What Argentina tells us about Greece

Greece and the euro

By G.I.

The Free Exchange column in this week's print edition is a guest article by Mario Blejer and Guillermo Ortiz, former central-bank governors of Argentina and Mexico respectively. They note that some advocates of Greek exit from the euro cite Argentina's abandonment of its currency board in 2002. The peso devaluation that followed the collapse of the currency board led to a boom in Argentine exports and growth. Mr Blejer and Ortiz say these advocates understate the chaos that occurred in Argentina, and how much worse it would be in Greece:

"As soon as devaluation was considered possible, a persistent bank run took place in Argentina. It lasted for over a year and consumed two-thirds of the country’s foreign-exchange reserves...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."

Bad as it was for Argentina, it would be worse for Greece: 

"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."

They go on to argue that Greece has something Argentina did not: an international institutional framework that can help it regain fiscal and external balance without the need of devaluation. 

They are certainly correct to point out these differences. But are the differences big enough to negate the benefit of Greece ultimately leaving the euro? First, Greece has already paid some of the costs: it has endured a bank run since its crisis began. The nearby chart shows that household and corporate deposits in the Greek banking system have shrunk by 27% since September, 2009. Loans from the European Central Bank (via the Greek central bank) now make up roughly a third of Greek banks' funding. By the time exit finally arrived, it's a good bet that ratio will have risen further. This means that the biggest loser from the redomination of the banking system's liabilities into drachmas would be the ECB and its member central banks, not domestic Greek savers. 

Second, 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.