There is a strong case that the only solution to Greece’s economic problems is to leave the euro. At current wage levels, Greek workers are unproductive, giving foreigners few reasons to buy their exports and giving Greeks every reason to import from outside their own country. There are two clear ways to restore competitiveness: drive down wages or depreciate the currency. The first diminishes demand in an already depressed economy and worsens unemployment, while the second allows the domestic economy to muddle through while sparking export growth. Argentina, Thailand and Iceland were able to emerge from financial crises on the back of a strong export sector enabled by a deflating currency.
Jane Jacobs (for my money the greatest thinker of the 20th century) made the point in her brilliant Cities and the Wealth of Nations more than 20 years ago. She asked us to imagine if Detroit had its own currency. As auto workers’ wages rose, and as demand for General Motors cars declined, the value of the Detroit dollar would fall, meaning that Detroit-made cars would be cheaper everywhere from California to Guangdong. If Detroit had its own currency, it would not be half-deserted today. But, since its currency was tied to the stronger economies of New York and Texas, the US dollar could not fall enough to save Detroit.
Currency depreciation is the relatively painless way to stimulate exports, restore competitiveness, and encourage economic growth. But were Greece to restore the drachma, all hell would break loose. For one thing, all Greeks assets denominated in Euros would lose half their value. The day after drachmatisation, the Greek middle class would wake up to find their bank balances worth a fraction of their value the day before. This, of course, is the inevitable (and just about bearable) result of currency depreciation. The real problem is that since savers are not stupid, more and more depositors will pull their euros from Greek (or Portuguese or Italian) banks and shift them to Frankfurt or Zurich. It is that bank run on PIIGS financial institutions that would devastate the European and global economies.
A Greek withdrawal from the euro would spread a contagion through all of southern Europe, as depositors in Italy, Portugal and Spain would fear that…