By Thomas, Rob
Financial Management (UK)
The events of the past four years have cruelly exposed the weaknesses in the design of the euro. But they have also revealed how difficult it is to construct a strategic response that balances the interests of growth and solidarity with the maintenance of appropriate incentives for nation states. Although viewed from Brussels or Frankfurt it may appear that there is no viable alternative to the current policy prescription for countries such as Greece, Portugal and Spain, the economic pain in these countries seems to be pushing them to breaking point and shows no sign of abating.
The remedy of internal devaluation to restore competitiveness, austerity to restore sound public finances, and bank deleveraging to restore the financial system to health, constitutes the most complete deflationary economic policy seen in western Europe since the war. Although the euro has taken surprisingly little of the blame, it seems just a matter of time before the electorates of southern Europe demand expansionary polices that are at odds with membership of the euro.
But to date, exit has only really been discussed as the product of a breakdown in relations between eurozone countries. A soft consensus has developed that if a country were to leave the euro it would have to exit unilaterally and float its new currency. Its government would redenominate contracts and bank deposits into devalued local currency, in what would represent a kind of "confiscation by redenomination". Who knows how far the exchange rate would fall.
This hardly sounds like a compelling alternative. But what if the various actors in this drama came to understand that an agreed exit plan for weak eurozone countries was in everyone's interests? Could Europe find a blueprint for exit that worked for the periphery and for core Europe?
In "How to manage a euro exit", using Greece as an example, I propose a blueprint that could, I believe, be seen as a more rational answer than the current binary alternatives of euro irreversibility or the chaos of a unilateral exit.
Under this proposal all euro-denominated contracts governed by Greek law (loans, wages, rents etc) would convert from the euro to a new drachma on a one-for-one basis. The external value of the drachma would be fixed at two drachma to the euro, supported by the ECB and the Bank of Greece, giving rise to a 50 per cent depreciation (although a smaller depreciation could be selected). Most significantly, deposits in Greek banks would be converted to drachma at a rate of one euro to two drachma, preserving their full value.
Maintaining the value of deposits on redenomination is a crucial feature of this proposal. Since bank deposits are instantly movable at face value, an exit that depreciated deposits would require exchange controls and a surprise announcement (implemented over a weekend) to avoid massive capital flight. The risk of contagion to other peripheral countries would also be huge--deposits would flood out of any other country thought to be at risk of a similar fate on an uncontrollable scale.
Preserving the value of bank deposits would make an exit a practical option by negating the need for a surprise announcement or the introduction of capital controls. Greece could take six months to ready itself for "conversion day", giving it time to print bank notes. The proposal would also remove the risk of capital (deposit) flight from other weak eurozone countries. Indeed, this blueprint would encourage depositors in other peripheral countries to repatriate funds already moved abroad.
Preserving the value of bank deposits is also a recognition that while an exiting government can legitimately redenominate domestic contracts, euro bank deposits are ultimately a claim on the ECB, not on national governments. …