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Meditations on the Eurozone and Secession

February 9, 2015

eurozoneHow, if at all, might the break-up of the Eurozone be accomplished non-catastrophically?

Just a year ago there was an optimistic sense in many quarters that the danger of a break-up of the Eurozone had passed. Thomas McMahon of FE TrustNet was suggesting, for example, that the European Central Bank by its “firm words … on standing behind member states’ debt” had saved the day.

That confidence has ebbed considerably. Near the end of last year, secret letters emerged that revealed that the aforementioned ECB had threatened to pull its emergency liquidity assistance from Ireland’s banks unless Ireland toed the Eurozone line on fiscal matters. The backlash against the disclosure of those letters has done little to lessen the fragility of the politics of the Eurozone.

Held Together by Bailing Wire and Fear

The (quite reasonable) fear, shared even by people who agree that the initial impetus to throw a single-currency blanket over such different economies and cultures was likely unwise, is that breaking up will be even more catastrophic than continuing with the status quo.

Years ago, Floyd Norris of The New York Times said that the euro was designed as the roach motel of currencies. Countries get in, but they can’t get back out.

In our own time the consensus is growing that the ‘hotel’ is an uncomfortable place to be. The attitude is shared in the ‘northern’ and the ‘southern’ countries as well: it is the view of free marketers and social democrats alike. But fear of the impossibility of a clean break keeps them together. One associated challenge is this: is it possible to introduce or re-introduce in a more-or-less orderly way in a seceding country a fiat national currency with a variable exchange rate vis-à-vis the euro and without a coercive conversion of savings?

Presumably (this idea was explored by Andrea Benetton and Tommaso Cabrini in a 2013 essay in The Fielder) a state wanting to secede could declare that a certain portion of its debts are to be paid in the new currency, while other debts or operating expenses will continue to be paid in the euro. New supplier contracts, for example, or new debt issuances, could be paid in the new currency, while euro-incurred debts could continue to the honored in euros. The (hypothetical) country’s ability to pay the new bills in a currency it could, um, print at will would not only ease that burden, it would ease its fiscal burden generally, making a default on its euro obligations less likely.

Currencies Sharing the Same Space

As Benetton and Cabrini acknowledge, this situation would be a very unusual one, bringing into existence “in the same physical space … two economic areas governed by different currencies.” One likely consequence: residents of this half-euro country would presumably make two income-tax payments, one on the income they receive in the new currency, the other on that they receive in the euro.

For any given company acting domestically within the seceding state, choice of currency could be voluntary. Employers for example could offer new employees payment in the new currency or in the euro, and quite possibly there would in time exist a duality of monetary systems even within a given medium-size company as a consequence.

Remember, the whole idea of a transitional currency that would be introduced to pay new debts is built on the premise that the nation-state will then re-acquire one of the abilities it gave up when it adopted the euro, the ability to print money. So: is such a plan a recipe for hyper-inflation? Will those who advance it be met with shouts of “Weimar Germany!,” “Zimbabwe!” etc.? Quite possibly.

But the great check on the inflationary temptation is that the seceding government will naturally want to new currency to succeed. It will want to complete the transition; it will want private employers to offer its currency, not the euro, to their employees (who will then pay their taxes in it): it will want those employees to bargain for it as their means of payment (thus declaring their personal independence from the ECB). Wanting such results, the seceding government would not want to print the new currency into valuelessness.

Not Pretty

In the process, incidentally, it will be restoring arbitrage opportunities that were lost when the various separate currencies disappeared, and creating a brand new arb opportunity in the domestic exchange rate the period of transition would require.

So this might be a non-catastrophic way in which individual states could pull out. But … it wouldn’t be pretty. As usual with the best laid plans of mice and men, it could go “agley.” There is for example the danger that such a plan would be instituted by a government that would not want it to succeed, and that accordingly would not experiences the restraints that implies. A government might announce a transitional secession from the Eurozone, and announce the ‘new’ currency,’ only as a ploy to get it passed a fiscal bump. It could then inflate the new currency at will, so long as it didn’t reach the point of utter worthlessness for, say, a fiscal year or so. At that point, the Machiavellian government could put on a sad face, acknowledge the new currency’s failure, retire it, and return to the euro-only fold.

Okay, let’s call the whole thing off.