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Euro is great but the politicians are killing it!

June 7, 2012

India’s Bengal is effectively in a monetary union without a fiscal union since India’s Central Govt. is refusing to bail out Bengal. Should it exit the Rupee and print its own currency? Thankfully, the unanimous answer here is No.

Similarly, Euro (a monetary union without a fiscal union) is fine. While Greece has to default, it should remain within the euro.

How can an unproductive Greece recover without devaluation?

Greece govt should restructure/default on most/all of its debt and firmly declare that it will NOT quit the euro (it does not need anybody’s permission to do this). Consequences (this is already happening in slow motion):

  • Lack of funding will limit the Greek govt’s spending to available tax and non-tax revenues.
  • To spend, politicians will be forced to reform the tax system and privatize (if they are smart, they will also deregulate, cut tax rates and encourage GDP growth)
  • Many Greek banks that have lent too much to the govt. will face a run and fail.
  • There will be unemployment, under-utilization of other factors of production like land, fixed assets and capital, susbtantial drop in discretionary spending as well as imports.

The good news

The ‘banking system’ will continue to function.

  • Deposits (and other paper assets) are currently leaving Greece for fear of being redenominated to Drachma. Once the threat of Euro exit is gone, deposits (and other banking activity) will stay within Greece but will leave ‘weak banks’ and move to local branches of strong (local, european and global) banks.
  • The weak banks’ shareholders will lose their investment but its creditors, strong banks and/or other investors will acquire/restructure (the assets of) these weak banks and run them.

The above is already happening.

The really good news

Productivity will increase due to fall in prices, rents, interest rates and wages.

  • Low costs of living and doing business will retain/attract local and foreign talent, capital, etc. The immense benefits of Euro/EU (single currency, free markets, capital and labour mobility, etc.) will strongly facilitate that.
  • When a country tries to print / devalue its way out of trouble, it experiences inflation.

The KEY:   Financial crises generally mean inflation but, for Greece, Euro will ensure deflation!

In a world of no bailouts and no inflation, hardworking Greeks will do well even if the Govt goofs up. Deflation will improve productivity and ensure high value for the low income and savings. (The govt. can also help this recovery by swift deregulation making it easier to do business in Greece. In any case, its ability to do damage will be curtailed.)

No doubt, there will be pain for unfit individuals, businesses and govts. in Greece (and other euro nations) but its unavoidable and default within the Euro will remove excesses in the system and incentivize everyone to shape up.

Also See: How did Greece manage to borrow so much money in the first place?


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  1. How could Greece borrow so much? « Democracy4India

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