Four economic myths that are worsening the euro crisis

Patrick Barron

Much of the commentary surrounding the Greek crisis has focused on whether or not the country will leave the Eurozone, with less attention to the structural problems that have arisen after decades of socialism. At the same time, the Greek government has borrowed more money than the local population can repay, and currency devaluation cannot make that fact disappear.

The best thing Europe and Greece itself can do for the country is to confront the economic fallacies that have long fueled the debates about Greece, the euro, austerity and debt. Here are four of the most damaging of them:

1. The Euro is too expensive a currency for Greece

This statement is usually accompanied by a reminder that Greece's productivity is lower than that of the northern countries in Europe. According to this thesis, the euro is not suitable for those countries in the monetary union whose productivity is too different from that of the other member states. This statement is usually followed by the recommendation that Greece should leave the European Monetary Union and reinstate the drachma. The National Bank of Greece should establish a very cheap exchange rate between the drachma and the euro, thus making local products more competitive on international markets.

We could spend a whole semester examining the economic fallacies that make up this logical chain. 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 people with different levels of productivity can. You can pay your neighbor’s child to mow your lawn in leva that you earned through highly skilled labor. But both of you use leva. There is no reason why the Greeks and the Germans could not use the same currency. During the gold standard era, national currencies were defined by their exchange value in gold, and against their face value, people had the right to receive precious metals against the face value of the banknote. So all countries used the same currency back then—gold.

2. Currency devaluation will help Greece claw its way to economic recovery through greater exports

Often associated with the above fallacy is the idea that currency depreciation will help the Greek economy through the stimulatory effects of increased exports. The idea is that Greeks can pay more drachmas for the currencies of their trading partners, which will make domestic companies' exports, denominated in foreign currency, cheaper, and the increased exports will stimulate the entire economy. According to this view, currency depreciation will simply cause a transfer of wealth within the monopolized currency union.

But the Cantillon effect teaches us that those who receive the newly printed money before everyone else benefit because they can buy resources at the prices set at that time. The losers from printing money are those who are furthest from the first owners of the new money. Among them, people with fixed incomes, such as pensioners, suffer the most. At some point, they will find that their money can buy fewer goods because of the price increases that are an inevitable consequence of the increase in the money supply. Eventually, export-oriented firms will feel the price of their resources rising. At that point, they will start to demand even greater currency depreciation (i.e., more and more money injections) in order to increase their sales abroad and avoid business losses. They will be forced to pay more for the factors of production they need, and they will have to increase the prices of their output expressed in local currency. And in order to keep the price of their products from increasing and the sales of Greek companies abroad from decreasing, their foreign trading partners will need to receive more local currency. This policy creates real structural problems. It is not a currency problem.

3. Restoring the drachma will allow the government to avoid unpopular spending cuts

In other words, currency devaluation is the way to avoid the hated monster of austerity. The government will make people believe that the rich have enough real resources to redistribute to eliminate all poverty. This thesis assumes that the rich have stolen wealth from the people and that redistributing it in a socialist way will create prosperity for all. The socialist slogan of “prosperity for all” has been around for a long time and has not yet proven to be a successful way to deal with poverty.

4. A currency must be backed by a political power that has the power to tax

Milton Friedman is credited with having proposed that a fiscal union is necessary for a European monetary union. Italy's Finance Minister Pier Carlo Padoan, quoted by the Financial Times, has said that the only way to protect the euro is to move "straight to a political union."

Of course, both are talking about fiat money (i.e., money imposed by the state and “backed” only by the laws of the monopolized currency area). Real money—stable money—is the commodity(ies) that the market determines to be the most useful medium of exchange. Stable money arises from the market process and is part of the market itself. It is created in the market and used by willingly cooperating participants. No one is forced to use it. But trading parties who use it enjoy the protection of the law. Counterfeiters are prosecuted. Bankers who fail to pay out precious metals when presented with money substitutes (such as money certificates) or bank notes (banknotes) are also prosecuted. The best monetary systems are private because they are required to operate within the law. The most disastrous monetary systems are government-run because the authorities circumvent the blows of the law.

Greece and Europe need monetary freedom

Leaving the Eurozone will not solve Greece's problems and will not eliminate the large number of structural problems inherent in the European Monetary Union. Adherence to the economic fallacies described above has created and strengthened the belief that with just a few adjustments, Greece's situation can be resolved.

But survey after survey shows that Greeks themselves, while not wanting austerity, do not want to leave the Eurozone. They know that such a move would allow their government to destroy the little wealth left in the country. The local population sees the euro – with all its flaws – as a better alternative than returning to the drachma. In fact, the best option for the country at the moment is to allow free competition in the sphere of money, which would allow residents to trade in the currencies they find most desirable. At the same time, Greece should welcome and legally protect the creation of private money.

But the fundamental problems of the euro will not be solved by this, and we must remember that the actions of the Greek government were rational in the context of the structures of the European Union and the European Monetary Union. [1] It borrowed colossal amounts of money from those willing to lend it at low interest rates. The authorities readily accepted the newly printed euros offered by various funds. Greece was not the first country to pursue such a policy; it was simply there that the fundamentally unstable structure of the European Union first became apparent. There will certainly be other such countries in which the unintended consequences of the structural problems of the euro and the EU will be much more severe.

Translation: Daniel Vassilev

You can read the original article in English here.

[1] See also: Philip Bagus, The Tragedy of the Euro, "MaK".

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