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A Way Forward for Greece

Personal_Finance / Eurozone Debt Crisis Feb 16, 2015 - 01:02 PM GMT

By: Frank_Hollenbeck


The current Greek crisis is exposing the elephant in the room - a worldwide problem getting progressively worse by the day. It’s a problem that has plagued developed economies for the last two millenniums. A problem currently metastasized into a full-blown cancer before our eyes: fraudulent fractional reserve banking (see here and here).

The recent ECB decision to limit liquidity to Greek banks and then force them to go cold turkey at the end of the month has put the Greek government between a rock and a hard place. Rumors of a “Grexit” have cause bank withdrawals to skyrocket. During the month of January, over 10 billion euros were withdrawn from Greek banks. The problem is that Greek banks simply do not have the money. Current non-performing bank loans in Greece are over 30%. Banks also hold large amounts of high risk Greek government debt. A likely collapse of the banking sector in Greece is forcing the Greek government to rethink its previous hard line approach to debt repayment.

Despite rumors in the press, there are no European mechanisms to force Greece out of the Euro. Greece would have to be the one to decide to leave. Current wisdom is that a bank run would force Greece to return to the drachma. Although this is a possibility, it is not a foregone conclusion. Even if Greece defaulted, it would still probably have a large euro debt which probably could not be financed with a greatly devalued new drachma. Greece needs a plan to stay with the euro, at least short term, but it also needs significant debt relief.

What should Greece do? Sometimes you have to consider the impossible to make the possible evident.

Greece should default on as much debt as possible. There is no benefit to meeting the EU halfway. Greece would then likely have to nationalize all its banks. This is not a big change since the government is already a large part owner of most banks, which technically are bankrupt. To meet withdrawals, the Greek government will have to run significant budget surpluses. This is achievable if Greece temporarily cuts government salaries over 1500 euros by 50%. Greece may have to impose capital controls, limiting, for the briefest of times, withdrawals from bank accounts.

The next step would be for Greece to covert banks into deposit institutions. Assets currently held by banks would be sold off. The model of such institutions would be like storage facilities where you charge a fee for the storage of items such as furniture. Ultimately, these deposit banks should be sold to the private sector but with strict laws defending property rights. A deposit is a bailment, not a loan, and any sleight of hand to convert a deposit into a loan should be considered fraud.

However, loan banking should be open to competition. These should be 100% equity financed. Putting money in a loan bank should be like putting money in the stock market. You know you risk losing everything. Such banks would be like any other business and would not need any more special regulation than the makers of potato chips.

Ultimately, Greece needs to leave the euro. Current monetary policy in Europe is reckless and a fiscal storm is brewing increasing the likelihood that Europe will try to print its way out of trouble. We have been down this path many times before. History is littered with examples of countries trying to defy the law of scarcity by printing pieces of paper. It took France 40 years to recover from the hyperinflation of 1790-1797. The German hyperinflation of 1921-1923 created a political vacuum that gave us mankind’s worst nightmare.

The new drachma and the Euro could trade side by side. There is no reason for a unique means of payment. Panama uses the US dollar, and Zimbabwe uses multiple foreign currencies as legal tender. Greece would benefit from having competing currencies. Yet government payments should be in new drachmas. The government must severe its link with the inflationary, irresponsible monetary policies currently being followed by the ECB.

For the sake of future generations, Greece should then fix its currency to gold. Few economists understand why so many advocate a return to the gold standard. Keynes called gold a “barbaric relic”. It’s not because gold is somehow special. Gold has many drawbacks, but gold’s primary advantage makes most of these drawbacks moot. The most important aspect of a gold standard is that it constrains current and future governments from using the printing presses to finance government expenditure. This struggle between governments and its people has been going on for decade. Kings, during the Middle Ages, would regularly debase their currency by exchanging one smaller 1 franc coin for a larger 1 franc coin and use the gold obtained in this fashion to print new coins. This was a drawback of the gold standard, but even the Kings were limited in the amount of debasement they could get away with. In today’s fiat currency world, the debasement possibilities are endless. It is important Greece put roadblocks so that future governments cannot use the printing presses to fund government spending.

In a relatively short period of time, Greece could go from being the example to avoid to an example to emulate. Greece also needs to dismantle crony capitalism and replace it with true capitalism where businesses are free to engage in mutually beneficial transactions that do not violate laws on property rights. No one should be given special government privileges to be shielded from the forces of competition. Even monopolies have to serve the public interest if they want to remain monopolies in a competitive environment.

With such an economic structure Greece would benefit from long term economic and financial stability. Greece once led other countries out of barbarism. Greece could lead them again out of the quagmire of our current economic system based on fraud and cronyism- a system plagued with incessant boom and busts causing so much hardship for so many.

Frank Hollenbeck teaches finance and economics at the International University of Geneva. He has previously held positions as a Senior Economist at the State Department, Chief Economist at Caterpillar Overseas, and as an Associate Director of a Swiss private bank. See Frank Hollenbeck's article archives.

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© 2015 Copyright Frank Hollenbeck - All Rights Reserved Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.

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