In an excellent paper pondering how an orderly exit from the euro could be achieved, CASS Business School's Rob Thomas starts from the premise that the euro's problems over the last three years have been caused as much by "the all too apparent failings of the eurozone's political elite as by economic fundamentals". The manic risk on/risk off frenzy that has gripped the markets as they rise and fall by 100 or more points a day in a seemingly random fashion, has made it very difficult for fund managers to do their job of managing client money. These are the people, after all, who, are responsible for seeing that Europe's pension funds have the wherewithal to meet their liabilities to their members.
The turmoil has also, of course, fogged over the markets so that a large number of businesses with plenty of cash on their balance sheets are simply sitting on their hands and shelving project after project while they wait for the view to clear. For all these reasons, Thomas argues, it is imperative for the politicians to get their act together and to come up with a viable solution. He argues that a large part of that solution has to involve finding a way of retrofitting an orderly exit mechanism back onto the euro. It was constructed originally without an exit possibility because the political elite wanted to drive home the point that the euro was here to stay.
Initially, in other words, not having an exit for any country that found the going not to its liking, was a palpable way of saying, tough, we're all in this for the long haul. However, what looked like a good idea at the time has now become a major part of the problem:
"... ironically, the absence of an exit route has increased the uncertainty around the future of the euro, rather than reducing it. Because euro area politicians gave no real thought to this issue, any exit from the euro today could lead to a financial meltdown that would make the aftermath of the Lehman Brothers' bankruptcy look like a storm in a cafe latte."
Thomas argues that the standard thinking on a euro exit is wrong. The standard line is that if a country were to leave the euro it would "have to exit unilaterally to a floating exchange rate and that bank deposits would have to be devalued alongside domestic contracts." The assumption is that this would be disorderly and chaotic. Thomas points out that this is overly pessimistic. The case of Greece demonstrates just how much willingness there is on the part of member states to agree on the big issues, with an orderly exit being right up there with the biggest of issues.
So what is needed then to retrofit an orderly exit mechanism onto the euro? The answer is enough cash to give the exiting economy a "sustainable boost", and a legal framework that gives the maximum amount of legal certainty to all parties while protecting the banking system and insulating foreign creditors as much as possible from the cost of exit. Depositors in the departing country also need protection against "confiscation by depreciation". If the exit is orderly and by agreement then the exiting country would be exiting the euro, not the EU, so capital controls would not come into play.
Thomas envisages a one for one swap between the euro and departing state's currency, as far as all contracts denominated in euros are concerned, with the exit being announced six months in advance to provide for time to mint coins, print notes etc. All euro denominated contracts under EU law would continue to be settled in euros. The difficult bit is that he also wants, to take Greece for an example, for day one to see a 50% depreciation of the home currency as far as external valuations are concerned, with a fixed exchange rate. His hope is that fixing depreciation at the top end of the range (50%) will minimise speculative attacks on the euro peg. Short term interest rates in the departing country would mirror rates in the euro. Currency pegs have, of course, had a very variable history.
To avoid depositors withdrawing their cash in droves, he wants bank deposits to be converted at a two drachmas to one euro rate.
"Greek (in this example) depositors would therefore see their euro denominated account balance switch to drachma on conversion day at 2 drachma for 1 euro. Plus the conversion works both ways, so depositors who get two drachma could convert them back to euros for a small FX fee.
The agreement of the ECB and the rest of the eurozone to explicitly support a fixed exchange rate of 2 new drachma to the euro would be a cornerstone for Greece's post exit monetary framework...as long as this exchange rate was believed to be credible."
There is more along these lines, but it makes for interesting reading. One can only hope that Europe's politicians are digesting this and similar briefing papers as they ponder their glacial but seemingly u unstoppable move to full fiscal integration. Not every country is blessed with the economic circumstances to enable it to thrive inside the euro. Those that are not so blessed should not be condemned to perpetual depression.
Further reading on the eurozone:
- The Tragedy of the Euro, by Philipp Bagus
- Europe and the Euro: A Geopolitical View—An Implausible Currency but the Best Alternative to Naked Conflict? by Marko Papic
- Disinflation and Low Growth versus Inflation and Reasonable Growth by Valentijn van Nieuwenhuijzen
Tags: capital controls , depreciation , EU , euro , euro exit mechanism , European Central Bank , European Monetary Union , eurozone , eurozone exit , financial crisis , Greece , Greek debt , sovereign debt , Spain , UK