Greek Monetary Maelstrom: 1914–1928

Greek Monetary Maelstrom: 1914–1928

Between 1914 and 1928 Greece saw annual inflation rates vary from 85 percent to 11 percent, and monetary experiments that rank among the strangest in history.

The seeds of Greece’s monetary disorder were sown in the middle to late nineteenth century, when the National Bank of Greece, founded in 1841, gradually acquired a virtual monopoly on the prerogative to issue bank notes and became the primary creditor of the government of Greece. The bank was founded as a private bank whose principal stockholder was the government and it dominated the monetary affairs of Greece, acting as a central bank until the establishment of a genuine central bank in 1928. The bank also made loans to the private sector.

Originally, the government conferred upon the National Bank the privilege to issue bank notes as long as the bank stood ready to convert its bank notes into gold. The government, however, suspended convertibility on four separate  occasions: right after the 1848 revolutions, again from 1868 to 1870, from 1877 to 1884 when the government borrowed heavily, and last from 1885 to 1928.

Inflation reared its head during the prolonged era of suspended convertibility, but never reached the frenzied hyperinflation levels that characterized post–World War I Germany, Austria, Hungary, and Poland. Between 1914 and 1928 the cost of living index rose 868 percent, perhaps reflecting the threat of losing access to foreign capital that may have helped Greece keep a tight rein on its monetary affairs. Between 1895 and 1910 international financial pressure put Greece on a stricter monetary discipline, requiring the government to withdraw and burn 2 million drachmas in bank notes each year. This pressure came from imperialistic powers with vast financial resources, such as Britain, and served some of the same functions now performed by the  International Monetary Fund. The Allies lifted these controls during World War I and even granted credits to Greece, allowing Greece to substantially increase the issuance of bank notes. The credits were never realized, further adding to the supply of unsecured bank notes in circulation.

The government budget of Greece was clearly in the surplus column at the opening of World War I, but by 1918 red ink had shown up in the deficit column. The costs of the war in Asia Minor sent the budget deficit soaring, and by 1922 the government was unable to raise additional revenue either from taxation or borrowing from traditional sources.

Under the duress of a deficit-ridden budget, the government of Greece carried  out one of the most fantastic pubic finance schemes in history. On 25 March 1922 the government ordered all citizens to physically cut in half bank notes in their possession. One half of each bank note was to be retained by its owner and could continue to circulate at half of its face value. The owner was to surrender the other half to the government and receive in exchange a 20-year loan at 6 1/2 percent interest.

The National Bank of Greece exchanged with the government fresh notes for the canceled halves, making the whole process a means of raising a loan for the government. The government enacted a similar measure again on 23 January 1926, this time putting three-fourths of the value of the note in the hands of the owner, and the remaining one-fourth the government took in exchange for a 20-year loan at 6 1/2 percent interest. Despite, or because of, these unorthodox financing measures inflation, after reaching a peak of 85 percent in 1923, steadily subsided until the end of the decade, even dipping into the negative range in 1930. The establishment of the Bank of Greece, a genuine central bank, began monetary rehabilitation, helping Greece to experience monetary stability during the decade of the Great Depression.