Ifo Viewpoint No. 135: Athens Today: Weimar Revisited

Hans-Werner Sinn
Munich, 2 July 2012

The departure of Greece from the European Monetary Union draws ever closer. This is not a disaster for the Eurozone – and certainly not for the Greeks. Here are twelve questions and answers about the economic benefits of a Greek exit and the possible course it could follow.

1. Why is Greece’s exit from the Eurozone inevitable?

Because the country has become too expensive, due to the cheap credit that came along with the euro. To become competitive again, Greece must become 30 per cent cheaper, according to some estimates. The Ifo Institute calculates that a 37 per cent devaluation is required just to draw even with Turkey.

2. Why can’t Greece keep the euro and lower its prices and wages accordingly?

The unions won’t go along with this, and even if they did, the bank debts of companies can only depreciate if everything is switched to the drachma.

3. Hasn’t Germany succeeded in becoming cheaper in the euro area?

It took Germany more than 13 years, from 1995 to 2008, to manage a real depreciation of 22 per cent, and this was accompanied by mass unemployment. But while Germany’s devaluation took place by means of inflation in the rest of Europe, Greece must actually lower its prices, since Germany will not support an inflation strategy in Europe. The Greek situation is more akin to the Weimar Republic. From 1929 to 1933, Germany had to deflate by 23 per cent, since it was pegged to the gold standard, while the other countries devalued. It will not be possible for Greece to achieve competitiveness within the Eurozone.

4. Should not the international community help Greece with a new Marshall Plan?

Assuming the same proportion of GDP as Germany had after the war, Greece would have to receive around four billion euros from such a development programme. In fact, with the rescue packages, the purchases of government bonds by the European Central Bank (ECB), the Target credit of the ECB and the haircut on its debt, Greece has already been granted 460 billion euros in assistance. That amounts to 116 Marshall Plans, and it hasn’t helped much at all.

5. Would other measures help, such as reducing unit wage costs or pushing through structural reforms?

Yes, but they will only improve competitiveness to the extent that they lower prices. So far prices in Greece have actually increased during the crisis.

6. What about the possible contagion effects if Greece exits the euro?

Contagion effects exist in both directions. If Greece keeps the euro and receives further support, the strong countries in the end will also have to help Portugal, Spain, Italy and ultimately France. Then one half of the euro area will be supporting the other, an impossible situation. Such a policy prevents the real depreciation of over-priced countries and pushes the more healthy states towards the abyss.

7. The financial industry keeps stressing the danger of contagion after an exit. Why?

The banks conjure up possible contagion effects to escape unharmed and to get the taxpayers to foot the bill. Greece has already gone through a partial insolvency, and in contrast to the horrors that were invoked before that came about, the markets took it in stride. Banks pursue their interests by driving fear into the politicians.

8. How much will it cost Germany if Greece leaves the euro?

A Greek default would cost the German government 80 billion euros. If Greece leaves the euro it would cost nothing. On the contrary, only by leaving the Eurozone can Greece devalue, become competitive and be in a position to repay. The necessity of writing down losses on exiting the euro should not be confused with incurred costs. The money has already been lost. Every day we wait increases the losses.

9. Won’t chaos break out when Greece leaves?

The chaos is already here. The mass unemployment that the euro has brought about is intolerable. Only an exit from the euro can give young Greeks jobs and hope for the future again. The assistance should be used to facilitate an orderly exit. In recent decades there have been dozens of sovereign defaults. In all cases it took a devaluation for those economies to recover.

10. Should Greece close its borders to prevent capital flight?

This should only be considered in advance of the transition. After the devaluation of the drachma, the rich Greeks will bring their money back home and invest it in real estate and jobs.

11. When and at what exchange rate should the transition take place?

The changeover should take place without advance warning on a weekend when banks are closed. As of the following Monday, all accounts, debt contracts, wage contracts and price tags will be denominated in drachma. The numbers will stay the same but not their economic value, which I imagine will fall by half.

12. How can we prevent euro cash from being smuggled out of the country?

The euro banknotes in Greece should be stamped. How much money the ECB would lose by this is secondary. The little cash that the Greeks have is not really the problem.

Hans-Werner Sinn
Professor for Economics and Public Finance
President of the Ifo Institute

Published under the title “Weimar in Athen”, WirtschaftsWoche, No. 22, 26 May 2012, p. 28.