other words, Buiter is painting a picture of the disaster awaiting Greece should it not knuckle under to troika demands and manages to get itself tossed out of the euro.

It is basically a threat in the form of a report: “Do what we say or there will be hell to pay.”

I read Buiter’s report with an eye to how SYRIZA or any Left government in the EU, might respond to this threat.

The scenario begins simply enough: Greece is forced out of the euro by the ECB which cuts off funding for its banks. Facing financial collapse, Greece would have no choice but to withdraw and begin issuing its own currency.

Buiter argues that since the EU and the ECB have forced Greece out, Greece will likely repudiate all of its debt, perhaps except for the IMF. Thus, the net present value of Greece public debt will drop to zero. According to Buiter, this will exact a very high cost on Greece: particularly the banking sector, but also firms outside the finance sector.

Before it leaves, however, Greece introduces the new drachma with a 1 for 1 peg to the euro. All financial instruments and all contracts are renominated in a new currency, the drachma, which, according to Buiter, almost immediately loses 40% of its exchange rate with the euro. Where the new drachma was initially worth 1 euro, it would now be worth just .60 euro. Buiter explains that this is because there will be a bank run and Greece will be cut off from a capital strike against Greece. People who have euros will hold their euros and won’t convert them into drachmas.

Thus, according to Buiter,

“What this means is that, as soon as the possibility of a Greek exit becomes known, there will be a bank run in Greece and denial of further funding to any and all entities, private or public, through instruments and contracts under Greek law. Holders of existing euro-denominated contracts under Greek law want to avoid their conversion into ND and the subsequent sharp depreciation of the ND. The Greek banking system would be destroyed even before Greece had left the euro area.

There would remain many contracts and financial instruments involving Greek private and public entities denominated in euro (or other currencies, like the US dollar) that are not under Greek law. These would not get redenominated into ND. With part of their balance sheet redenominated into ND which would depreciate sharply and the rest remaining denominated in euro and other currencies, any portfolio mismatch would cause disruptive capital gains and losses for what’s left of the Greek banking system, Greek non-bank financial institutions and any private or public entity with a (now) mismatched balance sheet. Widespread defaults seem certain.”

A euro peg for the drachma?

Apart from the difficulty in converting to the new currency, however, Buiter never explains why this disaster would be inevitable. For instance, Greece could allow euros and drachmas to circulate beside one another and guarantee drachmas can always been redeemed for euro at the peg.

Countries actually used to do this with gold, but there is no reason why it would not also be done with euros or dollars. Greece simply lets the two currencies circulate together and anyone can walk into a bank and redeem drachmas for euros 1 for 1. All Greece has to do is make sure there is always sufficient currency to facilitate the redemption.

By law, anywhere euros are accepted, drachmas must be accepted as well and then the merchant can, if he or she wants, go to the bank and redeem the drachmas for euros at a 1 for 1 rate. If the government is true to its word and always accepts its drachmas 1 for 1 in return for euros, suspicion will eventually subside.

What is the hole in this argument? Well, according to Buiter, the drachma must devalue because Greece has not implemented any meaningful reform of its labor and product markets and still suffers from a bloated, overstaffed public sector.

So SYRIZA will still have to figure out a way to reform Greece’s labor market, product market and the (by all accounts) bloated public sector. And the party will have to do this without throwing the tens of thousands of workers out of work and letting them starve in the streets like uncivilized financial predators.

But the full scope of the problem SYRIZA faces is even wider than this: SYRIZA not only has to reform its labor and product markets and reduce the size of its state sector, it will have to do all of this while putting hundreds of thousands of unemployed back to work,  restoring gutted social spending, and pulling everyone out of poverty.

Now this is going to be very difficult because Greece has just repudiated all of its debt. And, unlike Buiter, I am going to include the IMF on this list too, so NO ONE in their right mind will lend even bus fare to the Greece government. This will mean, Greece cannot run deficits to help the poor; it can’t run deficits to create jobs; it can’t even run deficits to reopen health clinics or reconnect electricity. No one in their right mind will ever lend Greece money again; and, moreover, since the drachma is pegged 1 for 1 to the euro, Greece can’t print money and spend it either.

Which is just the way we should want it: Communists don’t simply want a balanced budget in the state sector, they want the state to wither away.

A depression on top of a depression

The first big problem we run into, according to Mr. Buiter, is a full-blown depression on top of the present depression — a second leg down:

“In our view, the bottom line for Greece from an exit is therefore a financial collapse and an even deeper recession than the country is already experiencing – probably a depression.”

Although I have shown that a financial collapse is not necessary, we still have to address a profound depression that has lasted 5 years. Millions are out of work and have been out of work for years, public services have been gutted and the state sector remains an unreformable mess.

Elsewhere this may be a problem, but not for us. To fix the long running unemployment and poverty problems, we simply reduce hours of labor at least by half and raise the minimum wage to 25 drachmas an hour. The key to any communist anti-austerity platform is that those who work should never experience poverty. In this case since drachmas can be redeemed 1 for 1 for euros, the official wage will be equal to 25 euros an hour.

And since hours have been cut in half, labor time will fall from about 2000 hours per year to about 1000 hours per year. Which means the very lowest wage worker in Greece would earn 25,000 drachmas/euros per year. And they would have to work no more than three days a week.

A path to withering away of the state

Next we have to deal with a huge state budget deficit, which Buiter describes this way:

“So the authorities might have to finance at least 5 percent worth of GDP through issuance of ND base money, under circumstances where the markets would inevitably expect a high rate of inflation. The demand for real ND base money would be very limited. The country would likely remain de-facto euroised to a significant extent, with euro notes constituting an attractive store of value and means of payment even for domestic transactions relative to New Drachma notes. We have few observations on post-currency union exit base money demand to tell us whether a 5 percent of GDP expected inflation tax could be extracted at all by the issuance of ND – that is, at any rate of inflation. If it is feasible at all, it would probably involve a very high rate of inflation. It is possible that we would end up with hyperinflation.

The obvious alternative to monetisation is a further tightening in the primary deficit through additional fiscal austerity (of something under 5 percent of GDP), allowing for some non-inflationary issuance of base money. Because Greek exit would be in part the result of austerity fatigue in Greece, this outcome does not seem likely.”

Even after repudiating its debt, Buiter still estimates Greece will need an additional 5% of GDP to fix its public sector deficits. And we have already made sure Greece can neither borrow a dime, nor print any currency. This means the state must start withering away quickly.

Since we have to cut state sector expenditures by 5%, where do we start? Well, it just so happens Greece spend 3% of its GDP on the military. According to Wikipedia:

“Greece is the largest importer of conventional weapon in Europe and its military spending is the highest in the European Union.”

Thus, more than half of its budget deficit, after it has repudiated its debt, can be eliminated simply by eliminating its military. Oddly enough, however, the rest of the deficit went away as well when we reduced hours of labor: reducing hours by half was the equivalent to eliminating 350,000 jobs in the public sector — only no one lost their jobs — hours of labor were reduced for everyone.

Bourgeois propaganda typically accuses the Greece public sector of being overstaffed by 50%. We fixed that too, simply by reducing hours of labor in the state sector by 50%. In fact we have reduced the expenditure of labor in the entire Greece economy by more than 30% without throwing a single person out of work anywhere. And we did it while giving even the lowest paid workers a 25,000 euros wage.

Thus, with two critical measures, we forced capitalist firms to restructure their labor forces without firing anyone, reduced the size of the public sector, eliminated all deficit spending and put an end to poverty among the working class.

Now here is the thing: According to labor theory, if you can eliminate 50% of the labor time in production, this should lead to fall in prices of commodities produced in the economy. If this is true, at the end of our exercise, the purchasing power of a drachma should have dramatically appreciated. Drachmas should no longer exchange 1 for 1 with euros; instead, each drachma should now be worth almost 2 euros.

While the purchasing power of the euro is mostly unchanged over the period, the purchasing power of drachmas should be rising. Which means, instead of hyperinflation, as Buiter predicted, we should now have deflation in the Greece economy. At the end of the transition, the 25 drachma per hour minimum wage in Greece should now be worth 50 euros per hour.

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