Eleftherios Venizelos, who lost the "battle for the drachma," ca. 1915. Source: Library of Congress Prints and Photographs Division
Eleftherios Venizelos, who lost the "battle for the drachma," ca. 1915. Source: Library of Congress Prints and Photographs Division

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 Europe.”

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 devalued.

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.

(Sean Vanatta is a graduate student in history at Princeton University. The opinions expressed are his own.) Read more Echoes columns online.

To contact the writer of this post: Sean Vanatta at svanatta@princeton.edu.

To contact the editor responsible for this post: Timothy Lavin at tlavin1@bloomberg.net.