.
BY DR. JIM LEONTIADES
CIIM, The Cyprus Business School
Many countries would like to see another reserve currency as a rival to the US dollar. The Euro has been seen as the prime candidate for this position. The current crisis has until recently been working strongly in that direction, favouring a strong Euro and a weak dollar. That prospect has been damaged severely by the economic problems of the PIIGS (Portugal, Italy, Ireland, Greece and Spain).
The dollar has its own major weaknesses which seem to be getting worse. But these things are relative. The dollar has one major advantage over the euro which is political rather than economic. If California’s debt spirals out of control and it has to take stringent measures to correct it, opting out of the national currency for some form of California money is not an option. For Eurozone member countries, it is.
The Euro is the product of a political decision of 16 members to adopt it. Theoretically, the member countries can opt out. Greece can go back to the drachma. Improbable? Yes. Impossible? No. The possibility of any Eurozone country opting out of the Euro remains very small indeed, virtually nil. The economic and political cost would simply be too great. That does not mean that this possibility, no matter how small, is negligible.
If you were the finance minister of China responsible for over 2 trillion dollars worth of foreign reserves, would you accept even a small chance that these might one day be worthless or drastically reduced in value because the currency in which you placed the nations reserves no longer exists?
The Politics of Economic Adjustment
The economic advantages and disadvantages of the Euro have been debated at great length. Much less has been said about its political implications from the viewpoint of the government in power.
Like the other PIIGS, the Greek economy has been “living beyond its means”, characterized by overspending, high debt and high prices. It now has to undergo major, costly and painful adjustments. It must reduce debt and spending, making an adjustment to a more realistic level of consumption. How will this be done? Who is to do it?
Prior to the adoption of the Euro this adjustment would be typically implemented by Greece through a devaluation of the national currency. Once such a devaluation takes place, the economy goes through a process of change brought about by market forces. The impact of this adjustment would then be experienced by various sectors of society, some gaining by the change, many losing. Exporters and tourism would gain by a devaluation. Importers and consumers of imported products would lose. Many investors would also lose. Even the hint of a devaluation causes funds to flow out of the country to avoid a drop in value. Interest rates would rise, share prices and bond prices would drop. However that may be, the government in power would not be seen to be directly responsible for the distribution of gains and losses.
The “Bad Boy” of Europe
Such is not the case today in Greece. The Greek government itself will have to make the necessary decisions. It will be seen to be directly responsible for the allocation of economic pain. Not a situation which most governments would envy. Some steps in this direction have already been signaled – a freeze in public sector hiring, cutbacks in pensions and wages, higher taxes, reduced spending on infrastructure. All are in process.
The Greek government also has to placate the European Union which has left no doubt regarding its dissatisfaction with its past behaviour. One Swedish diplomat called it “fraudulent”. It has been made clear to the Greek government that it must adopt and maintain a schedule of major cutbacks which will usher in a lengthy period of economic austerity.
This is now becoming clear to many but perhaps not yet fully appreciated by the Greek labor unions and other interest groups. Traditionally, these have not been slow to take to the streets in such situations, calling for a change of government. There is little doubt that economic stoppages will make the political situation of the government extremely difficult. Not a pretty picture. But, there is another possibility, which is in some respects even worse. Given that these measures are being implemented under the strict instructions and oversight of the European Union, the fiercely independent Greeks may turn against the EU – just as other countries have turned against the International Monetary Fund when it was playing a similar role.
It is clear that for the foreseeable future Greece will be cast as the “bad boy” of the EU. Given our close association with Greece, it is imperative that Cyprus tries to keep its own economic house in order. Any further deterioration of our economic situation may tempt others to look for a new acronym, one which contains a “C”.
