Greece, the Euro, the Drachma, and bad ideas...

On Tuesday, Martin Feldstein wrote an article for the Financial Times offering a solution to the Greek debt crisis: have Greece temporarily use the drachma instead of the euro. He suggests keeping bank deposits and obligations denominated in euros, while converting wages and prices to the new drachma, which will be fixed at 1.3 drachma = 1 euro. He suggests this will make Greece more competitive in the global market, as exports will be cheaper. This will stimulate the Greek economy and make paying off their debt easier and blah-blah-blah. Well, not only will this pose insurmountable logistical problems, even Krugman sees this; the macroeconomics supposedly working here is full of holes, something Krugman does not see: "In terms of the macroeconomics, this actually does make sense." Here is where Krugman is wrong:

Prices reflect the value of a good, determined by market forces. If you change the currency and reduce its value by 30%, prices negotiated after this date will take this into account. Thus, you have changed the nominal price of goods and services, but the real prices (were you to convert them back into any other currency) would remain exactly the same. Where this wouldn't apply is to contracts that have already been negotiated, as Feldstein suggests all payments would now be payable in the cheaper drachma. This means if you had negotiated a contract with set prices in euros, based on either your projected costs or cash flows, you would now receive a different amount (larger or smaller depending on which side of the transaction you fall).

What this will effectively accomplish is a transfer of wealth from employee to employer, from those who sold items on credit to those who purchased those items, and from those who prepaid for items to those who sold these items. It also acts to punish those who have entered long term contracts (and chosen the wrong side).

Also, keep in mind the bank balances and debt of the Greeks will not be changed, so while the (previously negotiated) wages of Greeks will fall by 30%, their mortgages and other debts will still be payable in euros.

Finally, and most worryingly, Feldstein is proposing that the Greek government should have the authority to arbitrarily renegotiate and enforce all contracts that are currently in place in the country. Further, the government should be allowed to exercise this authority because it has overspent and racked up an unsustainable level of debt. If that wasn't scary enough, Martin Feldstein is an adviser to President Obama (serving on the President's Economic Recovery Advisory Board).