Greece: Why Not Go Back to the Drachma?

What is the real reason Greece’s political elites might favor a return to the drachma?

February 7, 2012

What is the real reason Greece's political elites might favor a return to the drachma?

There are three problems with Greece abandoning the euro and returning to the drachma. The first two pertain to the sphere of macroeconomics. Most immediately, there would be turmoil and difficulties involved in the transition from the euro to the drachma.

This will likely include a run on the banks, strict control of capital movements, inconveniences in payments and settlement of debts, and shortages of essential imports such as oil, spare machinery parts and medical supplies. During this phase, Greece’s GDP will most likely continue to fall rather than recover.

The second problem is more crucial. It is doubtful whether a devaluation of the drachma will strengthen the economy and lead to sustained growth. It will certainly increase Greece’s debt-to-GDP ratio, as most of its debt is contracted in euros, and will make borrowing from international capital markets practically impossible for a long time.

It will also quite certainly rekindle inflationary tendencies, as the prices of imported goods will rise. The increase in the prices of raw materials and intermediate goods will increase domestic costs and cancel out the competitive edge provided by devaluation. More devaluation will then be needed to restore competitiveness — and the end result, with inflation tending to accelerate, risks being a devaluation-inflation spiral.

Such an outcome is not dissimilar to the historical experience of the Greece’s economy in the two decades prior to its adoption of the euro. This experience is, to a large extent, the result of the political elite’s handling of the economy in their boundless quest for political power. The politicians’ appetite for power, and for fighting each other in their quest for control, seems hardly to have abated. This is the third problem — and it bodes ill for the future.

It is indicative of the mentality characterizing the political class that the major political parties are far more indebted than the Greek state. Despite allotting themselves subsidies, which exceed more than 10 times (on the basis of votes received in the most recent election) the corresponding ones for Germany, they have borrowed from the banking system the equivalent of four to five times their current revenue from the state.

And yet, even today, they are trying to borrow more. Though it may sound incredible, borrowing from the banking system is still feasible, given that the state still controls a sizable part of it. Moreover, the declared intention of the majority party in parliament, PASOK, is to effectively nationalize the main private banks, which hold a considerable amount of government debt and will need recapitalization following the impending haircut.

It is true that state subsidies to the political parties were reduced, under the pressure of the debt crisis, in 2010. Nevertheless, the subsidy level was nearly restored in 2011 — and it is planned to be increased in 2012. It should be added that the parties’ finances are scandalously opaque. Not only are they not properly audited or controlled, but one of them (the Communist Party, which holds the third most seats in parliament) has emphatically declared that it will never accept any inspection of its finances.

All of this should suffice to explain not only the generalized distrust towards the politicians, but also the fear that a return to the drachma will inevitably result in a devaluation-inflation spiral. In this respect, it is instructive to consider the beneficiaries of devaluation and inflation.

Clearly, borrowers who have to repay their debt in the devalued currency stand to gain. This includes not only the political parties, but also most of the press and the media, as well as a host of firms that depend on state orders and political favoritism.

This is a formidable nexus of influence and power, which has a common interest in returning to the drachma. Its rallying cry is invariably nationalist-populist and, of course, hides this interest behind appeals for resistance against the loss of national sovereignty and the “humiliating colonization” of the country by Europe and the Germans.

In short, the true beneficiary of a reversion to the drachma is the whole system of power cultivated by the political class since the fall of the dictatorship in 1974. It is this informal, implicit power arrangement, which until recently was often invisible to the general public, that is presently under threat. It would be given a fresh lease on life by a return to the drachma and the nearly certain devaluation-inflation spiral that will follow.

That is the last thing the Greek people should want. And it should gravely concern the international community as to the forthrightness of the intentions of the Greek political class in its negotiations with the EU, the IMF, the banks and so on.

The self-interest of Greece’s political parties, or so it seems, does not lie with the outcome of staying in the euro. They may, in fact, be paying mere lip service to it.

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Takeaways

It is indicative of the mentality of the political class that the major political parties are far more indebted than the Greek state.

Borrowers who repay their debt in the devalued currency stand to gain. This includes the political parties and most of the press and the media.

The true beneficiary of a reversion to the drachma is the whole system of power cultivated by the political class since the fall of the dictatorship in 1974.