Greece And The Gold Drachma: A Possibility For Returning To Solid Fiscal And Monetary Policy

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Includes: FXE, GLD, GREK
by: Open Outcrier

Summary

Greece has the 17th Largest per Capita Gold Reserves in the World.

Bailout Provisions Leave the Greek People the Worst of all Possible Deals.

A Gold Drachma Could be a New Model for Sound Policy, affecting GREK, FXE.

With the recent acceptance by Greek Prime Minister Alexis Tsipras of additional bailout funds including some small debt forgiveness, it may seem as though the Greek debt problem has been solved again for a time. The action has been viewed by IMF chief Christine Lagarde as a welcome agreement, but considers the battle far from over as Greek debt is far from sustainable for the Mediterranean country. But with significant opposition to additional austerity measures, higher taxes and even more reduced government spending, the solution is far from found, especially as the measures include requirements that could strongly impact the country's tourism, agricultural, healthcare, transportation and fossil fuels sectors while reducing social welfare, retirement and government travel payments. With Greece's already-high unemployment still dangerously close to 25%, implementing the measures will be highly unpopular with the Greek people. The 323 billion Euro Greek bailout by Eurozone countries and the prospective default faced in late June 2015 has raised a lot of questions over how future payment should be handled and whether they should be made at all. There's also the question of whether Germany and other Eurozone member countries will accept the bailout terms after so many problems with implementing austerity measures in the past and a good portion of the summer spent trying to negotiate terms.

Reserve Gold Sale Option

Some suggestions made around the time of the default included having Greece sell its reserve gold, estimated at 112.5 metric tons according to the World Gold Council's August 2015 Top 40 Gold Rankings. But with a total value of 3.6 billion Euros, Greek gold reserves would cover just over 1% of the country's total debt. Though the original bailout agreements included a clause that would allow for seizing the country's gold in the event of a bailout, such action would be a drop of water in the ocean of Greek debt. If the country were to sell an estimated 47 metric tons to cover the 1.5 billion Euro payment that was due at that time, it would cut its gold reserves by almost 42%, making a repeat performance an act that would finish removing any reassurance investors may have in the country. Because such a sale would also have a resounding impact on the world's gold market, simply due to the size of the transaction, there are requirements in place to sell the gold to another central bank, limiting its sale options even further.

High Per-Capita Gold Holdings

But what about Greece's per-capita gold holdings? Greece has the 17th-highest per-capital gold holdings worldwide at an estimated 112.2 metric tons, dangerously close to what the government already holds. As we posted recently, "#Greece has the 17th highest per capita #gold holdings in the world... ...what an interesting #Drachma that would make".

Instead of having the country pillaged further by international banks such as the International Monetary Fund and the European Central Bank, what would it look like if Greece choose to revert back to the drachma, but backed by gold? The implementation of the Euro made it less risky for investors to put money into Greek industry and business, but with the Great Recession, that investment dried up. The Euro has also increased Greek labor costs, making them less competitive across the Eurozone while removing Greek options to depreciate their currency to fix the high-debt problems the government faces. The gold-backed Greek drachma may make an interesting option for this difficult situation.

How can it be implemented?

But what would a gold-backed drachma look like? One option would be to allow those possessing gold to simply trade in their gold for the new drachma. Unfortunately, due to low confidence in the Greek government due to a string of scandals involving government reporting of financial matters, there would need to be additional protections in place to encourage Greek citizens and investors to convert their gold - currently one of their best stores of value - into the new drachma.

This could perhaps be achieved by implementing a new central banking system separate from the current system that has been involved in the bailouts. Implementing a new drachma could have serious effects the Greek relationship with the rest of the Eurozone, however, especially if the new drachma is implemented as a stand-alone currency instead of working alongside the Euro.

Would Greece be forced from the Eurozone?

It's tough to determine what would happen to Greece if the gold-backed drachma was introduced. It could, quite easily, especially if the drachma was adopted as the sole currency. But by creating it as a secondary currency, it may leave the door open to continued participation in the Eurozone while improving citizen confidence in their currency. Unfortunately, trying to run two currencies side-by-side can be very difficult to say the least, opening up potential for legal issues with the IMF/ECB bailouts, loss of confidence by investors and similar issues.

What would happen if Greece leaves the Eurozone?

On the other hand, if Greece did leave the Eurozone voluntarily, it could default on the current bailouts while accepting payment from Russia for the pipeline project that is currently being blocked by other Eurozone parties, even arranging a regular lease agreement to provide much-needed government income. Of course, if Greece was using a gold-based drachma, Russia could pay in gold, increasing Greek holdings.

There's no doubt that there would be serious repercussions if Greece took this route, including lowering further international investment in Greece, but it could give the country some serious breathing room from the current bailout payment issues. There have been threats by some member countries such as Germany that Greece won't be allowed to leave the Eurozone, though how Germany would back up that threat remains to be seen, especially with Greece perhaps receiving military backup from new trading partner Russia, who has had not qualms about stationing troops in the Ukraine in recent history.

What are some of the potential effects on the Greek economy?

How would this affect the euro (NYSEARCA:FXE), and the Greek stock exchange (NYSEARCA:GREK) - is anything at this point better than pure conjecture? At a minimum, there would be serious changes in international trade. With a gold-based drachma, investors who have been avoiding Greece due to the economic turmoil may be more willing to invest in a currency that is backed by precious metals. The Eurozone may push for an embargo on exports to Greece, but other countries such as Russia may then become better trading partners. If defaulting on their debt payments cause the Eurozone economy to falter, Greece may even see increased investment as its new metal-based currency is seen as more stable than the fiat-based Euro. On the other hand, not being able to import goods from the Eurozone would mean that Greece would need to go back to producing its own goods, helping push cottage, local and national industry, an act that would surely solve some of the country's terrible unemployment woes. Perhaps in these issues, Greece would do well to look to Cuba, which has had its share of economic woes and triumphs as a country that has undergone swift and drastic economic change in difficult times. Indeed, Cuba's newest economic policies have produced over 400,000 new entrepreneurs in the country while implementing deregulation of 181 official jobs and increased import tariffs.

Right now, Greece is suffering from the worst of all worlds. It has high debt, a currency it can't regulate, a strong trade deficit, high unemployment and higher labor costs. By readopting the drachma as a gold-backed currency, the country could see significant improvements in its economy, but only with serious reformation to its government practices, revision to its policies and restoration of the people's faith in their government. With some strong intelligence, serious planning and hard work, the gold-based drachma could prove a successful experiment in restoring a fiat-based currency to the gold standard. It could even provide the necessary encouragement for other high-deficit, high-debt economies to consider making the same change, allowing their citizens to enjoy the benefits of real wealth over inflated bubble markets such as the US economic downturn and severe recession that occurred during the housing bubble crash.

Perhaps more importantly, what would this do to confidence in Gold (NYSEARCA:GLD) versus that of Cetral Banks?

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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