Greece's Lesson for Gold Bugs

I have been predicting for years that the only solution for the Greece problem is for it to exit the Euro, go through a horrible economic crisis and deal with substantial devaluation, and then hopefully move on with a cheaper currency that makes its tourist industry look better and plugs the hole between taxing and spending with inflation.  It appears we are closer than ever to this actually happening.  The Greeks would likely be moving forward now, like Iceland, if they had taken their medicine years ago rather than try to kick the can.  Now it is just going to be worse.

I have been enamored off and on with the idea of a gold standard but Megan McArdle made some powerful points today about how the Greek situation teaches us that a gold standard doesn't necessarily impose discipline on governments.

It's easy to moralize Greece's feckless borrowing, weak tax collection and long history of default, and hey, go ahead; I won't stop you. But whatever the nation's moral failures, what we're witnessing now shows the dangers of trying to cure the problems of weak fiscal discipline with some sort of externally imposed currency regime. Greek creditors and Brussels were not the only people to joyously embrace the belief that the euro would finally force Greece to keep its financial house in order; you hear the same arguments right here at home from American gold bugs. During the ardent height of Ron Paul's popularity, I tried to explain why this doesn't work: "You don't get anything out of a gold standard that you didn't bring with you. If your government is a credible steward of the money supply, you don't need it; and if it isn't, it won't be able to stay on it long anyway."

This goes double for fiscal discipline. Moving to a fixed exchange rate protects bond-holders from one specific sort of risk: the possibility that inflation will erode the real value of your bonds. But that doesn't remove the risk. It just transforms it. Now that the government can't inflate away its debt, you instead face the risk that they are going to run out of money to pay their bills and suddenly default. That's exactly what happened to Argentina, and many other nations on various other currency regimes, from the gold standard to a currency peg. The ability to inflate the currency had gone away, but the currency regime didn't fix any of the underlying institutional problems that previous governments had solved with inflation. So bondholders protected themselves from inflation, and instead took a catastrophic haircut.

Postscript #1:  I had one issue with McArdle's piece when she writes

The only people this will be good for is people who long to vacation on the Greek Islands. If Grexit actually happens, book those plane tickets now, but hold off on the hotel. It will be cheaper in six months. Then try to enjoy it as you remember that those fabulous savings are someone else's whole life evaporating.

Hey, if Grexit occurs, you have no reason to feel guilty about taking advantage of the weak currency and low prices for a Greek vacation.  There is nothing the Greeks need more than for you to do exactly that.   It is the single best thing you could do for the Greek people.

Postscript#2:  Here is why exiting the Euro, devalutation, and inflation are the only way out for Greece at this point. Creditors allow countries to run long-term deficits and keep lending despite rising debt (see: Japan) because of a combination of a) the country can always just print the money they need; b) the country can raise taxes and take the money it needs or c) the country can keep spending flat and grow their way out from the debt.

None of these are available to Greece. They can't print money, at least without running up new debts (excess printing of Euros is automatically added to Greece's debt to the ECB).  They can't raise taxes because their citizens don't pay the taxes that already exist.  And they can't grow their way out because there is zero support for austerity or market-based reforms that would be necessary, and besides a huge portion of Greek deficit spending is for inherently unproductive activities.  At this point Greece's only option is charity, that the other countries of the EU will forgive debt or write them new debt, either to be nice or to avoid bad precedents with other PIGS countries.  But  the EU seems at the end of its charity rope, and besides given zero prospects of any sort of Greek recovery, even after a major write-off of debt the EU would be in the position of still having to send Greece new money for its new debts.


  1. Joe:

    "But the EU seems at the end of its charity rope, and besides given zero prospects of any sort of Greek recovery, even after a major write-off of debt the EU would be in the position of still having to send Greece new money for its new debts."

    Paul Krugman says you are very wrong
    A country such as Greece can never run out of other peoples money.

  2. Vypuero:

    That is why rather than a gold standard, we need free gold - free floating currencies with gold held physically as the ultimate reserve money for banks and individuals.

  3. Incunabulum:

    Its not so much a 'gold standard vs fiat currency' thing as it is a 'only one official currency allowed at all' thing. Simply do not have the government issue money. At all.

    A free market in currency. Anyone can print money - bitcoin showed this. The trick then is to get others to *value* it.

  4. Incunabulum:

    "Then try to enjoy it as you remember that those fabulous savings are someone else's whole life evaporating."

    Yeah, I'm supposed to feel bad about someone who has made several generations of bad decisions finally having to face the consequences of those decisions? Seems to me we should be rejoicing that these guys might finally learn a valuable life-lesson and grow up a bit. Then maybe, with their new-found understanding, the example they set in the future could persuade the people of *this* country to not continue down the same path.

  5. kidmugsy:

    Why would anyone go on holiday to Greece in january? Bonkers.

  6. herdgadfly:

    Greece's problems begin with no economic engine other than tourism and ends with the world's most corrupt society. Everybody wants government freebies and nobody wants to pay taxes. Government rules make it impossible to hire employees at reasonable wages and government corruption includes blackmailing citizens to get permits and licenses processed. As a result, the rich do not pay their taxes, the unions control wages and impede growth and the everyday citizen buys everything on the black market.

    So the too-large government keeps demanding more taxes to pay for policies that were never affordable and the citizens keep demanding more for less. Crashing Greek economies is commonplace and so when the answer was to join the EU and get the benefit of the super-state's supposed wealth, that is what they did. The liberals who believed that adding unstable economies into the EU made sense are now about to crash the Euro.

    So when the Grexit occurs, watch for the return of the gold-backed Deutchmark to save Germany which will then be adopted by France, Belgium and all stable European countries currently on the Euro. But the PIIGS will be crying for a bailout and Obama is already talking to Greece.and the EU.

  7. CapnRusty:

    After Grexit, before you leave on your budget vacation to the Aegean paradise, you'd better verify that Greece finds a way to pay its border patrol. There are hundreds of thousands of desperate people in the Mideast and North Africa looking for a place to wash ashore in their rubber boats . . .

  8. CT_Yankee:

    My wife and I are actually in the position of changing plans from vacationing in Greece around September or October. We are interested in a few places, but Greece was high on the list. The likelihood of strikes or protests ruining the trip means we are preparing standby plans if things heat up. The notes about places to go and sites to see are mostly about places that have been around for a few thousand years, and putting off a tour for a couple years wouldn't change them. Like Egypt, the historical interest is high, but the instability says now is not the best time. So Greece needs money, and chases away the tourists that bring it. Because who wouldn't like to spend this year's vacation dodging protesters and missing trains or flights due to strikes?

  9. McMegan:

    Obviously, if Greece's economy implodes, it will still be better for them to have lots of tourists than not, so vacationing there is not morally wrong, and indeed, may almost be a moral obligation. :) But it will still be true that the reason prices are so cheap is that a lot of poor bastards lost half their life savings in a brutal devaluation.

  10. ErikTheRed:

    You're right in that a gold standard can't save those whose buy bonds in irresponsible governments but:

    1) It also removes the some of the distortive belief that ridiculous debts will be repaid with bailouts comprised of newly created currency - would anybody be buying Greek bonds if they weren't counting on an endless cycle of ECB forgiveness? Cue the shock and outrage when this fails to come to pass anyway...

    2) At least people's savings won't be wiped out by a currency collapse. They do still have to worry about "bail-ins" and other forms of confiscation, but at least if you can protect your money by physical means (hiding it or whatever).

    3) If individuals or banks or whomever do want to speculate in stupid things like Greek bonds ... who cares if they lose their money? It's a speculation, and a stupid one at that.

  11. Dan Wendlick:

    And what do you do with your hoard when the government passes a law prohibiting the sale of gold in quantities larger than a wedding ring to anyone but the government, who declares a strike price at 10% of market value? If you remember, that was the plot of the original Ian Fleming "Goldfinger" novel. the great criminal conspiracy was not to take over the world, it was to get rich by smuggling gold out of the country in violation of Britain's capital flight regulations.

  12. mlhouse:

    Here is the real argument to the Gold Bugs: ALL currency is fiat. It doesn't matter if it is "backed" by gold. Gold is just as arbitrary as anything else.