"If
member states leave the Economic and Monetary Union (i.e. leaving the euro),
what is the best way for the economic process to be managed to provide the
soundest foundation for the future growth and prosperity of the current
membership?"
I realize that this is a rather lengthy posting, however, it is an issue that one way or another will impact all of us. In light of that, let's open
by looking at the debt-to-GDP levels for Europe's Member States to the end of 2011 to put the issue into perspective:
In order to
answer Mr. Bootle's question, we must first look at the economic problems
facing the Member States and how these problems could be tackled by breaking up
the eurozone. Once departed, the former Member State must adopt a new
currency, re-denominate wages and prices and then rely on the world's currency
markets to set the value of the new currency which would most likely result in
a substantial devaluation. Mr. Bootle suggests that there could be more than
one scenario; first, the eurozone could break up because of the departure of one or more
strong economies, second, there could be a division of the eurozone into a "hard" and
"soft" euro and third, there could be the departure of at least one weak country. No
matter which scenario occurs, the countries that remain under the euro umbrella
will find themselves weaker with a less valuable currency, higher inflation and
a weakened banking system.
Mr. Bootle
examines in some detail the scenario where a weak country leaves the euro and
makes the assumption that Greece is the first to leave and that its new
currency is called the drachma. That said, he notes that any of the other
so-called PIIGS debtor nations could also be vulnerable and that any of them
could well be the first nation to leave.
As we know
too well, the biggest problem facing the eurozone is the over-indebtedness of
some Member States which have unsustainably high public and private debt levels
as you could see in the graph above. Many of these nations have costs and
prices that are high relative to other nations in the EU, resulting in a loss
of competitiveness. This results in a shortage of demand which results
in high levels of unemployment which worsens the debt situation.
Unfortunately, austerity through the cutting of deficits alone will not
work because it will result in reduced demand which again, will worsen the
problem. Price deflation will not work since it will increase the real
value of the debt, adding to the nation's debt burden. Basically, it's a
"damned if you do, damned if you don't scenario".
Leaving the
euro and letting the value of a new currency fall (i.e. devaluation) would be a
solution that would result in increased net exports (because the price of the
exports would be more competitive) without increasing the
debt-to-GDP level. That said, history is rife with examples of devaluations
that failed; Argentina in 1955, 1959, 1962 and 1970, Israel in 1971 and Brazil
in 1967. The author suggests that the following devaluations may be
required in new currencies:
Greece and
Portugal - 40 to 50 percent drop in exchange rate
Italy and
Spain - 30 to 40 percent drop in exchange rate
Ireland - 15
to 25 percent drop in exchange rate
The biggest
problem with devaluation lies in the fact that because of the current
multi-state monetary union, the exiting country's debt is denominated in euros
and, if the new currency devalued, the debt problem would worsen, likely
resulting in a default. While this would be quite painful over the
short-term, it may, in reality, be no worse than if the debt transgressing
nation stayed within the euro. Over the long haul, the remaining Member
States may find that their combined economies are stronger with the departure
of their weaker counterparts.
Which
European countries would form the core of the "new euro"? Mr.
Bootle suggests that economically, it is important to retain a core of northern
European countries including Germany, Austria, the Netherlands, Finland and
Belgium and possibly France. The remaining southern European nations
would not form a "southern euro" since they have relatively little
trade with each other, rather, they would develop their own independent
currencies and economic policies. Mr. Bootle notes that it is interesting
to see that nations like Spain, Portugal and Italy are attempting to make it
clear to the world that they are NOT another Greece. So much for
"union"!
The
formation of a "new euro" by the stronger northern Member States
could result in a flight of capital from the weaker, departing southern Member
States. Departure could also result in a run on banks, plummeting asset
values (i.e. real estate), large rises in interest rates on bonds and negative
impacts on consumer and business confidence. These issues would most
likely rise if the departure were planned in secret rather than involving the
public in a democratic decision-making process, however, even if a departure
was well known by the voting public, there is no guarantee that there would not
be mass bank withdrawals for example. Here is a graph showing dropping deposit levels for the PIIGS nations between 2007 and 2012, suggesting
that the problem of a run on banks is far from remote, particularly for Greece
and Ireland who have already suffered from a major drop in bank deposits:
Mr. Bootle
makes the following very interesting suggestion about the departing nation:
"...leave
quickly. Once it has become clear that a country needs to leave the euro-zone,
it should waste no time doing so. Accepting more and more bail-outs before
finally deciding that membership is impossible, then leaving and defaulting,
could be far more damaging than simply leaving immediately. So far, best
practice has certainly not been followed on this front. There is already clear
evidence that the core euro-zone governments are tiring of Greece‘s financial
requirements and would perhaps prefer a speedy exit."
He notes
that the shock of a sudden euro departure announcement is probably less
damaging to a nation's reputation and international standing than the financial
cost of bailouts in a long-winded exit.
With all of
that in mind, here are his seven recommendations for exiting nations:
1.) Honour
official debts (as far as possible).
2.) Pre-warn
other governments.
3.)
Co-ordinate planning with other eurozone and EU Member States.
4.) Stay
within the European Union, even if it is only for the short-term.
5.) Leave
quickly (as noted above).
6.) Stay
within existing EU laws and treaties.
7.) Manage
the media by stressing that the departure was amicable. Basically, even
though we're now estranged from the EU, we're still best of pals.
One of the
issues facing Greece (or whoever) would be printing up a new currency and
establishing a value. Mr. Bootle notes that physical coins and notes are
not as essential to an economy as they once were, however, small transactions
by private citizens are frequently consummated using physical currency.
If new notes and coins are not immediately available, this could be
overcome by using a dual-pricing system where items would be priced in both the
new currency and in euros. The only negative issue with this scheme is
that if the new currency is devalued and people are allowed to pay a lower
price using euros, the system could be drained of euros very quickly since that
would be the preferred means of completing a transaction.
In closing,
let's look at one of the big issues that will face the departing country; the
collapse of the banking sector. As I showed in the graph above, both
Greece and Ireland saw a collapse in the funds on deposit in their domestic
banking system as their debt crises deepened. Right now, the ECB is
providing liquidity to these banks so that they can keep functioning, however,
this may not go on forever. Here's where the author gets into a rather
frightening scenario:
"Accordingly,
it would be advisable to prevent people from withdrawing more money from the
country in the run-up to exit by effectively bottling it up within the domestic
economy. In particular, when the redenomination was announced but before notes
were available, cash machines, or ̳ATMs‘, would need to be shut down. Otherwise, realising that the euro would
become more valuable than the drachma, most Greek residents would attempt to
withdraw as many euros as possible from their bank accounts. The maximum daily
withdrawal at ATMs in Europe is typically around 300 euros. If every Greek
citizen of working age withdrew that amount, this would amount to 2.3bn euros
per day, or a reduction in banks‘ assets of 3.5% per week. In practice, banks
would soon run out of notes."
Mr. Bootle suggests
the imposition of a bank holiday in which all banking transactions were
prevented and all ATMs were shut down. I don't know about you, but I can't
imagine that this would make any citizen of any country very happy and, once
the banks reopen for business, a delayed bank run could still occur.
As you can
see, the issue of a European state divorce is extremely complex. There is
really no way of foreseeing the repercussions of an unprecedented departure
from what appeared to be such a strong economic union just 10 short years ago.
I can remember much discussion about the euro replacing the United States
dollar as the world's reserve currency; no one foresaw the collapse in the
value of one of the world's key currencies and certainly no one was discussing
the demise of Europe as a union.
As Star
Trek's Spock once said "...logic dictates that the needs of the many
outweigh the needs of the few". Apparently, the writers of the Wrath
of Khan were way ahead of their time. Perhaps a European divorce is the
answer to one of the 21st century's great dilemmas even though the impact of such an event is far from clear and the issue
is extremely complex with many unforeseen consequences.
Europeans might find searching for income protection a wise thing to do in such an unstable economy.
ReplyDeleteHow does sequestering the bank deposits of the many assist in their needs, Mr. Spock? Letting the Greeks return to the "good old days" of the Government dishing out favors without the surly Uncle Euro looking over their shoulders wold not appear to be to anyone's benefit. Decades of mismanagement cannot be overcome by separating from the Euro, especially if the goal is to return to that mismanagement. I envision a time when productive people live in North Europe and retire to the Club Med Countries. Kind of like the US where people retire to Arizona and Florida.
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