Too much of the commentary about the Greek crisis has focused on whether or not Greece should drop the euro and not enough on the structural problems arising out of decades of socialism. Meanwhile, the Greek government has borrowed more money than the Greek people can possibly repay, and debased money will not make this fact disappear. On the contrary, more easy money will cause even more harm.
The best thing that Europe and Greece can do for itself right now is to confront some of the economic fallacies that have long driven the debate over Greece, the euro, austerity, and debt. Here are four fallacies that are among the most damaging:
1. The Euro Is Too Strong a Currency for Greece
This statement usually is accompanied by a reference to Greek productivity being lower than that of the northern tier EU countries. The logic, such as it is, states that the euro is not a suitable currency for countries with vastly different levels of productivity. This is followed by a recommendation that Greece leave the European Monetary Union and reinstate the drachma. The National Bank of Greece then would set a very low exchange rate between the drachma and the euro, making Greek products more competitive.
Well, there is a semester’s worth of economic fallacies embedded in this chain of logic. A currency is an indirect medium of exchange. Two countries with different levels of productivity can use the same medium of exchange just as two individuals can. You may pay the kid next door to mow your lawn with dollars that you earned in a highly skilled and highly compensated profession. Yet you both use dollars. There is no reason that the Greeks and the Germans cannot use the same currency. In the age of the gold standard, national currencies were defined by their exchange rates to gold and were redeemable in specie; therefore, in effect, all countries were using the same currency — gold.
2. Debasing the Currency Will Help the Greeks Export Their Way to Recovery
Correlated to the above fallacy is the notion that debasing the currency will aid the Greek economy by the stimulative effects of an increase in exports. The idea is that the Greeks can give more drachma for the currency of its trading partners, making Greek exports cheaper in terms of the foreign currency. Increased exports will stimulate the entire economy. But currency debasement merely causes a transfer of wealth within the monopolized currency zone.
However, the Cantillon Effect tells us that the early receivers of the newly printed money benefit by their ability to purchase resources at existing prices. The losers are those furthest removed from the initial increase in spending, such as pensioners. They will find that their money doesn’t buy as much, due to price increases that are an inevitable consequence of an increase in money spending. Eventually, the exporters find that the cost of their resources has risen, at which point they demand another round of money debasement in order to prop up foreign sales and avoid business losses. They will be forced to pay more for their factors of production and must raise prices in local currency terms. In order to avoid losing sales they need their foreign buyers to receive more local currency so that their goods do not increase in price in foreign currency terms. This policy masks real structural problems. It is not a currency problem.
3. Instituting One’s Own Currency Will Enable Government To Avoid Unpopular Spending Cuts
In other words, debasing the currency is a way to avoid the dreaded austerity monster. Governments would have the people believe that there are sufficient real resources to redistribute from the wealthy to alleviate all poverty. It is assumed that the wealthy have nefariously confiscated the people’s wealth, and redistributing it along socialist lines will result in plenty for all. The socialist “plenty for all” slogan has been around a long time and has yet to prove its worth in alleviating poverty.
4. A Currency Must Be Backed by a Political Power with Taxing Authority
Milton Friedman has been quoted as saying years ago, in reference to the formation of the European Monetary System, that a monetary union needed a fiscal union. Italy’s finance minister, Pier Carlo Padoan, was quoted in the Financial Times of London on July 27, 2015, as saying that the only way to defend the euro was to move “straight towards political union.”
Of course, both men refer to fiat money (i.e., money imposed by the state and backed by nothing except the legal tender laws of a monopolized currency zone). Real money — sound money — is a commodity that has been found by the market as the most useful intermediate means of exchange. Sound money arises out of the market process and is part and parcel of the market itself. Sound money is discovered by the market and is used willingly by cooperating parties. No one is forced to use sound money. Parties using sound money enjoy the protection of the rule of law. Counterfeiters are prosecuted. Bankers who fail to deliver specie upon presentment of money substitutes, such as money certificates, and bank drafts are prosecuted, too. The best monetary systems are private, because they must operate under the rule of law. The worst monetary systems are run by governments, because governments exempt themselves from the rule of law.
The Greeks (and Europe) Need Monetary Freedom
Dropping the euro will not solve Greece’s problems, nor would such a move remove the many structural problems underlying the European monetary union. An adherence to these economic fallacies has encouraged a belief that a few adjustments can fix the Greek-euro situation.
But, it is telling that in poll after poll, the Greeks themselves show that, although they do not desire austerity, they also do not wish to abandon the euro. They know that such a move will allow the government to destroy what little wealth remains in the country. The Greeks see the euro, with all its flaws, to be superior to a reinstated drachma. In fact, the best alternative for Greece right now is to allow free competition in currencies which would allow the Greek people to trade in whatever currencies they deem most desirable. At the same time, Greece should welcome and protect, via the rule of law, the establishment of private monies.
But the fundamental problem of the euro remains, and we must remember that the Greek government itself responded rationally to the structure of the European Union and the European Monetary Union. It borrowed heavily at low rates of interest from willing lenders. It accepted all the newly printed euros so eagerly offered by these flawed organizations’ various funds. It is not the only country to do so, merely the first in which the adverse consequences of the EU’s flawed structure became apparent. There will be others and the adverse consequences will be greater.
