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Why the Default of Greece Should (not) Drag the Euro behind

October 19th, 2011 by Leonardo


This is the translation of an article previously posted on Linkiesta and IlSussidiario.

by Leonardo, IHC

It is common wisdom that the problem with the Greek debt is very serious, as a Greek default would drag the Euro behind, and the consequent Euro-failure would imply carnage of European people. I do not exactly know how people can figure the monstrous disaster of the Euro falling apart – the terms used are evocative but far from being descriptive – but I sincerely find a lot of rhetoric aimed to convey the common consent.

Some historical hints. By the information officially spread, Greece “is bankrupting” for a year and a half, and every week during all this period somebody howls that “time is over”; this “bankrupting period” is really long to get over!

We must moreover consider that, from mid ‘800 on, Greece has renegotiated its debt several times (it could not pay it bank, the same as today) thus recording at least eight official defaults; this long “bankrupting” is therefore one in the several preceding events which, finally, did not make the drachma disappear – What is the real danger for the Euro, then? I add that in the USA more than 2,300 municipalities have defaulted (city defaults, as the single States are permitted to transfer their deficits into the federal budget) from 1980 to 2002 for a value of about 33 billion dollar; finally, New York e Cleveland defaulted respectively in 1975 and 1978 … it does not seem that all this mess has destroyed the dollar, which keeps being the common currency of several federated fiscal entities.

Let’s think now of the hypothetical case of a State using gold as a money: if the State would default (being not able to pay its debt back), then gold becomes “lesser gold”? Don’t think so, gold is gold, it remains perfect as a money for the other countries which are adopting it. The consequent conclusion follows: an exogenous money (whose dynamics does not depend on the fate of fiscal entities) has got its own existence grounded on the legal tender status (the State monopoly imposes its legal use, like Hayek points), network effects (advantages stemming from being a money already widely accepted, like Friedman stresses), and its real value determined by the quantity of goods and services it allows to reach.

If the Euro was emitted by an independent entity (exogenous money, then), the default of one of its users would involve financial losses just for the user’s creditors, logically consequent distrust in the defaulted user, and probably a temporary shrinkage of general economic activity. Euro – the money – would get out of this mess substantially untouched, as it is the legal tender in a well vaster area and is therefore “backed” by a great deal for real production (the Eurozone’s, and from abroad within the limits that the European production is demanded). The same story goes in case of the default of Italy. Anyway, Portugal and Ireland have already gone bust, they do not collect funds on the market but completely rely on the UE rescue funding; in spite of this burden, Euro reached 1.46 against U.S. Dollar. The “default” danger is not, in natural terms, a monetary concern.

Eurozone does not actually fit the case illustrated above: the ECB is the monetary agency of a political directorate (for details see here and here) made up of 17 countries; its policy is neither “monetaristically” or “teutonicly” managed to control the supply rate of money in an exogenous fashion, nor it purely targets the purchasing power thus necessarily coordinates with production; its policy gets indeed used as an instrument for political ends. Bagus clearly explains the situation: politicians (at least the majority) want a European Super-State, so they manoeuvre the Euro to “buy” – via bailing out States and banks – the necessary consent. This is it.

The Euro, as a political tool, must follow the destiny of the managing political entity; the fight against the debt crisis is conducted by issuing new money, and through the dilution of the greater supply of Euros against a constant real production it passes the cost – which in origin must be paid by creditors only – onto the shoulders of all the users of the money. The single Euro unit therefore loses value, as it buys less stuff: it chases a lesser fraction of the available real wealth. Political interventionism just forces real resources toward poorly productive political ends (bailing out a defaulted entity implies the opportunity cost given by the lack of resources that wealth increasing employments may need); in the long run, the single Euro unit will represent a reducing fraction (because of new money is issued) of a reducing or poorly increasing real production set. This is themechanism which leads to the devaluation of money and lets the Euro risk a fall of its appeal both outside and inside the Eurozone! This is the actual Euro-failure we must fear.

A Euro-failure is possible just as long as the politicians impose the economic goods “money” to work as a political instrument; its “value” is therefore bent by non-economic forces, which make the Euro a “bad money” that, North docet, can only displace the “good moneys” as long as the State controls its price. On the free market of exchange rates the Euro would dissolve; within Europe people would use other moneys (save the sanctions), and this would be the actual “Euro-failure”. Everything else is just rhetoric.

If an European firm defaults, the Euro does not; is a State like Greece or Portugal defaults, then the Euro does not the same. Money naturally lives its own life, but it must be consistent with the magnitude of the real economic activity which – by force of law, in the current world – it can be traded against. Private operators let the insolvent default, try get repaid the most possible, and look for better employments for the resources – this maintain the economy working; the State is a provider of services and, if insolvent, we can let it default so that creditors can be repaid as much as possible and get into more profitable businesses (while some entrepreneurs will arrange a new, more efficient supply of the services now “lost”).

Anyway, it must be up to the creditors to decide whether it is more profitable to renegotiate the debt or look for alternative employments. It has however to do with employment and distribution of real wealth which the monetary instrument conveys, not the very existence of money per se.

This is the rhetorical game of politicians (sadly, many people dropped in): let people think that we must rescue Greece to save the Euro. The Euro would be paradoxically stronger if Greece was let default, as it would prove that a political question would not be able to bias the amount of Euros in circulation at mere discretion, and that the value of the money is anchored just to ability of the economy (or part of it, see the case of EU and Germany) to create new wealth appreciated abroad; in such a case the cost of the default of one among all the fiscal entities using the same money would have the same transitory effect of the historical defaults of  New York e Cleveland. But politicians involve the Euro, as the majority of the European people (the Greeks, especially) are well aware that without the Euro they could not – neither temporarily – jump out of their growth and inflation traps; politicians can this way justify interventions directed to bail out the political end – in their own interest – of a European Super-State

It is politics itself which, to pursue their political ends, actually creates the basis – the link between money and State – for the Euro to be dragged down by the default of a marginal fiscal entity. Politicians have a first problem (consent at risk because of the Greek default), they create a second problem (menaces over the Euro) to solve the first, then they lament on the first problem declaring that from its solution stems the solution to the second; causal links are actually in the opposite direction and due only to the existence of politicians. Getting rid of political interferences, and letting the principle of individual responsibility on own debt, would immediately erase any menaces on the Euro.

Fall into this “muddle” means aligning with a political faction on the basis of a false, though evocative, portrayal of reality.


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