What Would a Greek Drachma Look Like? Painful.

Reaction As Greece Imposes Capital Control

Pensioners queue outside a closed National Bank of Greece branch in the hope that it might open in Athens on June 29. Greece shut its banks and imposed capital controls in an announcement designed to avert the collapse of its financial system, heightening the risk it will be forced out of the euro.

Photographer: Kostas Tsironis/Bloomberg

When it comes to Greece, things are moving fast.

Peter Spiegel at the Financial Times hints at "humanitarian aid." The popular media plays up actress Kate Hudson contributing tourist dollars in Skiathos; jokes are made, but there is nothing funny here. Just for starters, all of Greece will need medical supplies that come from outside the country.

The traditional adjustment out of depression—and Greece is most certainly in a depression—is debt restructuring and currency depreciation. Paul De Grauwe, of the London School of Economics, insists that debt forgiveness and restructuring is the dual path and they are, right now, the roads not taken by Greece. (All of thinking Europe leans forward when Professor De Grauwe speaks. Hear him on Bloomberg Surveillance, from June 26.)

What if Greece was normal and not linked at the hip to Germany?

The Greek drachma as compared to the Deutsche mark. DEM-GRD: Shown are two bouts of drachma depreciation then the salvation of euro stability. I extend one trend of drachma debasement. Everyone goes downfield and the wide receiver goes wide-right to the goal line.
The Greek drachma as compared to the Deutsche mark. DEM-GRD: Shown are two bouts of drachma depreciation then the salvation of euro stability. I extend one trend of drachma debasement. Everyone goes downfield and the wide receiver goes wide-right to the goal line.

The above chart needs a modest explanation. It answers some painful questions. Once upon a time there was no euro. The deutsche mark was dominant and the Greek drachma went through two slopes of depreciation. I have been bold and shown an extension of drachma depreciation over decades (the blue arrow). That did not happen because Greece had the same currency as Germany and other euro members. Alberto Gallo of RBS suggests that if there were a new drachma, Greece would enjoy a 50-percent depreciation.

What if the euro had not happened? What if Greece had gone through the kind of abrupt depreciations seen, for example, in Indonesia, Russia, and Mexico?

I use the advent of the euro, at the end of 1998, as the pivot point for our story (the blue circle). Indonesia depreciated about 81 percent, Russia 72 percent, and Mexico a modest 48 percent. These are the green, red, and yellow arrows. These numbers are all approximate and the three arrows are spread out. The actual moves, across three time frames in the 1990s, were brutally immediate and would overlay each other. Note that Indonesia, green, got crushed compared with Mexico in solid yellow.

What if Greece was Mexico? What if Greece was not in the euro, had an abrupt depreciation, and then since around 1998 had further currency debasement? There are three examples of "currency adjustment" from a pre-euro time in the above graph. I don't know which arrow is Greece but let's be optimistic and say Greece, in some form, will "do a Mexico." The profound reality, on a log y-axis, is if Greece depreciated in the glide path similar to Mexico it would follow the abrupt 1990s debacle, then glide along the more gradual path shown by the yellow-dotted line.

The point of this exercise is how stunningly close the end of the Mexico-peso path is to where Greece would be if the euro had never existed. The yellow circle is appallingly close to the end of the blue deutsche mark/drachma extrapolation. There are a lot of what ifs and to-be-sures here. I am not saying that Greece is Indonesia or Russia. The point is the distance from where a euro-restricted drachma is now (the green circle to the "Mexican" yellow circle) signals stark depreciation that may possibly be a best-case scenario for the country. In any event, the trauma to the Greek people will be tangible.

Extrapolate, then discuss.

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