Remember the last time Greece was kicked out of a monetary union?

Speculation about a Greek exit for the euro zone continues ahead of the weekend’s Greek parliament elections. If Greece leaves the euro (or is kicked out) then it will not be the first time Greece has been forced out of a currency union.

This is from a 2003 working paper from the Greek central bank(!):

“The Latin Monetary Union (LMU) is thought by many to be the 19th predecessor of the recent venture of the European Monetary Union. It was designed for the same reasons that led to the adoption of the euro in the dawn of the new millennium, i.e. “the creation of a lake of monetary stability in the very perturbed ocean of the international monetary system”… The LMU was in essence a metallic monetary system in which the two precious metals, gold and silver, were used as a numeraire, i.e. as a unit for determining the value of all the other currencies. The benefit from the creation of the LMU was the moderation of fluctuations observed in the market prices of gold and silver, caused by the discovery of new supplies of precious metals.

…Although participation in the LMU demanded strict monetary discipline, this was not secured via an institutional framework that would impose firm criteria for fiscal management.

…The need to reform the Greek monetary system became urgent in the mid-1860s when Spain abandoned the monetary system that was based on the distilo. At that time, international trade transactions were made in currency directly convertible into precious metals at a fixed rate, and, therefore, Greece had to adopt a monetary system that would be acceptable by other countries. The Greek governments expected that by joining the LMU the country could enjoy monetary stability. First, Greece would no longer face money scarcity since domestic transactions would also be carried out in French francs; second, tying the drachma to the French franc at a fixed rate would reduce exchange rate fluctuations; and, third, Greece would improve her solvency in the international capital market of Paris.

…Beginning in the mid-1870s, political instability in Greece led to an increase of fiscal deficits. The segmentation of the Parliament into many small political parties and the short-lived governments caused a loss of revenues due to the laxity in tax collection and an increase in expenditure due to the numerous dismissals and transfers of civil servants that accompanied each change of government. None of the 19th century governments dared to undertake a budget reform, namely to improve the tax collection system and raise revenues from income taxes.Public expenditures – overwhelming government consumption – were financed by domestic borrowing contracted on unfavourable terms to the government, resulting in an excessive burdening of the budget during the second half of the 1870s.

In an effort to ensure banknote convertibility, the Greek government tried to avoid inflation as a tax instrument but rather incurred welfare losses in return for income tax revenues. However, the Russo-Turkish War of 1877-78 caused new wartime emergencies and aggravated the position of the budget even further. Considering the rise of its defence expenses as temporary and with the intention to maintain the specie convertibility rule during the war, the government tried – unsuccessfully – to finance them by domestic debt issuance. The loans, however, were only partly covered and, ultimately, the government relied on inflation finance to meet its borrowing requirements.

…However, the new system only lasted nine months, as the government failed to control the fiscal deficits and thus to support the credibility of the system. The high interest payments as well as the economic crisis, which had started out as a commercial crisis near the end of 1884, caused large gold outflows. In addition, the long-lived fiat standard that the country experienced prior to 1885 caused a lack of confidence in the domestic currency, which resulted in a massive de-hoarding of banknotes immediately after the restoration of specie standards.”

And it goes on and on…

“Foreign creditors demanded the presence of foreign experts for the monitoring of the economic policy pursued and, especially, of the tax collection and management systems. This demand was seen as a pre-condition for the government to pursue a monetary and fiscal policy, which would ensure both the regular repayment of the foreign debt, as well as its repayment in drachmas convertible to gold at par value. After her humiliating defeat in the Greco-Turkish war of 1897 and the resulting huge war indemnity she had to pay to Turkey, Greece was forced to accept the presence of the International Committee for Greek debt management. 1898 was the beginning of a period of intensive disinflation. Successive Finance Ministers curtailed expenditures and increased indirect taxes in an effort to balance the budget.

But prudence apparently never lasts for long in Greece and in 1908 the other countries in the currency union had it enough and effectively expelled Greece. However, Greece was allowed back in in 1910, but when first World War broke out in 1914 the Latin Currency Union effectively collapsed.

This is what University of Chicago economist Henry Parker Willis had to say about the whole thing in his 1901 report ‘History of the Latin Monetary Union’ (I got this from Oliver Marc Hartwich):

“It is hard to see why the admission of Greece to the Latin Union should have been desired or allowed by that body. In no sense was she a desirable member of the league. Economically unsound, convulsed by political struggles, and financially rotten, her condition was pitiable. Struggling with a burden of debt, Greece was also endeavouring to maintain in circulation a large amount of inconvertible paper. She was not territorially a desirable adjunct to the Latin Union, and her commercial and financial importance was small. Nevertheless her nominal admission was secured, and we may credit the obscure political influences … with being able to effect what economic and financial considerations could not. Certainly it would be hard to understand on what other grounds her membership was attained.”

Surreal isn’t it?


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1 Comment

  1. dwb

     /  June 13, 2012

    great historical context.

    However, “fool me once shame on you, fool me twice shame on me.”

    Reply

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