A question for Greece and elsewhere

Suppose that Greece had never adopted the Euro and the terms of its external borrowing had remained subject to “market discipline”, as it had been in the 1990s. Would Greece today be better off or worse off, in real terms, looking forward?

This does not seem to me an easy question to answer. On the one hand, Greece’s borrowing on easy terms inspired a great deal of real activity, including valuable development in a variety of sectors. On the other hand, it is now clear that indiscriminate credit enabled patterns of behavior that were unsustainable, the adjustment from which will be costly and painful. If foreign capital had been available but discriminating, perhaps some of the real activity and development of the 2000s would have not have occurred. But perhaps the activity that would have occurred would have been channeled in different directions, forming patterns more sustainable and profitable, and less corrupt.

This question isn’t really about the Euro per se. Several Central and Eastern European members of the EU also enjoyed indiscriminate credit booms without formally adopting the common currency. Ultimately, the question is whether market discipline, and the restriction of choice that it implies, is a long-term benefit or a long-term cost to the nations that face it. Does active monitoring by foreign creditors ever actually help nations develop well? Or is that a kind of capitalist pipe dream? And if useful market discipline is an old wives tale, is it better for countries to take whatever money is cheaply on offer in spite of the likelihood of inefficient use, or to restrict external borrowing on the theory that undisciplined cash promotes corruption and boondoggles and ultimately leaves nations hobbled?

These sound like “emerging markets” questions, and they are, but they are more broadly applicable. I find myself asking the same set of questions about the United States, whose external borrowing seems famously immune from market discipline. On net, is that fact a blessing or a curse?

Update History:

  • 3-July-2011, 8:25 p.m. EDT: Removed an unnecessary “the” and an ungrammatical “that would”. No substantive changes.

15 Responses to “A question for Greece and elsewhere”

  1. aelle writes:

    You seem to be assuming there was there “market discipline” before the Euro. But having a look at this Greek Debt/GDP chart, it does not seem clear to me the Euro period represented anything but the resumption of a path which was only temporarily interrupted by Maastricht (not the markets) in 1993.


  2. Alex writes:

    Greece’s problem today may have been the total cost of the Olympics Greece. Some estimates have it at around e6.5bn. Remember how long it took Montreal to pay off theirs.

  3. Foppe writes:

    A few issues.
    The credit boom occurred because currency peg removed revaluation worries. (If you look at the Eastern European countries, you’ll see most of the debt was denominated in Eur/CHF rather than the local currency.) Therefore, if Greece had not adopted the Euro (or tied the value of its currency to it, like those other countries have), it would have been much less safe for the banks to borrow money to greece (nor would greece have had the rating that made it possible to file away that debt as low-risk, and to sell it to pension funds and similar institutions.
    Secondly, in response to ‘real activity’: Debt-financed growth is only useful if the loans are being used to improve your manu/export base with. If this is not the case, it is far more problematic. Having said that, it was in large part because of the Euro peg that Greek industry was outcompeted by the Germans; what little it had before is pretty much all gone now.
    As such, I would argue that the problem isn’t so much the loss of choice, as the fact that you’re enabling banks to lend large sums of money (basically unlimited amounts thanks to Basel-2’s risk-weighting in combination with the leverage caps being lax to start with), which they do because they’re interested in extracting interest payments.

  4. Ramanan writes:


    I will rephrase the question (which I think is a very nice one). Would Greece have faced the balance of payments constraint a la Nicholas Kaldor if it hadn’t adopted the Euro?

    One misunderstanding with which the Euro Zone was formed is that since there was one currency, there would not be a balance of payments constraint. One importantly, it was formed with the ideology that the invisible hand would take care of everything and that there is less role for the States. It turned out to be exactly the opposite. The Euro Zone nations surrendered their sovereignty for adopting a common currency and this left them with very little power to defend themselves against failure.

    The market discipline actually worsened the effect – some kept pointing to the fact (in 2006) that the markets were consistently pricing government bonds within the Euro Area as equivalent to each other and this led to massive capital flows and easy finance.

    Greece as a nation faces the balance of payments constraint but does not have any tool to improve its external situation except deflating demand. Countries with flexible exchange rates can hope that market forces will cause an appropriate smooth depreciation (but not too high a depreciation to the point of making the currency unacceptable in international markets). However, capital flow is not smooth. Capital inflow can continue for a long time and the government has no control over it, really.

    I find it difficult to believe market forces can achieve the trick in case of flexible exchange rates. Governments and central banks themselves are worried about these things, even though they (at least central bankers) may speak about free markets in their speeches.

    Even US policy makers such as William Dudley have started recognizing that the way forward is coordination between institutions running the world economy.

    http://www.newyorkfed.org/newsevents/speeches/2011/dud110607.html is his speech where he uses the sectoral balances approach!

  5. Ramanan writes:

    .. the United States itself has its own issues and the external sector is important in this analysis. The US external debt is shared by the public sector and the private sector. While the US has been muddling through the crisis with even some mainstream economists pointing out that fiscal stimulus is really helpful, there is no “market” mechanism via which the US achieves a balance on its current account. Via the sectoral balances, a higher current account deficit would imply a higher public sector deficit and this adds to the public debt with even growth insufficient to put the public debt/gdp under control (growth faster than the ROW growth worsens the CAB).

    The question whether the US is immune is a vague one. The US already has high unemployment and any attempt to bring this down fast to reach full employment will lead to a deterioration of the current account balance, rising public debt/gdp and rising external debt/gdp.

    “Market discipline” or the perceived discipline imposed at some point by the markets in the future actually leads to fiscal restraint and muddling through with high unemployment. One hope the US has is to believe that if it carries out fiscal expansion on a massive scale, the dollar depreciate smoothly by some market forces which is difficult to believe.

  6. Foppe writes:

    is it better for countries to take whatever money is cheaply on offer in spite of the likelihood of inefficient use, or to restrict external borrowing on the theory that undisciplined cash promotes corruption

    1. ‘countries’ do not take whatever money’s available; the ones taking that money, and deciding how to spend it were, at least in case of Greece, the politicians and local elites. Consequently, the Greeks who profited most from Eurozone participation were the upper class ones. Additionally, they need not even suffer if the country goes broke, while the poorer Greeks probably will, as they have no exit opportunities. (Corruption among high-level officials taking money from German/French companies that wanted to sell stuff to the Greek state was also an important problem.)
    2. Restricting external borrowing is not enough. The Irish banks also became huge, and also expanded into the Eurozone periphery. What you need is supranational agreements (a la Basel-3, only than actually pro-stability in stead of pro-revenue-growth) that limit leverage, while banning Rating Agencies and risk-weighted debt.

    But perhaps the activity that would have occurred would have been channeled in different directions

    The problem with this argument, it seems to me, is that, ultimately, it leads to trying to make every country into a little Germany. Ignoring for the moment that you cannot have a world make of export economies only, it means requiring the Greeks to adopt the protestant work ethic, and restructuring their entire society, simply because that is the only way to function within the Euro. Now, I realize you did not say this, but it seems to me that this is a rather peculiar thing to demand, especially considering the fact that Greece was perfectly viable (if not rich and ‘growing economically’, if GDP is the metric you use to establish such facts by) before.

  7. […] A thought experiment:  is Greece better off for having entered the Euro?  (Interfluidity) […]

  8. RSJ writes:


    You are using the phrase “market discipline” in a strange way. I can see what it means in the labor market or tradeable goods. But I don’t understand what market discipline means in the sphere of credit. The discipline there is about arbitrage, or trying to guess what someone else will do tomorrow. That’s not discipline in any meaningful sense. If you have 10 bottles of beer, then you can let market forces allocate this beer by adjusting the price. But when the act of lending creates more credit and more wealth that can be lent out, then the relationship between price and quantity no longer holds. You cannot rely on market forces to set the price.

    As a concept, market discipline of credit availability is a bit like market discipline of the distribution of wealth. We know what the market outcome will be in both cases — massive booms and busts in the former case, and huge concentration in the latter case. What we need is discipline of the market in the areas of credit and wealth distribution, just as we need market discipline in the tradeable goods sectors.

    One of the best things we got in the post war Keynesian order was to have this necessary discipline of the market. An era of incredible stability, high productivity, and almost no financial crises to speak of. And this era resulted in a blossoming of human capital and rapidly increasing living standards. What we are seeing is the effects of dismantling that order, by cutting top marginal rates, financial de-regulation and in the case of the EMU, having government lose the ability to issue risk-free debt and set the short rate. The results have been the predictable combination of wealth concentration and a series of financial crises that have been increasing in their intensity and frequency.

  9. […] What if Greece has never joined the Euro Zone?  Would it still have found a way to get into debt trouble?  (Interfluidity) […]

  10. Indy writes:

    It’s a curse, no doubt about it. Proof: Do you have any confidence in the ability of our current political structure to rationalize the present mess and make prudent, hard-trade-off decisions going forward without market discipline and the appearance of the “invisible vigilantes”? I don’t.

    You might very well ask the opposite hypothetical about the United States. If we default and our credit rating goes to D – from the point of view of July 4, 2026 (“Sestercentennial”?) – will that be a better or worse result than our ability to net finance at $4 Billion a day at zero-bound real interest rates?

  11. Greg Marquez writes:

    Isn’t the real issue the difficulty in changing from one currency to another. The lenders knew that under the Drachma Greece could always pay off in Drachmas, even devalued drachmas, the change to the Euro made this impossible, thus making loans more secure. (I wonder if the added security of Euro denominated debt resulted in lower interest rates for the Greek government.) This increased security probably resulted in increased lending. I’m thinking that this, coupled with the desire of Germany to sell more stuff to the Greeks resulted in the current crisis.

    It would be interesting to know where the money went. It didn’t just dissappear, somebody got it. I mean actual numbers over time, not just speculation about it going to government employees or their pensions.

  12. […] WALDMAN asks the burning question: Suppose that Greece had never adopted the Euro and the terms of its external […]

  13. From the ‘Parallel Greek Universes’ department: what would happen if?

    What has happened over and over (and is also happening in Brazil) when ‘hot’ money flows in looking for the next ‘transitional state’. That is, a state that is vaguely pre- modern making its way toward being the next Taiwan or Singapore … or Dubai.

    Something happens — high energy producer prices or a finance ‘innovation’ — and capital flows seeking energy new consumption markets. This happened in South America and East Asia thirty years ago … and in Greece, Spain and Portugal over the past ten years.

    The euro enabled a quasi- fiscal credit machine to emerge, the union promised more ‘security’ to euro- denominated debt. The easy capital flowed toward property developers (destinations), infrastructure (to get to and from the destinations) and toward the car makers/dealers that are always the primary credit beneficiaries within mercantile states that manage the capital flows.

    Something happens next and the capital flows away like the tide leaving the Argentinas and Thailands and PIIGS high and dry. The repo man comes to haul away the BMWs and Benzes. The ‘suburban’ developments rot. Weeds sprout though the cracks of unused superhighways to nowhere.

    Greece and the rest would have gotten credit because the shadow banking system made private credit available on a very large scale and F/X became more sophisticated. In a way, the euro was an unnecessary convenience that nobody in the EU can now escape.

    Greece would have gotten credit because the high energy prices post 2004 put hundreds of billions in Eurodollars into circulation looking for an investment home.

    The future means less credit for Greece and the rest of Europe. This reality flies in the face of the underlying assumption on the part of the establishment that holds that after a ‘rough spell’ Greece and its neighbors will be able to service — and the EU provide — continually increasing credit for a ‘modern’ (credit dependent) Greece.

    This assumption runs aground on the EU establishment’s contradictions. It isn’t just Greece which is broken. The almost farcically punitive (and counterproductive) austerity guts confidence in the EU just as much as a PIIGS’ default.

    Who will ever trust the EU again? Nobody trusts them now, there is nowhere to go but down for the continent’s capital provider which cannot manage itself or its subordinate institutions. It has no management autonomy from its constituents or the US/IMF. This was a reason for the euro in the first place: it (the euro) was to be an escape from dollar hegemony and relentless dollar devaluation.

    The lack of imagination on the part of the governments is appalling. Why not ‘try anything’? Why doesn’t the Greek government issue drachmas on its own account w/o borrowing from a central bank? There would be no liability in euros OR drachmas and the liquidity issue would be eased. Greece would get its citizens off the streets of Athens and start adding some needed GDP. Some more output — even the abstract — and euro- denominated service becomes more manageable.

    Why not try the drachmas as a demurrage currency as- per Silvio Gesell? Have velocity do the heavy lifting of increasing currency float w/o the inflation or devaluation problems. Where are the 21st century John Maynard Keynes?

    I personally don’t see anyone in charge trying very hard, but rather continuing to use ordinary monetary measures — Taylor Rules and Phillips Curves — that are suited to adjusting a more or less well-functioning manufacturing economy rather than catabolic collapse and radical economic simplification that we are all faced with now.

    One thing to keep in mind is the Argentina/Iceland comparisons cannot be made. Both countries are net energy exporters. Not so Greece or the other EU nations other than Norway and Denmark. Sans- the euro and Greece will have difficulties importing fuel. A devalued local currency will not be readily exchangeable for crude. The only way out of the euro- gasoline trap for the EU is to scrap the euro entirely. Else, nobody can afford to abandon it w/o giving up the incredibly beloved and darling automobiles that people cannot live without.

  14. […] WALDMAN asks the burning question:Suppose that Greece had never adopted the Euro and the terms of its external […]

  15. Kosta writes:

    Greece differs from other peripheral Euro members in that it fraudulently concealed the size of deficit and debt at multiple times throughout the 2000s. This fraud allowed Greece to move from a merely difficult fiscal situation to something which is untenable. Now would Greece have been better off not joining the Euro? This depends on whether Greece would have had the motive and ability to continue to conceal the size of its deficit. This concealment sets Greece apart. Perhaps this question would be better focused on Portugal or Ireland?