An Orderly Withdrawal From the Euro: Like an Orderly Car Crash

During my time on the Treasury desk at KBC Financial Products in London, I was inordinately proud of a synthetic securitization transaction we structured, exotically named Picaros Funding LLP (a Belgian bank, so we named it after a Tintin story, naturally), which not only saved a considerable amount in funding costs but also won Euromoney’s “European Structured Finance Deal of the Year” award for 2005. I dined out on Picaros for quite some time, until the boss pointed out quite rightly, “Remember, you’re only as good as your last deal!” It’s the same for everyone—Fernando Torres moved from Liverpool to Chelsea for a record breaking £50 million ($79.3 million) and then took months before he scored a goal for his new club. His track record at Liverpool counted for nothing during this fallow period.

Crash Test
Crash Test

What is the connection with macroeconomics? Only this: Beware of employing sacred cows who made their reputations, however formidable, in the past when conditions were quite different, in policy making today unless one is prepared to challenge their recommendations whenever these are not necessarily appropriate. In the aftermath of the financial crisis, governments turned to individuals who may have worked in a bank 20 or 30 years before, if they worked in one at all, when looking to draft regulatory responses to the crash. Their responses may not be workable for current times.

Now to the point for this week: is it possible for a euro zone country to undertake an “orderly” withdrawal from the euro ? There is a competition being run currently to find the best solution on how this might be done. It has attracted responses from some well-known individuals of high repute, as well as some more esoteric ones such as the 11-year old Dutch schoolboy whose suggestion is that “Greece should quit the euro, revive the drachma and slap penalties on those who try to avoid holding the new currency.” That is certainly no less coherent a strategy than some of the other suggestions I have seen.

Whether we are considering the views of the Dutch youngster or the more established commentators, this column will ask only one question: if a country announced a withdrawal from the euro, how would it prevent an immediate and catastrophic bank run?

Unless the suggestion is that the government announces an instant conversion from euro to local currency, the minute that it did communicate such intent all depositors would withdraw their soon-to-be heavily devalued funds from local banks and place them elsewhere in the euro zone. That would precipitate a catastrophic banking crash in the home country, with corresponding knock-on effects in the entire euro zone. Perhaps simultaneously with the announcement of withdrawal, the EU will publish an order that withdrawn euros will not be acceptable as liabilities in “foreign” EU banks? It’s possible, if perhaps morally dubious.

The EU is stuck with the current euro membership, and the prospect of fiscal transfers from the north to the south, for many years to come. This is what comes from jumping in to a project without having thought through what many economists, starting with Professor Milton Friedman, had warned about in the 1990s: how does one have sustainable monetary union without political (or fiscal) union? The “Growth and Stability Pact” clearly didn’t cut it, even before the crash. The best lesson one learns from the entire euro project is that one should never get into something like this for political reasons (“ever closer union”) unless one is prepared to pay for it. And EU taxpayers are already paying for it.

The author is Professor Moorad Choudhry, Treasurer, Corporate Banking Division, Royal Bank of Scotland.

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