As Voltaire remarked in his 1759 masterpiece Candide “in this country (Britain) it is good to kill, from time to time, an admiral to encourage the others.” Admiral John Byng, shot in 1757 for losing Minorca, is generally thought to have been unfortunate in his fate. Nevertheless the treatment worked. Only two years later Sir Edward Hawke swung the fate of empires at the Battle of Quiberon Bay, arguably a more important British naval victory than Trafalgar since it prevented France from any serious attempt to recapture Canada. The same principle is applicable in the EU financial crisis today: if the EU wishes to make the euro work, it must demonstrate that the fiscal rules of euro membership have teeth. Greece seems an ideal candidate for the role of Byng.

When you compare Byng and Greece, the admiral did rather less to deserve his fate. The son of Admiral Sir George Byng, first Viscount Torrington and victor of the 1718 Battle of Cape Passaro, Byng had a gilded naval career almost entirely in peacetime, occupying the more comfortable naval commands and rising smoothly on the basis of his connections. He avoided serious action in the War of the Austrian Succession (1739-48) being Governor of Newfoundland, and became MP for Rochester in 1751. He was then unlucky enough to be appointed commander of the Mediterranean Fleet when war broke out again in 1756. At the Battle of Minorca he failed to engage the French fleet closely enough and retreated to Gibraltar after a modest and inconclusive battle, resulting in the island falling to a French invasion three weeks later.

British naval history has had a number of worse admirals than Byng – one thinks of Thomas Graves, who allowed the French fleet to take control of Chesapeake Bay in 1781, James Gambier, who lost the battle of the Basque Roads to the pathetic post-Trafalgar remnants of the French fleet in 1809 and Sir George Tryon, who in 1893 while running at full speed, turned his flagship HMS Victoria in the wrong direction, collided with his second in command’s vessel and sank with the loss of 358 lives including his own. Nevertheless in 1756-7 both the public and George II were appalled by the sloppiness of the peacetime navy and wanted a sacrifice. “The House of Commons, Sir, is inclined to mercy,” said William Pitt (the Elder), recently appointed first minister. “You have taught me to look for the sense of my people elsewhere than in the House of Commons,” responded the King.

Byng and the modern Greek economy shared a pampered quality that was bound to get them in trouble if things got rough. However, whereas Byng was merely effete and indecisive, Greece since it joined the EU in 1981 has been thoroughly corrupt and economically misgoverned by any reasonable standard. Andreas Papandreou, the current prime minister’s father who led Greece for the first decade after joining the EU, was a uniquely unpleasant combination of corruption and academic leftism (he had chaired the Economics Department at Berkeley.) Instead of steering the Greek economy to reap the enormous potential benefits of its premature EU membership, the internationally sophisticated Papandreou manipulated the EU system of slush funds so as to keep a gigantic stream of resources flowing to the bloated Greek public sector. The result was an economy focused almost entirely on the public sector and tourism (which also benefited from innumerable EU grants) with the populace enjoying living standards far in excess of their ability to pay their way.

Greece joined the euro in 2001 based on false statistics, its debt total manipulated by an extremely expensive deal arranged by the ineffable Goldman Sachs. Once a euro member, it took no notice of the “Maastricht Treaty” strictures against excessive public sector deficits, other than to falsify its figures for a number of years in order to avoid excessive criticism which might have blocked the flow of slush funds.

The result of all this was to give Greeks as a whole, and particularly the Greek public sector, living standards hugely in excess of those justified by their productivity. By 2008, Greek GDP per capita, based on purchasing power parity, was a staggering $32,000. That was almost level with the EU average ($33,600), not much below Germany ($34,800), above Italy ($31,000) and South Korea ($26,000) and far above Portugal ($22,000) which in reality had productivity well ahead of Greece. By sucking in borrowing and massive EU grants Greece had distorted its economy as much as the former East Germany, which in 1989 was reckoned by the Economist to be richer than Britain. In productivity Greece’s real comparables were its neighbors Bulgaria (GDP per capita $12,900) and Macedonia (GDP per capita $9,000). While Bulgaria and Macedonia had suffered under a communist dictatorship and a social-ownership dictatorship respectively, by now, 20 years after their liberation, both countries have decent governments and economies more market-oriented, with more productive businesses, than a Greece that willingly succumbed to 30 years of Papandreouism.

Because of the size of the required adjustment and the misconceptions of its people, Greece is now quite unable to remain within the euro and converge its productivity to its living standards. Latvia managed to adjust its living standards successfully (it was not a euro member, but the lats was fixed against the euro), but the required adjustment was much less and the Latvian people were less pampered and much more disciplined. Even in this deep recession, Greece runs a substantial current account deficit, while its budget deficit in 2011 is almost 10% of GDP in spite of alleged massive and painful austerity measures.

At this point the incentives are all wrong. Greece cannot solve its own problems, so its best hope is to get massive “loans” from the EU and the IMF, while reforming as little as possible. Privatization, touted by the EU as a potential partial solution, is not going to work because the Greek public sector is so featherbedded and unproductive that its assets are worth very little. Thus Greek public sector workers throw paving stones, the Greek government produces “reform” programs that do as little as it can get away with and pressure is continually put on the EU, the European Central Bank and the IMF to find more money from somewhere.

Not only does this make no progress towards reform in Greece, it produces perverse incentives in the other weaker euro members that make the currency’s position increasingly precarious. While Portugal and Ireland have thrown out the governments that caused most of the trouble, in Italy and Spain it is becoming increasingly clear to the populace that the best way to maintain their living standards, especially in the public sector, is to reform as little as possible, thereby gaining access to cheap public sector funding from the EU, the ECB and the IMF rather than relying on the expensive and doubtfully available free market.

In other words, just as was the case for the admirals of 1756, the weaker sisters of the EU need a little “encouragement” to convince them that reining in their public sectors and reforming their economies is truly in their interests. As George II was well aware, this can best be achieved by making an example of an unlucky backslider.

One cannot shoot a country, or even an economy, but the EU can achieve the required effect by compulsorily drachmaizing the Greek economy (if necessary, by refusing to lend any more money, to accept euro payments from Greek banks, or to deliver any further euro currency within Greece’s borders.) This can be done quite quickly; the new currency can be printed by an international security printer in a few weeks, and the exchange can be mandated over a weekend. The process would be very similar to the “pesoification” of the Argentine economy in December 2001. For a temporary period, Greeks would be placed in the same position as Bulgarians and Romanians, without full rights of movement in the EU. To keep the Greek banks solvent, their euro deposits would be converted compulsorily into new drachmas. The Greek government might also find it needed exchange controls in the short term as no new international funding would be available.

Following the conversion, the drachma would probably drop to about one quarter of its previous value, as did the Argentine peso in 2002. This would not reduce Greek living standards by three quarters, but by about half – Mercedes in Athens would become four times as expensive, but haircuts and moussaka would not. Greece would then need to renegotiate its international debt, involving a substantial write-down of principal. Greek banks would be insolvent, but could be recapitalized with new drachmas by the government, while foreign banks which suffered losses on Greek paper could be bailed out by their own governments if that was mistakenly thought desirable.

With wage costs at one quarter of their previous level, around those of Bulgaria and Macedonia, Greece would now be able to export successfully, and within a year or two its payments deficit would become a surplus. At that point, the future would be in the hands of the Greek people. If they continued to elect Papandreouists, expanded their public sector and presented a surly attitude to foreign tourists and investors, they would stay poor. Their lives would be much less comfortable than those of the post-2003 Argentines, because unlike Argentina Greece has few natural resources. If on the other hand Greece developed its now bargain-priced tourism on a free market basis, cut back its overgrown government and remained a haven for shipping services, then from their new lower level the Greeks’ living standards would rapidly improve, this time on a sound unsubsidized basis.

Either way, EU subsidies should be cut off altogether, to keep the Greek government honest and assist in repaying EU taxpayers for the costs of the bailouts followed by default. If Greece foolishly wished to leave the EU because of the new austerity, it should be free to do so.

For the rest of the eurozone’s weak sisters, and their inhabitants, the Greek example would be salutary. They would see that the cost of misbehavior is truly gigantic, and is imposed by a cruel world rather than by politicians who can be badgered for more loans and subsidies. Instead of a formula to which lip-service is paid, the Maastricht Criteria on budgets and debt, or even tighter restrictions, would be taken as genuine constraints. Since the consequences of failure would now be visible, weak sister politicians would no longer have the incentive to continue wasteful spending and subsidies, fudge the figures, beg for funding from international lenders and engage in anti-market demagoguery. Instead, they would have to take steps to slim down the weak sisters’ public sectors, reform their labor laws and improve their education and training systems. Thereby their economies would once more become productive members of the euro area.

With austerity being engaged in voluntarily by its weaker members, the euro itself would be immensely strengthened, without any need for draconian, undemocratic and intrusive centralized budget rules (which in any case, would themselves have very little political legitimacy, thus leading to endless cheating and political back-scratching.)

The Greeks, having again and again democratically voted for a system of excessive borrowing and looting from EU taxpayers, will have less justification than Admiral Byng to complain of their treatment. In any case, after it they will not be dead – just compelled to live on what they can actually produce.

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(The Bear’s Lair is a weekly column that is intended to appear each Monday, an appropriately gloomy day of the week. Its rationale is that the proportion of “sell” recommendations put out by Wall Street houses remains far below that of “buy” recommendations. Accordingly, investors have an excess of positive information and very little negative information. The column thus takes the ursine view of life and the market, in the hope that it may be usefully different from what investors see elsewhere.)