Greece, The Euro and A Growing Currency Dilemma

At present roughly 67 percent of all U.S. dollars in circulation are overseas or held by those with a foreign address. This reality is necessitated by the fact that for good or bad, the dollar is the world’s currency.

Considering the trading markets for currencies themselves, the dollar figures in 90 percent of those transactions, nearly 70 percent of global central bank holdings are denominated in dollars, and with cross border trade in mind for individuals in countries with thinly traded currencies, the dollar is the go-between currency of choice 90 percent of the time. So while there are myriad currencies around the globe, the unit of account utilized for trade and investment, not to mention the benchmark money concept against which all other currencies are measured remains the dollar. Much of the world is dollarized no matter the currency used locally.

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The above is notable given all the talk from mercantilist economists of the Peter Morici variety who continue to argue that Greece should leave the euro. Assuming Greece’s leadership approves such an economy-retarding move, it should be remembered that if so, the country will largely remain on the euro.

That is so because while Greece may re-introduce the drachma, the debt its government has raised and that it cannot repay in full is still denominated in euros. Though those holding the euro debt may well be paid back less than is owed, it is euros that will be paid by Greece’s government. Lots of luck convincing creditors to accept drachmas.

Of course the above reality speaks to the absurdity of leaving the euro at all. As my fellow Forbes contributor Nathan Lewis has observed, California finds itself in a somewhat similar debt situation as that in Greece, but no one’s calling for a California to leave the dollar. What would be the point? California owes dollars, so what positive could be achieved for it in issuing a currency a great deal less credible than the dollar presently is?

The answer to the above is one that’s fooled economists and politicians for centuries, including the aforementioned Morici. Convinced that money can be used to trick those who use it to exchange real wealth, Morici and many others think a devalued drachma will make Greek products cheaper such that the country can export its way out of its depressed state.

Of course missed by Morici and the rest of the devaluationist crowd is that the latter doesn’t occur absent harsh, economy-wrecking repercussions that more than overshadow any near-term illusions wrought by cheap money. For one, Greece’s producers must import from points local and international the inputs necessary to create any finished product, so assuming the reintroduction of a limp drachma, the nominal drachma cost of production will skyrocket.

Second, Greek workers paid in drachma wouldn’t just sit back and watch their pay be eviscerated by a currency lacking any credibility, so very soon Greek labor costs would similarly spike in drachma terms. Third, exporting locally and internationally involves shipping costs that would rise substantially along with the others. Devaluationists don’t understand this, but inflation always more than steals the illusory benefits of devaluation.

“More” is the operative word in the above sentence because what Morici et al additionally miss is that companies can only operate to the extent that investors purchasing future income streams allow them to. In this case, the devaluationists assume that a currency being systematically devalued – the drachma – wouldn’t turn off investors buying future drachma income streams. Lots of luck with that.

And then assuming Greek companies could secure financing in drachma, does anyone think they’ll be able to do so at remotely low interest rates? It would be naïve to assume yes in this case, which means the finance costs of returning to the drachma would be quite burdensome (what’s that about devaluation reducing the cost of exports?), thus revealing in even higher resolution the shockingly dim thinking underlying the argument that Greece should leave the euro.

Of course even if Greece does, the financing scenario just described probably won’t play out as written. The title of this piece speaks to how leaving the euro really won’t lead to anything of the sort, and this certainly applies to private companies in Greece. A reintroduced drachma would once again be the opposite of credible, so private companies would likely continue to seek financing in the European continent’s reserve currency, the euro. Sadly for those companies, Greece’s return to the drachma will simply add on for them hedging costs as the producers continue to transact with those that use the euro to exchange wealth.

Considering Greece’s government, good luck to it borrowing in drachma. Though it may well be able to float debt locally at nosebleed rates of interest, any attempts to draw in larger institutional investors from around the world assumes that Greece will still issue debt denominated in euros. With the drachma reissuance it will join the Peso, Kenyan Shilling and other paper currencies utterly worthless outside country borders.

Greece’s government, and by extension its commercial class may leave the euro, but neither will ever escape it. That’s a good thing, though as explained throughout, the near and long-term results of the ailing country leaving the euro will be painful, which means a departure from Europe’s main currency should be avoided at all costs.

John Tamny is editor of RealClearMarkets and Forbes Opinions, a senior economic adviser to H.C. Wainwright Economics, and a senior economic adviser to Toreador Research and Trading.

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