Drachmas, Dollars, and Debts

One proposed solution to Greece’s European debt problem is for the Mediterranean country to abandon the euro and resurrect its old currency, the drachma. In his April Gold Videocast, Peter Schiff explains why a new drachma would be ideal for Greek politicians, but a disaster for Greek citizens and creditors. Peter also reveals why the United States faces the same debt dilemma as Greece. There’s just one major difference – the US already has a currency it can devalue.

Follow along with this full transcript:

“As you may or may not have heard, the Greek government is thinking about reintroducing the drachma. Now why would they do something like that? After all, it’s not as if Greece really flourished under the drachma. After all, they gave up the drachma for the euro. The reason they did that of course is Germany prospered under the mark, and the idea is going to be the euro is going to be a lot more like the Deutsche mark than the drachma. So Greece was happy to sign on. In fact, I think they even cooked the books with the help of Goldman Sachs to get accepted into the euro currency when they really didn’t qualify. So [if] they really did everything they could to become a member and adopt the euro, why would they want to get rid of it?

“Well, one of the other things that was so enticing for Greek politicians about the prospect of being part of the euro was that they knew that they could borrow a lot more money if they can do it in euros rather than drachma. After all, you’re much more willing to lend money if you have confidence that when it’s paid back it will have buying power, and certainly people would be more confident in the euro than they were in the drachma. So this was great for Greek politicians, because the minute they got their hands in that cookie jar, they were able to promise a lot more to their voters to win their votes and to cement their power.

“So Greek politicians can go into debt making all sorts of promises they couldn’t keep because they were promising to pay in euros. For a while none of the creditors cared. That was part of the moral hazard with this experiment. Greece never could have borrowed that much money had the creditors been more concerned about default. Apparently they thought Greece was too big to fail. Well, they were wrong. They’re not too big to fail, in fact they have failed. The only question is acknowledging it.

“Whenever a country borrows more than it could realistically repay, the only option is to fall. But the question is how do you do it? Do you do it honestly by not paying what you’ve borrowed? Or do you do it dishonestly through inflation? Now of course all politicians are going to choose the latter, because it’s much more secretive and it allows them to blame the problems on somebody else. They just print money. But Greece can’t do that because they can’t print euros.

“So the reason they want to go back to the drachma is so they can create a currency out of thin air. They want to have money they can print. Now, of course, that’s still means defaulting on their bonds, because even if they paid their creditors in drachma instead of euros, their creditors are not going to feel that they’ve been made whole. They’re still going to feel that Greece didn’t honor their commitment, which of course would be the truth.

“But Greece doesn’t really care what their foreign creditors think, because they can’t vote in their elections. What Greek politicians are more concerned about – and that’s true for all politicians – is their own re-election. What they don’t want to do is to default on their own citizens, because it’s not just the debt, it’s not just the money that governments borrow. They make other commitments. They make promises. They promise their employees wages and in general the government workers are overpaid, so they have promised overpayments to their workforce, and generally government workers reward politicians with their support politically when they get overpaid for their government jobs. But also there’s an army of retired government workers. In many cases they’ve retired very early, [and you have] very young ages who have been promised all sorts of benefits. Then you have just regular citizens who are part of a government retirement scheme, kind of like our own Ponzi scheme of social security. So politicians have made all sorts of commitments to voters to make payments. They don’t want to default on the voters because the voters will take it out at the polls. So they want to try to find a way to default on the people who can’t vote but still pay the people who can. And the way they want to do that is by returning to the drachma.

“The problem there is that it’s still going to be default. Even if you are a government worker and now you’re getting paid in drachmas, and even if you were promised a government pension and you were promised euros but you get drachmas – that promise hasn’t been kept. The problem is you’re going to have a lot of Greeks with paychecks full of drachmas with very little to buy because you’re not going to be able to use those drachmas to pay for your imports. Prices are going to skyrocket in Greece, and if you want to buy anything real you’re going to need euros.

“Of course a lot of the Greek citizens, they’re not going to want the drachma either. As fast as they get their drachma paychecks, they’re going to try to convert whatever’s left into something else. Maybe they’ll convert it back to the euro. If they’re smarter they’ll go for the Swiss franc. Some might even go for the dollar, although I think long term that would be a pretty dumb move. I think the smartest move would be to buy gold.

“Well, the reason I bring this point up is because the only difference between Greece and the United States is the perception of our creditors, because we are just as broke. We have borrowed more money than we can repay. Not only have we borrowed it like Greece, we owe over $18 trillion when it comes to the national debt, the bonds that have been issued where we actually owe principal and interest payments.

“But just like Greek politicians, American politicians have made all sorts of promises to everybody to get votes and there’s nothing that’s going to stop the US government from repaying its commitments in worthless money. Just like there’s nothing that’s going to stop the Greeks once they get the euro out of their way and go back to the drachma. We already have a precedent now for doing this. They call it quantitative easing. We’ve had three rounds of it. Everybody seems to agree that it worked, that printing money has no negative consequences. So why not do it? If we’re in trouble, why not print money? The difference is that our creditors still perceive that we’re good for our promises, and so the dollar is still accepted whereas the drachma won’t be. But the question is for how long?

“Look how long the Greeks were able to borrow in euros at such low interest rates, even though it should have been obvious to the lenders that there was no way the Greek economy could generate the surpluses to repay the debt. Well, the same thing is true in the United States. We can keep on printing money, but we can’t actually repay. It’s impossible to raise taxes sufficiently to honor the debt. All we have to hope is that our creditors never want their money back. That whenever the bonds mature that they roll them over, and they continue to do so at record low interest rates.

“Well, when our creditors decide that they don’t want to play this game anymore, then the Greek tragedy unfolds in the United States. Because if our creditors want our money back, we don’t have it. We’re no more capable of paying than Greece is. And that’s when the default to inflation really kicks in, because in the same way that Greek politicians don’t want to stiff their constituents, US politicians don’t want to come clean either. Our politicians don’t want to deliver the bad news. They don’t want to tell government workers that they’ve got to take a pay cut. They don’t want to tell government retirees that they’re not going to get all the pension benefits that they’ve promised. They don’t want to level with the American people that there’s not enough money to pay social security and now we’ve got a means test it. Or that we have to have some kind of an age-base, so we’ve got to raise the retirement age. They don’t want to tell people that, ‘Hey, if your bank fails it’s tough because we don’t have any money to bail you out.’ Or if your brokerage fund goes under, ‘Sorry, we can’t bail you out. We made too many promises.’ They don’t want to tell the cities and the states when they have a natural disaster, ‘You’re on your own.’ They want to play Santa Claus. They want to dole out all this government money and they can.

“What they can’t do is give that money any value. No more than the Greek government is going to be able to impose value on the drachma. The US government will not be able to impose value on the dollar if our creditors don’t want it. And when the dollar collapses and prices skyrocket, it’s not going to do any good if the government kept its promises when the dollar doesn’t buy anything. So I would give this same advice today to Americans as I would to Greeks. Don’t hold on to dollars, just like you’re not going to hold on to drachma. Turn your dollars into something else, something of real tangible value that the government can’t create out of thin air. I think the best choice would be gold. Gold or silver can retain their purchasing power in the face of government default through inflation.”

Reprinted from SchiffGold.com.