About the Greek losses

By Jerry L. Jordan
Economists and accountants don’t think about financial losses the same way. When a person buys an asset, such as shares of a company on the stock market, and then sees the price of the shares fall below the purchase price, an accountant will say the loss is not “realized” unless and until the shares are sold a price lower than the original purchase price. Certainly the tax authorities will not allow the investor to declare a loss on stock that is still owned, no matter what the price (of course, a gain when the price of shares goes up is also not taxed until they are sold). In economics, a loss occurs when the price of an asset falls regardless of whether it is sold or continues to be held. Students of economics are taught not the think—as many people do—that when the value of an asset has fallen they should hold on to it until the price goes back up to the original purchase price “so they don’t suffer a loss.” The owner of the shares must make decisions based on the fact of lower wealth, even while continuing to own the lower-valued asset. This distinction between an accounting loss and an economic loss is important when thinking about what would happen in Greece after the election in September. While estimates differ about how much of the money Greece has borrowed from foreign creditors can never be paid back, there is no one on the planet who thinks Greece can pay back all they have borrowed. Everything that has happened during the past five years has been about who is going the “realize” the losses in an accounting sense. The economic losses are real and unavoidable in the aggregate, the haggling is about who takes the write-off—acknowledges that their wealth is less than the balance sheet says. The Greek government’s requests for “bailouts,” and debt restructuring (lower interest rates, delayed maturities), is about getting the foreign creditors to incur as much of the losses as possible. Essentially, the “No” vote in the July 5 Greek referendum was a declaration that those who lent Greece the money (banks, governments, IMF) should be the ones who should bear the losses. Of course, ultimately only individuals can bear losses, so it means the stockholders of private lending institutions and the taxpayers of lending countries would suffer the losses. If the lending banks require home-country government bailouts as a result of their losses on loans to Greece, that too comes from the taxpayers of those countries. In financial circles, this is known as “socializing the losses.” On the other side, the leaders of the other countries in the euro zone have been demanding that Greece raise tax rates (impose the losses on Greek taxpayers), reduce actual and promised transfer payments—pensions, welfare payments, unemployment compensation (losses to recipients)—and cut other forms of spending by the Greek government. Naturally, neither lenders nor borrowers want to accept any of these explicit losses. But, remaining in the euro zone requires that some—or all—of these forms of wealth losses must occur. This reality leads to consideration of another option—exiting the euro zone and reintroducing a Greek national currency, the drachma. But, this option does not mean the losses are avoided or reduced. The economic losses are the same, but there is a different distribution of the accounting losses. Without question, a reintroduced drachma would be a weak currency—both within Greece (domestic inflation) and externally (falling value relative to other currencies). Why would anyone think that is a good option? Historically, inflation has always been the favorite tax of politicians. Debasing a currency (inflation) has been referred to as an “unlegislated tax,” the tax “no one has to vote for,” and a “hidden tax.” A weak and depreciating drachma would mean lower real wages of Greek workers, lower real pension benefits and other transfers from the Greek government, and higher prices of imported goods for Greek consumers. Because it would require increasing numbers of drachma’s to make the interest and principal payments of euro loans, explicit tax rates on Greek incomes and purchases would still be necessary unless the euro-denominated loans are written down or sufficiently stretched out. So, in answer to the question of who would favor this option, only politicians who cannot or will not tell Greek taxpayers, pensioners, and consumers the truth. A wise central banker once said that a place that tolerates inflation is a place where no one tells the truth. That is why inflation is also described by economists as a dishonest tax—it takes larger and larger wage increases and benefit payments to buy the same basket of goods, and changes in real relative prices are harder to observe. It is understandable that Greek political leaders are reluctant to tell Greek workers that their wages are too high and must be cut in order for the country to become more competitive in export markets. Inflation accomplishes the same result—lower real wages—and has the added benefit to politicians that the rising prices of everything can be blamed on “greedy” vendors. While economists know that inflation is caused by central banks that are controlled by governments, political leaders trust that the general public does not understand that “inflation is always and everywhere a monetary phenomenon.”These leaders also will not acknowledge that inflation is a highly regressive tax—it worsens the distribution of income because lower income people have fewer ways than wealthier people to protect themselves from the wealth losses caused by inflation. In economics, inflation is the worst of all taxes—it is dishonest, divisive, and regressive. Devaluing the external, and eroding the domestic, purchasing power of a currency makes a country poorer, not richer. A country cannot inflate its way to prosperity. Restoring prosperity to Greece would require many politically difficult structural reforms to regulations as well as tax and labor laws. A return to a weak national currency would make those reforms less likely.

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Jerry L. Jordan

Jerry L. Jordan is a Senior Fellow with the Fraser Institute and an Adjunct Scholar with the Cato Institute. He was President of the Federal Reserve Bank of Cleveland, a member of President Reagan’s Council of Economic Advisors, Dean and Professor of Economics at the University of New Mexico, and Chief Economist for two commercial banks. He has also served as Sr. Vice President and Director of Research at the Federal Reserve Bank of St. Louis and as a consultant to the Deutsche Bundesbank in Frankfurt, W. Germany.

Jordan earned his Ph.D. in Economics at the University of California, Los Angeles and his B.A. in Economics at California State University, Northridge. He holds honorary doctorates from Denison University, Capital University and Universidad Francisco Marroquin.