Would Greece or any of the G.I.P.S.I. countries improve their economic fate by leaving the Euro behind?

Exploring the Currency debate in Europe

Written by Exequiel Octavio Bertaina, Vice-Managing Editor

Eurotower by Cha già José (Flickr)If Greece, Italy, Portugal, Spain or Ireland were to abandon the Euro, their structural problems would not disappear overnight; they could actually become worse. For simplicity’s sake, Greece will be used as an example.

If Greece were to leave the Euro behind, we would initially expect the new Drachma currency to devalue such as was the case in Argentina in 2001. For investors outside of Greece paying in euros or other currencies, suddenly Greek assets would look relatively inexpensive and foreign investment would be expected to increase in the short-run. There would be a real depreciation of currency, which would cause an increase in its competitiveness and make selling goods abroad cheaper.

Initially, exports would increase due to the competitive advantage caused by the cheaper currency and capital would rush into the country. The issue is if the risks (such as excess domestic currency volatility) are too great with the new Drachma currency, investors might not be willing to invest! This could lead to panic-attacks, capital flight, the shooting up of interest rates, price inflation and larger deficits!

[pullquote]Devaluating a country’s currency always has a temporary effect.[/pullquote]If foreign investors do not step in to buy up domestic businesses and/or government bonds, Greece will not be able to pay back its debt and business activities would not be sufficient to spur economic growth. Hence, Greece’s economic outlook would be much worse.

Well, let’s assume investors have confidence in the New Drachma, what’s next?

Devaluating a country’s currency always has a temporary effect. The market prices of goods and services will catch up to devaluation, and national average wage will catch up to prices. Then, as prices continue to increase, we can expect an increase in the exchange rate of the new Drachma, which makes it less and less competitive in the foreign markets.

Hence, competitive gains will disappear unless new stimulus policies are imposed. The GDP booster will have disappeared and in the meantime, the prices of goods and services will have increased. We can now expect a loss of competitiveness against the world markets!

The issue is that having a lower currency does not automatically mean a country will move out of recession. The point of a country having their own currency, in these kinds of situations, is to be able to print money in order to pay off debts, absorb foreign price shocks, etc. Stimulating exports should be considered as a secondary effect through the devaluation of their currency.

Also, Greece has other problems which have accumulated with time, such as their low workforce productivity and structural deficits. Leaving the Euro would not be the right solution since, for example, Greece has made several bad policies in the past and the economy should be reformed. The country has many deficiencies, such as a high tax-evasion rate and questionable budget balance ethics from the past.

Greece and other countries have their reasons for being part of the so-called (G.I.P.S.I.) club. If any of them leave the Euro, then the European currency is doomed.

ARB Team
Arbitrage Magazine
Business News with BITE.

Liked this post? Why not buy the ARB team a beer? Just click an ad or donate below (thank you!)

Liked this article? Hated it? Comment below and share your opinions with other ARB readers!

Show more