Greece's 1932 default

History Offers an Ugly Precedent for a Greek Euro Exit

By Sean Vanatta
Jun 1, 2012 3:30 PM ET

Looking over the precipice of national default and an untimely exit
from the international monetary system, the Greek leader issued a
somber warning to Europe’s economic leaders: “Bear in mind that if you
leave the small states without assistance, a black future awaits

Delivered by Prime Minister Eleftherios Venizelos on April 15, 1932,
less than two weeks before his nation would suspend loan repayments
and exit the gold standard, the prescient remark and the trials that
followed offer urgent lessons for the current Greek crisis.

Before the euro bound the continent’s disparate economies into one
monetary system, European governments relied on the gold standard to
direct international monetary flows. This promised stability, but also
required the vigorous coordination of each country’s central-bank
policy. The turmoil of World War I disrupted the international order,
pushing Greece and the rest of Europe off the standard, a blow from
which the monetary system would never fully recover.

Modern State

Nevertheless, in the absence of alternatives, gold remained the
standard for much of the rest of the developed world, and Greece made
the drachma convertible to gold in 1928 under the leadership of
Venizelos’s Liberal Party. A centerpiece of the government’s reform
agenda, the return to gold, combined with vigorous economic
development and large-scale public works, promised to turn Greece into
a “synchronon kratos,” or modern state. Further, re-gilding the
drachma offered pride to a Greek nation that had recently suffered
prolonged inflation and political turmoil.

This triumphant return was not only desired from within Greece, but
imposed from without. Venizelos’s project was largely dependent on
foreign financing, both in the form of government loans and direct
foreign investment. The drachma’s convertibility was thus also meant
to appease investors. So too was the regime’s simultaneous creation of
the Bank of Greece, the country’s first true central bank, which
replaced the privately owned National Bank of Greece as the issuer of
the drachma.

The Great Depression, though, came at an inopportune time for the
fledgling Greek financial system. When the world economy began to
decline in 1929, Greek exports dwindled, creating an acute imbalance
-- more foreign currency left Greece through the purchase of imports
than came in through the sale of exports, draining the currency
reserves of the Bank of Greece. This situation was exacerbated by the
country’s foreign debts, which also had to be repaid in foreign
currencies, such as the U.K. pound and the French franc. As
effectively gold equivalents, these monies undergirded the drachma; as
they left Greece, each successive loan payment made defending the
currency more difficult.

To make matters worse, the country’s commercial banks began
speculating against the drachma. Led by the recently displaced
National Bank of Greece, these institutions purchased Greek national
bonds, securities denominated in pounds and francs, on foreign
exchanges -- securities that would be worth more if the drachma was

Spreading Contagion

Yet while Greece’s development had been financed by foreign borrowing,
the government could hardly be accused of profligacy. As Greece’s
exchange crisis increased during the late 1920s and into 1931,
Venizelos’s government still managed a budget surplus, and relative to
other nations the Greek economy suffered less from the global
depression. Nevertheless, as economists such as Barry Eichengreen have
conclusively shown, the gold standard, like the euro in recent years,
spread economic contagion.

The Venizelos government searched for a solution. In the first salvo
of the “battle for the drachma,” the Greek parliament considered a
regulatory package aimed at strengthening the Bank of Greece’s control
over the country’s commercial-banking sector. But the National Bank of
Greece and its allies intervened, so weakening the bill as to make it
virtually ineffectual.

As the crisis deepened, the government sought international
assistance, turning next to the Europe-dominated League of Nations
Finance Committee. The fight for the drachma was quickly draining
Greece’s financial resources, and the government’s 1931 surplus
flipped to a sharp deficit in 1932. To meet this shortfall, to keep up
its bond payments and to retain the gold standard, Greece needed an
injection of foreign capital. In a familiar tune, most recently sung
in a German accent, Europe’s financial leaders demanded austerity as
the price for assistance. The French delegate advocated closing
schools and cutting the salaries of public employees by 20 percent.

These were harsh terms, and Venizelos feared that the sacrifices
demanded by the guardians of the international monetary system would
doom his liberal regime and perhaps democracy in Greece. To build
national unity, he reached out to the opposition Populist Party,
hoping to form a coalition and share the burden of leadership. The
party’s leader, Panayis Tsaldaris, curtly refused.

By April 1932, Greece was out of options. Without substantive foreign
intervention, the combined pressures of foreign debt service and
hemorrhaging currency reserves finally forced Greece off the gold
standard and into default. By tying his regime to the integrity of the
drachma, Venizelos also ensured his fall from power, while the
subsequent decline of his centrist Liberal Party shattered the Greek
political system.

Coup, Fascism

After default the Greek economy actually began a steady recovery as
the nation turned its efforts toward self- sufficiency outside the
global market. But in this case, the inward-looking recovery was a
false friend, and the political instability that followed the
drachma’s devaluation paved the way for a successful coup by General
Ioannis Metaxas. Whether his regime was a fascist one or merely
conservative- authoritarian is an academic debate that accepts a
simple fact: It wasn’t democratic.

It is unlikely, whatever the outcome of Greece’s present currency
crisis, that fascism lies in the nation’s future. Venizelos believed
that liberal democracy couldn’t withstand the burdens imposed by the
international monetary system, and his solution was to exit that
system, with unfortunate results. Although to date Greek leaders have
made different choices, a black future may still await Venizelos’s
country -- and Europe - - if Greece and similar small states are left
without assistance.