Mismatched Socks

Khan Academy » Finance » Macroeconomics » How and why Greece would leave the Euro (part 3)

So that whole “inflate your way out of debt” thing I was talking about earlier? That would only work if Greece had its own currency — which it does not. In order to do that it would have to declare a “banking holiday,” which is far less relaxing than it sounds. A banking holiday would be a temporary shutdown of all of Greece’s banks to facilitate the transition from Euros to their new currency, probably a new form of the Drachma. They’d declare a conversion rate, convert all deposits into the new currency, and then reopen the banks and introduce the new currency into foreign exchange markets, where the value of the new currency would be dictated by the free market.

If you’ve got money in Greek banks, this could be terrifying for you. The conversion rate they set may be far higher than the actual value of the new currency, and as soon as the new currency hits the free market your savings could drop in value significantly. 

But it’ll probably happen. Austerity isn’t working, nobody likes it, and the rest of the Eurozone really doesn’t wanna be associated with Greece anymore. So they’ll probably move back to their own currency and inflate their way out of debt (along with a few cutbacks, but nothing quite as severe as what’s been done already). 

Good luck Europe.

Khan Academy » Finance » Macroeconomics » Greek Financial Crisis (part 2)

Something I wanna touch on that I think I forgot in the last post: Greece’s spending has been higher than it’s tax revenue for some years at this point. This means that their debt has been steadily (or not-so-steadily) increasing over this time period, and this was in part due to some shady accounting. What this does is lower investor’s trust in the country, and so they start demanding higher interest rates, thus increasing spending further (spending on interest payments) without actually increasing public services or anything meaningful.

Now we’ve gone over why austerity seems like such a bad idea (slows down the economy, reduces tax revenue, and it’s politically unpopular (to put it lightly)). So what do you do then? 

Well, one idea is to inflate your way out of debt. Print more cash, put it into circulation, nominal GDP increases proportionally to inflation, but debt and entitlement obligations stay constant — they do not increase with inflation! So you can literally inflate your way out of debt. Sure you’re still cutting people’s pensions in half in terms of buying power, but it’s much more politically stable to inflate away people’s buying power than to literally cut their pensions. 

That’s the logic anyway. I kinda think it’s bullshit because you’re doing the same exact thing, but there’s truth to it. People aren’t rational. And the economy is largely a function of the masses’ confidence. So you have to play the game according to those rules. 

We’ll see how it goes.