Greece has been having some financial troubles lately and economists have been blaming Greece’s use of the Euro. A small country should have its own currency, they say, so that it naturally falls in value when the government prints money or spends all of the income that today’s infants might reasonably be expected to earn over their lifetime. If only Greece had kept the Drachma its future would be as bright as China’s or Australia’s.
Conventional economic wisdom in the Americas, however, seems to have been that small countries do better when they don’t have their own currency. Ecuador, for example, prospered after “dollarization” (reference). Now that the local government could not print money, investors were more likely to trust the place (though of course lately these countries are having their currency devalued by the U.S. government’s spendthrift ways (chart)).
How come what was supposedly good for Ecuador is bad for Greece?
Separately, how do the Europeans go about printing money? In the U.S., we issue Treasury Bonds and then have the Federal Reserve Bank buy them (older posting). How can this work in Europe, though? They seem to have a central bank, but how would it decide which country’s bonds to buy? Must it buy equal weights of bonds from all of the members of the monetary union? Or do Europeans simply not print money?
In Europe we have the Eupean Central Bank (ECB) whose first mission is to control inflation.
The ECB decide when more money is necessary for the EuroZone and if so will print this money and will auction it. Commercial private banks will access this auctions which decide at which interest rate they will access this money. This auctions are of large sums of money, say 100 millons of euros and you have to return what you own to the ECB plus interest rates in a short time (for example two weeks), so only really big and powerfull banks will have access to this auctions.
But I think you forget to talk about Basel norms of banking. This norms let banks to offer credit with only a % of the money offered being real printed money. For example, being a bank you can offer credit to your customers for 6 millions of euros but you just need 1 million of euros in printed money ( http://en.wikipedia.org/wiki/Reserve_requirement ).
So the amount of virtual money is not controlled by any Central Bank or Federal Reserve. It’s a dynamic quantity.
You have real money that is printed by Central Banks and so, and virtual money that is created from nothing by private banks.
ECB use a measure called M3 to control the amount of euros in the world, that includes the amount of real euros plus part of the virtual money. If M3 or inflation is too big ECB will not offer more money in auctions.
How the ECB creates money is a good question, the answer to which can be found in the second half of this post:
BaselineScenario on Greece and the IMF.
The post and the whole blog are actually very interesting. But for those not inclined to click through, here are the two paragraphs that actually answer the question:
“This may not be obvious, but, creating money in a currency union is no simple task. In any single country, central banks usually restrict themselves to buying government bonds, and making loans to regulated commercial banks. Net purchases of these securities by central banks creates what is called “high-powered money”; this feeds into the financial system and results in the creation of what we all use to make payments and store value, i.e., money, plain and simple.
However in the European Monetary Union there are now 17 nations and a plethora of banks. So, to put it crudely, there is sure to be a fight to decide who gets the newly printed funds. The ECB resolved this by what seemed like a fair rule: All commercial banks can borrow from the ECB if they provide collateral, in the form of highly rated government and other securities, to the ECB. So, for example, a Greek bank can gain liquidity by depositing Greek government bonds with the ECB – as long as those bonds are “investment grade”, i.e., highly rated.”
The short answer is Greece had a better credit rating than Ecuador, thanks to cooking the books and the implicit Eurozone guarantee.
What was good for Ecuador would have been great for Greece if they’d encouraged value-creating investment with all this cheap money, but they mostly spent it on housing and unproductive social programs.
Good question about Ecuador. If I may speculate, I’ll say that there was never an implicit guarantee that the USA or any other currency-issuing entity would ever bail out Ecuador’s fiscal mismanagement, while clearly that was the case for Greece with the EU.
Ecuador has oil which explains a lot of their economic performance since dollarizing. It just happened to coincide with a huge increase in the price of petroleum.
[Unofficial] dollarization didn’t work so well for Argentinain 2001. If only they could’ve held out for the boom in soy prices they might’ve pulled through.