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Last February, I argued that Greece should abandon the Euro. My argument went as follows: Greece will never have the economy of France or Germany, so why tie it to that strong of a currency? If it has a weaker currency for a weaker economy, then wages and prices will be more in line with economic conditions. (Paul Krugman echoed my argument--with more economic muscle--on Friday.)
It looks like events have vindicated this view. Athens erupted in riots when the austerity package passed. Three people died during the riots. The Dow dropped almost 1,000 points--though no one really knows the cause--when these riots played on cable TV.
Its not even clear that the $140 billion IMF/EU bailout will work. Felix Salmon points out that even with austerity measures and a bailout for current bonds, it's far from clear whether Greece will be able to sell its bonds at a low cost again. Basically, those creditors would be last to be paid before the IMF gets paid in the event of default--a substantial risk.
What is clear is that the worst is yet to come. These austerity measures haven't even taken effect yet, and boy will they be bad. Wage cuts and tax increases will create unemployment and a worse recession. It's like when Herbert Hoover cut the budget during the depression to pay off the deficit, thus creating a larger depression.
Again, the worst way for Greece to leave the crisis, but better than all the others, is for it to leave the Euro. Greece would have enough short-term hardship from a currency conversion to discourage the other PIGS from leaving the Euro.
Greece having its own currency would make this crisis manageable. Greece could inflate its currency to pay off its debt. Then its currency would be at a level in line with its economy. Inflation sounds bad, but its better than the alternative--higher taxes and rising prices coupled with declining job growth.
This crisis is really showing the worst of the European Union. Angela Merkel didn't want to bail out Greece for political reasons, but then had to because it was TBTF. Meanwhile, bureaucrats in in Brussels and Washington have to give Greece a painful austerity package to pay back its debt. This will create the typical outrage towards these organizations.
The case for the Euro was always more ideological than economic--it's great for travel, smaller countries can have a stable currency, it will unite Europe, etc. But the economic idea of an optimal currency area is that regions have to have similar economies for them to share currencies never applied to the continent. Perhaps Europe will one day reach that point, but it wasn't when the Maastricht Treaty was signed nor is it now, as the disparate economies of Greece and Germany illustrate.
Note, I take no pleasure in seeing the EMU fail. I'd like it to work, but with only a few advanced economies, not countries on the perimeter. If you think differently, send me an email at firstname.lastname@example.org. I'm also on Twitter. On a related note, I'm in DC, and the Greek Embassy on Massachusetts Avenue is completely swamped with visitors for an open house.