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Euro devaluation this summer?

By Rodney Crisp - posted Wednesday, 29 June 2011


Tensions are growing not only on the street but also in parliament and could lead to a major political crisis bringing down the government and provoking new elections. This would result in the freezing of any further lending to Greece and plunge the country into default on its debt.

There has been some suggestion that the government should seek to restructure its debt with its creditors. In other words, try to negotiate a reduction of the debt of something between 20% and 50% and have the creditors write this off as pure loss, the alternative being that the country defaults and the creditors get nothing. The problem with this solution is that the international rating agencies would still consider it a default, making it impossible for any future Greek bonds to find takers on the market. Interest rates for other weak euro zone countries would also increase dramatically.

Default would be the worst solution. It would impact negatively on Greece's financial partners who would have to bear the loss. It would also have a catastrophic effect on Greece itself and its population already suffering considerable duress and struggling to survive. There would be a run on the euro as investors flee to safe havens and those weaker euro zone countries would feel the pinch as borrowing became more expensive. They would need further injections of fresh cash from the ECB and the IMF to prevent them from defaulting too.

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In addition, the credibility of the ECB in maintaining a sound, stable euro would be seriously jeopardised. This could have negative repercussions on any future international investment in the euro zone.

Another suggestion that has been made is that Greece should take leave of the euro for whatever period is necessary for it to put its house in order. It could temporarily go back to the drachma at a one for one exchange rate, devaluate and come back to the euro when things get better. This would have the advantage of boosting exports and cutting labour costs but it would not solve the problem of the mountain of sovereign debt which could only get worse because of the devaluation. It would also generate heavy administrative costs.

There is no obvious, clear-cut solution the Greeks can implement to solve the problem. The best solution probably lies in a combination of several factors. They obviously have to put their house in order. A report by the Federation of Greek Industries last year estimated that the government could be losing more than € 20 billion a year on tax evasion. This must cease.

The austerity measures need to be revised in order to gauge their efficiency and make whatever adjustments may be necessary to alleviate the burden on low income families and individuals. Current plans for the massive sell-off of national assets and public services should be scaled down to a strict minimum and limited to non-strategic and non-cultural assets and services.

Greece spends 4.3% of its Gross Domestic Product (GDP) on national defence. This is the same as Russia. Compared to the USA's 4.7%, China's 2.2%, the UK's 2.7%, France's 2.5% and Australia's 1.9%, it is excessive. The defence budget should be reduced.

Finally, the ECB should bear its share of responsibility in the euro zone financial crisis for maintaining an over-inflated euro exchange rate of € 1.42 to the US dollar. Monetary specialists consider that its true economic value is closer to € 1.2 or € 1.15. When it was floated on 1st January 1999 it was quoted at € 1.14 to the US dollar. Since then the euro zone economy has not surpassed the economy of the USA by the 24.5% increase in the current exchange rate.

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Significantly, the ECB operates from its head quarters in Frankfurt, Germany. Despite this geographic promiscuity with the euro zone's strongest national economy, the bank is totally independent and the sole authority for determining monetary policy. The euro is a floating currency subject to market fluctuations. It can only be regulated by the ECB. None of the individual member countries of the euro zone, including Germany, has the power or the right to manipulate it.

From the creation of the deutsche mark in 1948, until its replacement by the euro on 1st January 1999, the German currency was never devalued. In fact, it became so strong it was constantly revaluated during the period leading up to the creation of the euro. For over 60 years, the Germans have lived with a strong currency and it would be no easy task to persuade them that it is in every body's interest to devalue the euro.

Unfortunately, every solution entails inconveniences. The advantage of devaluing the euro is that it spreads the burden over the largest possible spectrum of stakeholders while leaving the door open for them to recuperate their losses as the currency appreciates over time.

If the ECB were to decide on a devaluation of the euro this should be accompanied by a series of operations on the Greek securities market by the ECB to force down the interest rates on Greek debt.

The timing of a major operation of this nature is important. Jean-Claude Trichet, the outgoing president of the ECB is French. He is fully aware of the pros and cons of devaluation. The French have acquired valuable experience devaluing the French franc. He is the right person to undertake such an operation and assume the responsibility, leaving a clean slate for Mario Draghi, the incoming Italian president.

Devaluations in France are traditionally conducted during the month of August when most people in Europe take their summer vacation and economic activity is at its lowest. The last one was in 1983 which came at the end of a series. It never particularly bothered anyone then. It should not now either.

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About the Author

Rodney Crisp is an international insurance and risk management consultant based in Paris. He was born in Cairns and grew up in Dalby on the Darling Downs where his family has been established for over a century and which he still considers as home. He continues to play an active role in daily life on the Darling Downs via internet. Rodney can be emailed at rod-christianne.crisp@orange.fr.

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