Five Steps to Fixing Greece’s Debt Problem
March 4, 2015
The ECB decision to limit liquidity to Greek banks was another nail in the euro-coffin, and rumors of a "Grexit" caused bank withdrawals to accelerate. Over 25 billion euros have been withdrawn from Greek banks since the end of November 2014. But there's a problem. Fractional-reserve Greek banks do not have the funds to cover all the withdrawals if trends continue. Current non-performing bank loans in Greece are close to 40 percent and banks hold large amounts of high risk Greek government debt.
Despite rumors in the press, there are no European mechanisms to force Greece out of the eurozone. Greece would have to be the one to decide to leave. So for now, Europe will continue to pretend it will be paid back, and Greece will continue to pretend it is implementing significant structural reforms.
Current conventional wisdom is that a bank run would force Greece to return to the drachma. Although this is a possibility, it is not a foregone conclusion. Even if Greece defaulted, it would still probably have a large euro-based debt.
So what can Greece do?
Step One: Default
Greece should default on as much debt as possible. There is no benefit to meeting the EU halfway. The Greek government is currently running a primary surplus (or is very close to it) so it does not need EU funds to cover Greek government expenses. However, the Greek banks will not have sufficient funds to cover withdrawals (and thus prevent a bank run) once the European Central Bank (ECB) and the EU cut off funds.
Greece could impose capital controls and bail-ins, but most deposits are from Greeks whose average monthly income is less than 780 euros per month, and these people are the voting foundation of the new government's popularity. In 2013, the Cypriot government quickly backtracked on its own attempt to bail-in small deposits once the population rose up in widespread anger over the measure.
Step Two: Implement True Austerity
If it wants to survive politically, the new government must find a way to meet this extra funding necessity.
To find the funds to meet growing withdrawals from Greek banks, the Greek government could drastically reduce excessive government salaries by reducing payments over 1,500 euros per month by 50 percent.
For example, a parliament employee in 2011 received an average of 3,000 euro net per month, not counting the bonuses and allowances on top of the wages. According to the budget of the National Assembly, the "15thand 16th month" salaries alone for these employees in 2011 cost taxpayers 16.9 billion euro. Politically speaking, a socialist government could easily get away with such a maneuver.
Step Three: Implement True Free-Market Banking
Assets currently held by the Greek government in banks should be sold off and Greece should then make a clear distinction between true depository institutions and loan banks.
Depository banks would function in a manner similar to that of a storage facility where customers are charged fees for the storage of items such as furniture, boats, clothes, books, etc. Attempts to lend money to such institutions should be viewed as a type of fraud.
However, 100-percent equity-financed loan banking should remain available and open to competition. Customers would need to keep in mind that putting money in a loan bank would be like putting money in the stock market. You know you risk losing everything. Such banks, or investment trusts, would be like any other business and this industry would not need any more special regulation than the potato chip industry.
Step Four: Institute Monetary Competition
Greece should then consider leaving the euro and emulating Switzerland in how it manages the relationship between the Swiss franc and the euro.
Unlike Switzerland however, a monetarily independent Greece would allow the new drachma and the euro to trade side by side as legal tender. The Greeks would benefit from competing currencies. Yet government revenues and payments would be in new drachmas, and no longer in euros. This would be necessary for the Greek government to sever its direct link with the ECB.
Step Five: Fix the New Drachma to Gold
Gold has many drawbacks, but gold's primary advantage lies in the fact that it constrains current and future governments from using the printing presses to finance government expenditures. Once the tie to the euro is broken, Greece should then fix its new currency to gold. Even though Greece has no significant gold reserves, it can follow the example of Germany in 1923 when a broke Germany slowly returned to a gold standard by first fixing its money to non-gold commodities (i.e., rye bread in the German case).
By instituting true austerity and freeing the banking sector from the euro and the EU, Greece could go from being the example to avoid to the example to emulate in a relatively short period of time. With such a financial structure, Greece would benefit from long-term financial and economic stability. It would force Greece to make hard choices up front, thus avoiding later problems in the first place.