Greece needs prosperity

Greece needs prosperity, not austerity. The Greek economy is being starved of the income from both domestic and foreign trade that it needs to prosper. This economic malnutrition is attributable to a disorder in the economy's monetary system. Associated with it are two growing "tumours": domestic debt and foreign debt.

These ailments can be painlessly treated to heal the Greek economy.
China is prospering from its foreign and domestic trade. Europe is not. Europe's monetary policy prevents its exports from stimulating its economy. If exports rise in one part of Europe, the value of the Euro must rise to reduce exports from other parts. The higher Euro also makes imports cheaper, so people buy less European products and more foreign imports. This monetary disorder, therefore, is starving the whole European economy, not just Greece.
Under the current European monetary system, the only source of additional money available to stimulate the economy is from bank credit. However, that source of money is not income and it does not sustain the economy.

It enlarges the first tumour: domestic debt.
People earn money from selling what they have produced. When they spend that money, they are buying the equivalent of what they have produced. Bank credit enables people to spend more than they have earned and so buy more than they have produced.
The only way an economy can buy more than it has produced is to import more than it has exported.

To pay for those additional imports, the economy must borrow. That borrowing enlarges the second tumour: foreign debt.
The economy is obliged to sustain those two tumours with interest payments and loan repayments. These debt servicing payments reduce the amount of money available to be spent on the productive side of the economy. As a result, production in the economy grows at a slower rate than its debts. Eventually, the tumours grow so large that the debt servicing costs overwhelm and destroy the host economy, in the same way that parasites kill their host.
A remedy to Greece's economic problems must treat both the economic malnutrition and the parasitic tumours.

The optimum exchange rate system is a two part remedy capable of controlling the tumours and nourishing the economy with income from domestic and international trade.
The first part of the system regulates the amount banks may lend according to the reduction in their foreign debt. For example, banks may be permitted to lend an additional Euro for every two dollars they reduce their foreign debt. Such a policy reduces the money required for debt servicing, leaving more money available to be spent on the productive side of the economy.
The second part of the remedy injects money into the economy from export income. It uses banking guidelines to provide rewards to the banks if they achieve the government's employment and inflation targets. For example, the guidelines may reward the banks with increased lending capacity (and profits) if unemployment is reduced to, say, 4 per cent and inflation is kept below 3 per cent.
Banks would respond to the incentives by pushing down the exchange rate.

The lower exchange rate would raise export incomes. Also, the lower exchange rate would raise the price of imports, thereby making domestic products relatively cheaper. People would shift their spending from the expensive imports to the cheaper domestic products. That would boost domestic incomes. The rise in incomes would generate additional employment.

Also, in response to the rewards provided in the banking guidelines, the banks would manage their foreign exchange and lending activities to ensure that the economy met the government's target for inflation.
The optimum exchange rate system provides Greece with a remedy for its ailments. If the other Euro countries were not prepared to accept the necessary reforms to the monetary system, Greece could establish its own currency and adopt the optimum exchange rate system. The increased prosperity generated by these reforms would raise government revenue and enable it to repay its debts. This remedy would not only be painless, it would rejuvenate the Greek economy.

* Leigh Harkness is a Canberra based economist and Director, Buoyant Economies.