Why can’t we be friends? (Reuters)
The survival of the eurozone now lies in the hands of Greek voters. If the majority of Greeks vote against the conditions of the bailout program in the July 5th referendum, Greece would be likely to abandon the euro as their currency. Any new independent Greek currency would rapidly depreciate in value, which would hurt the pocketbooks of most Greek citizens. On the other hand, sticking with the euro would require Greece to continue imposing harsh austerity measures for years — hardly an attractive option either.
Although the current Greek crisis is unprecedented in many ways, many countries before Greece have faced this same dilemma: Should we impose austerity or should we devalue? The choice that a government makes in these situations is inevitably shaped by the interests of their country’s voters and interest groups. Whether or not Greece will abandon the e
uro and adopt a new, depreciated currency depends largely on whether the Greek public favors or opposes devaluation. Due to recent changes in Greek financial policy, the citizens of Greece are likely to become more supportive of devaluation.
The amount of political support for devaluation obviously depends on many factors. My recent book,”Demanding Devaluation,” shows that strong state control over national financial markets makes more people want a devalued currency.
This week, Greece implemented radical changes to its financial system — changes that raise the odds of a Greek devaluation. On Monday, June 29, Greece’s government closed the banks and imposed restrictions on the ability to take money out of the country known as “capital controls.” These measures substantially increase the state’s presence in the financial system. As a result, voters and organized interests in Greece should become more enthusiastic about a Greek exit from the eurozone, or “Grexit.”
The benefits of eurozone membership aren’t what they used to be. One of the main advantages of the single currency is that it promotes cross-border trade and investment. But now that Greece restricts international financial transactions, much of this supposed benefit is more illusory than real, at least for the time being. Unable to access their euros right now, the Greek public may see little reason to stick with the common currency.
In addition, thanks to these new financial restrictions, leaving the euro is not as scary a proposition as it was a few days ago. The major concern about leaving the eurozone has always been the havoc that this would wreak on Greece’s financial system. But as Paul Krugman points out, since the financial system is already in distress, there is not much more damage left to be inflicted. Greek voters will probably not find that prospect of leaving the euro as worrisome as they did last week.
Argentina provides an instructive parallel. In 1991, Argentina fixed its currency, the peso, to the U.S. dollar at a rate of one-to-one. Argentina’s currency system, known as a “currency board,” was a softer version of a common currency arrangement like the euro.
Support for Argentina’s currency board was incredibly robust for years. When Argentina went into recession in 1999, the country implemented harsh austerity measures to save the currency board – much as Greece has done since the global financial crisis.
However, support for the currency board evaporated quickly after December 1, 2001, when the government imposed capital controls and froze deposits in response to distress in its financial system. Less than three weeks later, the Argentine Industrial Union, a prominent business group that previously supported the currency union, formally proposed abandoning the currency board. On January 6, 2002, Congress repealed the currency board law and the Argentine peso began to plummet in value. In short, barely a month after imposing intense financial restrictions, Argentina abandoned its eleven-year old currency board.
Will capital controls be the harbinger of devaluation in Greece, just as they were in Argentina? Surely the two countries are different in many ways, so it would be unwise to expect Greece to completely follow Argentina’s playbook. But even if Greece does not end up leaving the eurozone, support for doing so is likely to increase considerably. One should no longer ignore the serious potential for a Grexit.
David A. Steinberg is an assistant professor of international political economy at Johns Hopkins University’s School of Advanced International Studies.
Read more about Greece and the euro at the Monkey Cage:
Manuela Moschella: Rescuing Greece means rescuing Europe too
Mark Hallerberg: Why an agreement on Greece is so difficult.
Kathleen McNamara: The Euro is an experiment in making a currency without a government. That’s why it’s in trouble
Henry Farrell: Who’s lying in the negotiations over Greece and the euro?
Arthur Goldhammer: The austerity referendum solves a problem for Greece’s leaders. It may solve a problem for Europe’s leaders, too.
