How to Leave the Euro: A Guide (Part I)
Senior Editor, CNBC.com
Step 2: Plan for Redenomination and Devaluation
Leaving the euro will not just mean replacing domestic euros with Drachmas. While “going local” at parity with the euro would create some room for central bank quantitative easing , that almost certainly will not be enough.
Almost all domestic wages, prices and contracts will need to be redenominated into the new currency as a matter of law. That new currency will have to have its exchange value with the euro dramatically depreciated.
“It has to be both of these,” Bootle explains. “There can‘t be devaluation alone because the euro can‘t be devalued against itself, and a mere redenomination into a new currency would achieve nothing. It would be like measuring the distance from Paris to Berlin in miles rather than kilometers. The numbers would be different but there would be no change in the spatial relationship between the two places.”
A Secret Plan?
Step 3: A Secret Plan?
You are going to want to keep your plan secret for as long as possible. At least in theory, it would be best to have your plans to leave the euro shared with as few individuals as practically possible.
“Almost all emerging market devaluations were 'surprise' devaluations, and there is no reason to believe that any exit from the euro would not be a surprise as well,” writes Jonathan Tepper, the author of the bestseller “Endgame: The End of the Debt Supercycle,” whose own Wolfson prize entryruns through a number of historical examples currency conversions and devaluations.
If your plans to exit the monetary union become known early, you risk triggering a massive capital flight by both foreign and domestic investors. Bank runs, threatening what’s left of financial stability, will likely occur. Asset prices will fall; bonds yields may soar.
The problem is that europe is awash in rumors and leaks. Coalition parliamentary governments require information sharing at a much broader scale than a country with a unitary party or strong executive can get away with. There are just too many people who must be consulted and cajoled to go along with the plan to keep anything this important secret for very long.
South Sudan managed to secretly print currency for six months before declaring its independence in July 2011. This probably is not an option for any European country considering exiting the European Monetary Union. Once the printing presses are fired up, you have to assume that word will leak out.
Step 4: Act quickly.
Because secrecy probably isn’t an option, several measures will have to be taken relatively swiftly. First, you’ll have to implement capital controls to stem the flow of money out of the country. Second, you’ll have to prepare the banking system to stem a run on the banks. Third, be prepared for unanticipated chaos the will accompany the sudden repricing of assets and wages.
Many of those who have looked at a possible exit agree that you may have to move over a weekend. The takeaway: get it done over a weekend.
“Convene a special session of Parliament on a Saturday, passing a law governing all the particular details of exit: currency stamping, demonetization of old notes, capital controls, redenomination of debts, etc. These new provisions would all take effect over the weekend,” Tepper writes.
Capital controls almost certainly violate your EU treaty obligations. After all, the free movement of people, goods and capital is at the heart of the idea of the union. Fortunately, there is an emergency provision that may allow you to legally impose controls.
“There is a provision (Article 59) which might allow the temporary imposition of capital controls for a period not exceeding six months, if approved by the Commission and the ECBand agreed by a qualified majority of states,” Bootle explains.
Bootle argues that getting approval might not be as impossible as you might think. Your fellow EU countries are worried about their own exposure to your financial system. They don’t want a disorderly collapse of the banks that would accompany a bank run in your country. What’s more, the capital in-flight could be destabilizing to their financial system and national economies.
The best path may be to implement controls first, ask for permission later. Once you’ve put on the controls, it will become harder to deny plans to change the currency. Everyone will know what this means. So you cannot afford to drawn-out negotiation with other euro-members before you close off the avenue of capital exit.
It’s also important that you are prepared to immediately announce which contractual arrangements will be redenominated into the new currency. For contracts governed by local law, this should be relatively straight-forward. You simply announce that amounts once payable in euros are now payable in Drachmas at the appropriate conversion rate.
Contracts payable outside of Greece and to foreigners are more complex. It will be impossible for the country to unilaterally declare that these are now payable in the new currency at the new conversion rate without triggering a default on many of the obligations. Courts may attempt to enforce EU treaty obligations, which would mean that a country seeking to unilaterally change the terms of contracts would face the possibility of being forced out of the European Union altogether.
But don’t rule out EU cooperation here either. Even if a country is going to leave the currency union, other EU member-states may have incentives to agree to measures that could keep the broader union together. Avoiding a disruption in international trade is no doubt important to exporter states such as Germany, who don’t want to see their businesses shut out of markets. So it’s always possible that the currency exit includes a global agreement about what happens to foreign law contracts, including which ones will be redenominated and what the exchange rate will be.
Bootle recommends that an exiting country work closely with other countries prior to the exit, honor its official-sector debt commitments, attempt to avoid violating relevant international law and EU treaty obligations, and maintain a “friendly” public stance toward other nations.
It’s not clear, however, that this will be possible. There is a lot of animus in Greece about the Germans and vice-versa. If Greek leftists, in particular, triumph in the upcoming elections, it may not be possible for the leadership of the countries to agree to exchange rates and contractual currency conversions.
These are not just problems faced by the official sector. Private businesses engaged in international trade will face serious challenges. Let’s say an exporter of olives has a contract to ship 1000 cases of olives for 100,000 euros to an Italian merchant. After a currency conversation, does the Italian pay in euros or Drachma? Clearly, the Italian business would prefer to pay in devalued Drachma while the Greek olive-grower would want euros. There will be a lot of litigation surrounding these kinds of disputes.
In short, expect lots of confusion and disruption when the currency change is announced.
Follow John on Twitter.