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In May, 2012 the euro fluctuated against the dollar after touching the weakest level since July 2010 on speculation European leaders may seek measures to contain the debt crisis among monetary union members. Economists such as New York University’s Nouriel Roubini say that by quitting the euro, Greece would seize control of its fate. Having a cheap currency would make Greece’s goods and services more affordable, drachma advocates say, shrinking a current-account deficit that’s about 9 percent of the entire economy. It actually poses a huge risk.
There’s no question that quitting the euro would be an easy way for Greece to shrink its unsupportable debt. Yet if Greece does leave or is kicked out of the single currency, it will most probably suffer inflation, layoffs, capital flight, shortages of essential commodities, and civil unrest, judging from what happened in Argentina when that country quit its dollar peg a decade ago.
“Leaving is difficult and messy, so anyone who thinks it’s easy is just wrong,”
says Lorenzo Bini Smaghi, a University of Chicago-trained economist who left the European Central Bank’s executive board last year.
What’s more, Greece is likely to find that a devalued currency doesn’t buy competitiveness. Outside of agriculture, many Greek exporters rely on imported components and raw materials that would soar in price in drachma terms, erasing the hope that exports could quickly lead the nation back to a trade balance.
Beauty is one thing Greece doesn’t need to import, and it will be more attractive on sale as a result of a currency devaluation. Tourism would be the largest beneficiary of a devaluation because it would make Greece a cheaper travel destination than Turkey, Croatia, and other vacation spots.
“A German guest complained the other day that ‘You don’t have an economy, government, or money, but you’re charging me €4 for a coffee,’ ”
says Costis Mouzakis, who works in a downtown Athens hotel.
Still, tourists might not come for bargain holidays if Greece is in chaos and xenophobia is running high. Air Berlin, a discount carrier, says its Greek business has declined about 30 percent from a year ago—not a huge surprise, considering that some Greek politicians’ speeches have demanded reparations for the Nazi occupation of Greece.
Greece’s export profile looks like something out of the 1950s. Aside from tourism and shipping, there are petroleum and aluminum products, medicines, fish, iron, piping, vegetables, fruits, cotton, cheese, fur and, of course, olive oil. Income from those exports is not enough to pay for everything Greece imports, from crude oil and vehicles to computers and consumer electronics.
Quitting the euro is only one way to solve what everyone agrees is Greece’s underlying problem: The nation lost cost competitiveness and became dependent on foreign capital after joining the euro in 2001.
Germany reduced its inflation-adjusted labor costs four times as fast as Greece did over that period, according to an analysis of data from Eurostat, the European Union statistical agency. Greeks lived beyond their means, paying for imports with IOUs instead of exports.
Whether in or out of the euro region, Greece has to lower its costs (mostly via wage cuts) and increase efficiency by weeding out corruption, streamlining government, and reducing the power of entrenched interest groups.
The advantage of staying with the euro is that the other 16 euro area nations are giving Greece the time it needs to make those painful adjustments. They’re providing fiscal transfers from the EU and easy lending terms from the European Central Bank.
The deal is harsh: Liberal economists such as Nobel prizewinners Paul Krugman and Joseph Stiglitz argue that austerity is driving Greece deeper into recession, making it even harder to balance the budget.
Still, the terms are better than Greece will get if it’s suddenly on its own. It would lose the backing of the European Central Bank and may also be forced out of the EU. The International Monetary Fund would probably continue limited lending to prevent complete chaos, but Greece will be cut off from private borrowing and run out of money, at least until lender amnesia sets in. That’s why economists fear a shortage not only of luxuries but of such essentials as food and medicine.
Economists such as Roubini—call them the drachmatists—say Argentina’s rapid return to growth after its chaotic devaluation in 2002 shows that Greece should drop the euro immediately.
“A breakup is painful and costly, but a rotten marriage is worse,”
Roubini wrote last year. He went on to say “In short order, Greece could restore its competitiveness, turn its current-account deficit into a surplus, and start growing rapidly again.”
Argentina’s experience does show that devaluation and default don’t have to be disastrous in the long term. The short-term costs are sky-high, however. And if Greece goes off on its own, the useful external pressure for reform (aka meddling) will diminish.
The best outcome would be for Europe to form a fiscal union and switch decisively from austerity to growth—rescuing not only Greece but Ireland, Portugal, Spain, and Italy as well. That, however, doesn’t seem to be in the cards. Greece faces a choice between a bad situation and one that looks even worse.
The bottom line: Greece’s main problem is its lack of competitiveness, and switching to the drachma would do little to remedy it.
Article Source: http://www.businessweek.com/articles/2012-05-24/what-a-return-to-the-drachma-really-looks-like
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