The Corner

Greece & Argentina

The collapse of Argentina’s currency peg at the end of 2001 is sometimes seen (including by me…) as a possible pointer as to how things might unfold in Greece.  This week the the Economist is running a piece by two former central bank governors from Argentina and Mexico in which they argue that Argentina’s broadly successful (if unorthodox, and, now, increasingly troubled) emergence from the wreckage of its currency peg should not be seen as a precedent for Greece to follow.

It’s worth reading the whole thing, but here’s an extract.

Exiting the euro would require the compulsory redenomination of banks’ assets and liabilities, and of practically all contracts, prices and wages. In Argentina, where dollars were widely used as a unit of account, redenomination took the form of “pesification”. It had vast redistributive consequences. If Greece abandons the euro the “drachmatisation” of loans and deposits—and the exchange-rate movements that would follow—would benefit bank debtors and harm depositors, leading to further social turmoil.

 Argentina’s experience also shows that exiting a long-term peg tends to sink large private corporations with access to international financial markets, because their foreign-currency liabilities cannot be redenominated. Indeed, Argentina’s companies devoted years to negotiations with their foreign creditors and many had no choice but to default. The position of Greek companies in this regard may be even worse. Many Argentinian contracts had continued to be denominated in pesos, since the currency board did not eliminate the local currency. These contracts, at least, could be honoured. But Greece would have to deal with the complete universe of covenants since every contract would need redenomination. A sea of bankruptcies would follow.

The end of Argentina’s currency board was harrowing. It led to endless violations of contracts that left an enduring stain on the investment environment. But reintroducing an abandoned currency is even more difficult. Argentina never stopped using the peso, but Greece discarded the drachma. To generate confidence in the drachma in the midst of a crisis would be very challenging. Convincing potential investors to commit to projects denominated in a reintroduced currency is an almost unachievable task.

The proponents of a euro-zone exit for Greece grossly underestimate its devastating consequences.

I doubt that that last comment is true, and so, I think, would G.I., the author of the Economist’s Free Exchange blog, who discusses these issues here. Critically, G.I. focuses on the question that the two central bankers (inevitably, I’d argue) find the most difficulty in resolving:

if Greece stays in the euro, how does it restore its competitiveness? Greece’s current account deficit has narrowed, but remains disturbingly wide. Moreover, as the second chart shows, it has achieved that narrowing almost entirely via a collapse in imports, a direct consequence of its economic depression. Exports were lower last year than in 2008. As Mr Blejer and Mr Ortiz acknowledge,”All successful adjustments in Latin America involved huge initial devaluations and immediate reductions in real wages, thus cutting unit labour costs.” I would go further and say most, if not all, resolutions of balance of payments crises involve devaluation. For Greece to pull this off without devaluation will require a brand new template.

It will almost certainly mean almost unimaginable wage and price deflation. The  popular fury that the latest round of austerity, which includes private sector wage cuts, has unleashed demonstrate how treacherous that path will be. And even if it does happen, it will restore Greek competitiveness far more slowly than a devaluation would, so unemployment will be higher for longer.

There is no question that a Greek exit from the euro would be convulsive and impose enormous costs on the Greek economy and its people. But will those costs be any higher than if Greece stays on its current path? That question is far from settled.

That’s putting it mildly.  


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