Minds Changing on the Drachma

It doesn’t seem like all that long ago that Greece’s abandoning the euro in favor of a return to its own currency was an extreme, farfetched idea. Now it’s apparently the prevailing wisdom or at least prevailing wisdom adjacent. David Ignatius, the high priest of the prevailing Washington wisdom muses over the prospects for Greece’s return to the drachma:

WASHINGTON — The Greek financial nightmare is a reminder of why countries benefit from having their own currencies. In the old days, a flexible drachma could have been devalued to boost exports and economic growth. But today’s euro trades at a single exchange rate that may suit some of its member nations but not others. For Greece, it has become the equivalent of a straitjacket.

So why doesn’t Greece drop the euro and restore its freedom of maneuver? A cheap drachma would boost exports and tourism — and it might be the easiest means of post-crisis financial adjustment. But separating from the eurozone would mean rewriting thousands of contracts and deals. And it could put Greece in a monetary free fall, perhaps forcing Athens to look east for support to Moscow, Riyadh or even Tehran.

and

As Greece is discovering, it’s difficult for small, ailing economies to threaten big, strong ones. Greece’s implicit threat over the last three years has been a “Grexit” — a Greek withdrawal from the euro that could undermine European solidarity and increase pressure on other weak eurozone members. But it seems that the leaders of Germany and other strong eurozone economies are more worried about another kind of contagion — the demand for concessions from Portugal, Spain, Italy and other debtor nations that might ensue if Greece’s confrontational tactics were seen as succeeding.

Greece and its creditors need the monetary equivalent of a divorce lawyer who can help reckon the costs and benefits of a breakup. Restoring the drachma would give Greece more flexibility, but at the price of much greater vulnerability. For the eurozone, a Grexit would signal that the promise of monetary union was conditional — and unreliable. Bad divorces happen when each side is too angry for rational decision-making.

Greece’s problem is that it really doesn’t have much choice. When you combine the inefficiency and inadequate capitalization of the Greek economy with the efficiency, size, and mercantilist policies of Germany you get exactly what the Greeks have gotten. Inexpensive, high quality German goods bought with borrowed money, the need to pay back the loans, and no practical way of doing it.

Now, in the absence of debt forgiveness that would require a change in the political winds from Germany, Greece has the Hobson’s choice between a perennially deteriorating economy with declining standard of living and a return to the drachma.