The Least Bad Option for Greece
There’s a school of thought that Greece is destined for so much financial pain that it would be better off outside the euro system. The secessionists’ reasoning goes like this: Suppose Greece somehow resolves its short-term debt problems through default or other means and brings its budget deficits under control. It will still have a crippling lack of competitiveness. Labor costs in Greece have risen much faster than in Germany and the rest of the euro core, making its exports expensive and imports cheap. The result is chronic trade deficits, which must be financed through continued borrowing.
If Greece still had a drachma to devalue, it could cut the price of exports and raise the price of imports that way. Because it doesn’t, it has to restore competitiveness more brutally: by cutting wages, which in turn requires persistently high unemployment to suppress workers’ bargaining power. It’s a political impossibility and an economic disaster, leaving an exit from the euro system as the only choice.
The trouble is, leaving the euro would be an even bigger economic disaster. It would cause a run on Greek banks as depositors rushed to move their euros abroad before the balances could be converted to drachmas. And Greek borrowers would still owe euros to foreigners. Because the new drachma would instantly depreciate, the borrowers would have a diminished capacity to service those debts, causing new waves of bankruptcies.
Difficult as it may be, debt restructuring plus “internal” or “fiscal” devaluation looks preferable. Explicit wage cuts, and the recession needed to induce them, don’t have to carry the whole burden of cost adjustment. A combination of increased value-added tax and lower payroll tax (Greece could easily do both) mimics a currency devaluation by raising the price of imports relative to the price of exports, lowering real wage costs by stealth. This should be part of the mix.
True, once the accumulated cost gap has been closed in this way, Greece would have to maintain competitiveness by keeping wages under tight control. In this ongoing effort, a floating exchange rate might look helpful, but in practice it would be a mixed blessing.
In theory, persistent cost inflation can be smoothly offset by a steady devaluation of the currency, but many countries have found controlled depreciation hard to achieve. The typical result is high and variable inflation, recurring currency crises, fluctuating competitiveness, and needless economic uncertainty. This experience is what commended the euro to many countries to begin with.
Inside the system, the peripheral countries have learned a harsh lesson: They must hold growth in wages to the euro area’s rate of inflation plus any increase in national productivity. In countries such as Greece, this demands a new approach to wage bargaining by employers and unions. Overall, though, it should be no more difficult than managing a floating currency. And on this path the reward for success is greater: lower inflation rates and, with luck, faster economic growth.
Give Regulators Radar Guns
The past year in U.S. stock markets earned a place in the Volatility Index Hall of Fame. For this, credit (or blame) goes to Europe’s debt mess, U.S. political paralysis, and upheaval in the Middle East. But something else was at play: the increasing dominance of so-called high-frequency trading driven by computers and programs that thrive on and exacerbate wild market swings.
U.S. securities regulators have been examining the trading records and computer codes of brokers, hedge funds, and banks. This welcome inquiry delves into a world where buy-and-sell orders are executed at speeds normally associated with astrophysics, and traders profit from opportunities that may last a few millionths of a second.
The Dodd-Frank law gave short shrift to high-frequency trading. But it’s crucial that market overseers limit the possible harm high-frequency trading can cause, without compromising its benefits: lower trading costs and increased liquidity.
Here’s one suggestion: High-frequency traders can bombard markets with buy-and-sell orders and then instantaneously issue cancellations. This might be a legitimate tactic for price discovery in much the same way that an auctioneer seeks to find out how much money potential buyers are willing to offer. Yet this also might be used to skew a market, perhaps even leading to mini-flash crashes in specific securities. Regulators, therefore, might impose some discipline by requiring traders to stick with bids or offers outside a certain price range for a specific period of time, say 1,000th of a second or longer, before canceling.
Such a requirement would be consistent with something else the SEC might consider. High-frequency traders now do much of the work once performed by humans on the stock exchange floors. Regulators could ask that they fulfill an obligation to make markets, helping maintain the functioning of the stock exchanges by offering to buy and sell securities when others refuse.
Overloading market trading systems with excessive buy-and-sell orders offers another potentially unfair advantage to high-frequency traders. Some traders may be able to exploit the minuscule lag between the time a transaction is recorded on a local exchange’s electronic ticker and when it shows up on a feed that consolidates information from all the exchanges. By stuffing the system—or another trading firm’s computer systems—with quotes, this lag widens, yielding trading opportunities. Regulators might be able to combat this by imposing a fee on traders who introduce excessive messages into the data stream. Fairness is the only way to ensure faith in markets, even when those markets move at unfathomable speed.