Drachma!
May 29, 2012
by David R. Kotok, Cumberland Advisors
The drachma, the Greek currency name, is over 3000 years old. It was the most widely circulated coin in the world prior to the time of Alexander the Great. Readers may enjoy a few minutes of study about Alexander the Great. His was the Macedonian conquest of Greece and the rest of the ancient world. His education came from Aristotle who was his tutor. He changed the political geography of the Balkans and the Mediterranean. See a few notes at the very end of this commentary.
Back to the drachma.
Since reintroduction in 1832, all modern Grecian drachma forms have ended badly. The single exception WAS the exchange of the drachma for the euro in 2001. That chapter of Greek history is being re-written now.
The worst Greek hyperinflation was during World War 2. At its extreme, the Nazi-Fascist occupation Greek government inflated at rates similar to recent Zimbabwe or the infamous Weimar Republic. At one point Greece issued a 100,000,000,000-drachma note. Greek monetary history also includes one previous failure in a currency union (The pre-World War 1, Latin Currency Union).
After WW2, Greeks attempted to halt inflation with entry into the Bretton Woods fixed currency regime. They created a new version of the drachma by replacing the old one at a ratio of one new drachma for every 1000 old. When the Bretton Woods structure reached its demise in 1973, the then new version of the drachma declined in value. The post WW2, revalued drachma was 30 drachma to 1 US dollar at Bretton Woods entry (1954). The drachma reached about 400-to-1 US dollar prior to Greece joining the euro in 2001. In 2001, when Greece was admitted to the Eurozone, the official exchange rate was 340 drachma to 1 euro.
Will there be a “new” drachma? If yes, what will it look like?
Money has three basic characteristics. They are: (1) unit of account. This is how we enumerate a price or a debt. (2) Store of value. This is the issue of “trust.” Does money hold its value or does it lose the value to inflation. (3) Medium of exchange. This means acceptance, by others, of the money as a form of payment.
Nothing in modern Greek history suggests that a new drachma will qualify on any of these three measures. Modern Greek monetary history is one of default, inflation and destruction of wealth when the wealth preservation was entrusted to the government. Centuries of history support this statement.
Of course, any new Greek government can “force” its citizens to accept a new drachma as payment of obligations issued by that government. Greece may elect such a government on June 17. Argentina imposed force with the peso after it repudiated its governmental promise to maintain the peso at parity with the US dollar. In the Argentine case, the peso quickly went from one to the dollar to three to the dollar. Years later, Argentine citizens are still paying the price for their government’s monetary failure.
If Greece leaves the Eurozone and launches the new drachma, the internal outlook for a post-Greek exit of the euro is destruction of remaining Greek wealth, confiscation through taxation, high inflation and monetary turmoil. That is what would happen within the post-euro Greece. That is a repeat of Greek history.
The external (outside of Greece) outlook is worse. The private holders and investors in Greece have already been crushed and burned. They are no longer involved in the decision-making. They avoid any Greek obligations. They function on a cash basis only or with secured or hedged letters of credit. The Greek stock market has been decimated; its percentage decline exceeds the losses of American markets during the Great Depression.
The Greeks owe several hundred billion Euros to European and international institutions. That debt cannot be paid. The Greeks do not have the money. Holders of those obligations are mostly governmental institutions now. Those institutions can hold obligations for a long time and can negotiate political changes in the structure of those obligations. Meanwhile the related institutions can also defer the default impact by postponing recognition of it while they negotiate. In sum, we are not worried about losses on Greek debt by the ECB, IMF or others.
If Greece were to leave the Eurozone unilaterally, we expect that the post-euro Greece will have no market access for years. Greeks, with a new drachma, would function on a mostly cash basis in making their external payments.
Were Greece to exit, other European commercial and banking holders of Greek obligations would have to take more losses. They already know these exist in principal. They would need to mark-to-market. That means they will have charges against their capital and may need infusions of new capital. The equity owners of those commercial institutions will suffer losses. Many already have lost as the markets are adjusting prices to reflect this risk. These losers are the banks in Europe, the insurance companies in Europe and others who are involved in the finance of the Eurozone.
