A How-To Manual for an Amicable EZ Divorce

A How-To Manual for an Amicable EZ Divorce
By Arnab Das
“If member states leave the Economic and Monetary Union, 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
Table of Contents
Chapter 1—Negotiation Phase: The Political-Economy of an Amicable Divorce
Chapter 2—The Legislative Phase: Contracts, Jurisdictions
Chapter 3—Implementation Phase: Macroeconomic Management of EZ Exits
Chapter 4—Managing the Financial System
Chapter 5—Capital Markets
Chapter 6—The Real Economy
Chapter 7—Lessons of the Past for Those Who Make EZ History
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Chapter I—Negotiation Phase: The Political-Economy of an Amicable Divorce
Chapter I—Negotiation Phase: The Political-Economy of an Amicable Divorce
We explain why the inevitable divorce needs to be amicable, which partners should stay and which should
go, and how to negotiate an amicable divorce. A minimum of five distressed members of the eurozone (EZ)
periphery—Portugal, Ireland, Italy, Greece and Spain—should negotiate a cooperative exit with bridge
financing and retain the EU customs union, to restore the viability of exiting and continuing member states.
I. Divorce Is Inevitable; Amicable Divorce Is Crucial
The aftermath of the Global Crash of 2008 highlighted unsustainable intra-EZ macroeconomic imbalances.
Subsequent crisis management has revealed that the EZ not only lacks key features of monetary unions that
have withstood the test of time, but also the political will to establish them. Reform plans, even if
implemented, are not transformational and may actually render EMU even less resilient to asymmetric
regional or sectoral shocks, given the absence of a major fiscal overhaul for the pooling of public-sector assets
and receivables, as well as liabilities, complete with the possibility of fiscal transfers; far greater labour
mobility—including greater harmonization and portability of social safety nets across national borders, wage
flexibility and far lower barriers to entry and exit from the labour market; and breaking down national barriers
to changes in corporate control, as well as far greater harmonization of business operating conditions, to
encourage direct investment. Such changes are extremely unlikely to be agreed fast enough to restore
confidence that the EZ periphery can thrive within EMU. Therefore, the exit of several countries is inevitable
and must be properly managed. Our plan for an amicable divorce from the euro and the EZ currency union to
a mix of freely floating, newly recreated national currencies and a rump euro has three key overarching
objectives, which in combination aim to maximise the future prosperity of the current membership:
Ensuring the short- and long-term viability of exiting countries. Foundations for balanced,
sustainable growth in the long run must be laid in exiting countries, as well as stabilizing public debt,
the financial system and the overall economy in the near term. Restoring monetary/currency and
fiscal sovereignty and thereby the capacity for counter-cyclical policies is essential to manage the
current crisis. Political reality must be balanced with the imperatives of financial and economic
stability. For countries with rigid labour markets, generous welfare states and heavy automatic fiscal
stabilizers, a flexible currency can be a useful shock-absorber.
Ensuring the long-term viability of the rump euro, without which speculative attacks and selffulfilling runs would resume (perhaps immediately), undermining the stability of both exiting and
continuing countries, the wider EU, the global economy and financial markets. For the long run, the
rump EZ must also be seen as more durable than today’s EZ. The internal inconsistency of a single
money and distinct national sovereignties, politics and fiscal, structural and incomes policies among
continuing member states must not become an existential threat, as it has become with the EZ-17.
Maintaining free trade, in particular the EU customs union, without which the lost benefits of trade
integration and high risk of protectionism would be destructive throughout Europe and the wider
world economy. For exiting countries, free trade is essential for exploiting an eventually more
competitive exchange rate for better balanced growth and to repay external debt; for continuing
A note on terminology: We use Economic and Monetary Union (EMU) to refer to the conceptual basis of the eurozone (EZ) as currently
configured or with planned reforms; eurozone (EZ) to the current membership; rump EZ to refer continuing countries; rump ECB to a
slimmed-down version of the current ECB; national central bank (NCB) to central banks of current, continuing and exiting member states;
rump euro to the new euro; EZ periphery collectively to distressed member states Portugal, Ireland, Italy, Greece and Spain; troika to the
European Commission, ECB and IMF; program countries to countries with a troika support program, currently Portugal, Ireland, Greece.
Optimal currency area (OCA) caveat: We acknowledge the academic controversy over the validity and applicability of OCA concepts to
the real world, and take due note of various strands in the academic literature that prioritize political commitment over purely economic
considerations in sustaining currency unions. But we recognize that the body politic of the EZ lacks the political cohesion to sustain EMU as
currently configured, and therefore couch our efforts to transform the EZ and replace EMU with a politically viable construct.
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countries, continued free trade is the flip side of the coin—they are more likely to be repaid, and to
have more stable, viable trading and investment partners in the longer run.
EZ member states share an interest in an amicable divorce, because the debt crisis facing the periphery
represents a bank capital shortfall and fiscal liability for the EZ core, because it is increasingly clear that their
joint interest in a debt workout and return to growth within the confines of EMU is unachievable. It is
increasingly clear that the current approach to solving the debt crisis is self-defeating (about which more
later); nor can more resources be put on the table as the debt crisis worsens because of domestic political
constraints in both creditor and debtor countries—despite much-ballyhooed insistence that the EZ leadership
will do anything to save the euro. The extreme difficulty of coordination to maintain, let alone deepen, the
existing EZ Economic and Monetary Union, points to the even graver downside risks of disorderly defaults or
eventually disorderly exits or dissolution.
To get to grips with the crisis once and for all, EZ leaders must recognize the basic principles of debt crises:
A national or systemic, balance-of-payments and cross-border debt crisis almost always becomes a
currency crisis—and most involve maxi-devaluation (over 25% nominal and substantial real
depreciation within six months as part and parcel of a rapid external adjustment in the subsequent
one-two years) and/or exchange rate regime change. Such a typical crisis in this case would lead to
national bankruptcies across the EZ periphery; the cascading defaults would create a far worse
financial collapse and credit crunch than during the Great Crash of 2008, virtually ensuring that the
aftermath of the Great Recession would be a Great Depression 2.0.
Democracies almost always turn inward rather than outward to step-up cooperation in serious
national, regional or global crises, given the force of popular pressure to husband scarce and
dwindling domestic resources for domestic consumption and welfare. In this case, the pressure for
fiscal control by creditors of debtors, under the aegis of EU or EZ institutions and the IMF, represents
a far greater violation of national sovereignties among putative partners and equals that threatens to
tear apart the fabric of EU solidarity.
The macroeconomic management of an orderly EZ dissolution therefore requires re-alignment of creditor- and
debtor-country national interests to induce cooperation, before the politics worsens to the point where the
already low hopes of orderly resolution become infinitesimal.
II. The Policy Strategy in Brief: A New Monetary Framework for the Rump ECB and Exiting-Country NCBs
We propose a two-stage strategy for returning monetary sovereignty to exiting EZ member-states:
Transition the hardest fixed exchange rate system to a temporary exchange rate-targeting system.
This transitional state would consist of FX trading bands that are widened stepwise from a fixed parity
of 1:1 to +/-2.5%; then +/-5%; then +/10%; then +/-15%, and ultimately a free float. The trading band
would be widened not on a timetable, but on a state-contingent basis, as and when expectations for
inflation and the exchange rate have stabilized and reverted to an acceptable “new normal.” Support
for the exchange rate target bands would come from the rump ECB, which would sell euros at the
floor of the band, discouraging the spot FX rate from hitting the floor. Conversely, the exiting country
national central banks (NCBs) would be willing to buy euros at the ceiling of the band in the far less
likely event of excess demand for new local currencies.
Transform exchange rate targeting to inflation targeting and freely floating exchange rates between
the rump euro and new national currencies, with fully independent exiting NCBs. When inflation
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expectations have decoupled from the exchange rate, as indicated by market measures such as realnominal bond spreads and FX forward markets, the exchange rate could be fully floated.
Ultimately, of course, a real devaluation is desirable and necessary, but rapid, destabilizing currency
collapses are typical of shifts from fixed to floating exchange rates under pressure, with inadequate FX
reserves. In such regime changes under the pressure of large imbalances and inadequate reserves, the collapse
is exacerbated by the enormous balance sheet mismatches, which are transformed from latent credit risk to a
combination of credit and currency risk, often along with convertibility and transfer risk. The trick is to
gradually exit to avoid a jump move in the exchange rate and the associated balance sheet effects.
Herein lies the shared interest and the solution to the lack of FX reserves and credibility of exiting countries:
Both partners, EZ creditors and debtors—continuing and exiting countries—have an innate interest in seeing
their debtor client states return to growth and stability in order to be more capable of repaying their debt
and being responsible trading and investment partners in the long run. Along the way, the trading and
investment partners aiming to continue their relationship as members of a customs union, but no longer
wedded in a monetary union, will want to avoid shutting down borders to trade and capital flows—even
though they will retain such an option as a temporary expedient.
To ensure an orderly transition from a fixed exchange rate through a discretionary exchange rate-targeting
system finally to a freely floating exchange rate with inflation targeting, there would have to be a credible
commitment to unlimited intervention on either side of the band. This commitment is a part and parcel of
exchange rate targeting, just as the provision of unlimited liquidity at any given interest rate is the basis of a
monetary policy framework with an interest rate target; or a quantity target implies allowing the price of
money to adjust freely. The lack of reserves would not be a constraint in this case, since the rump ECB can
create unlimited euros at will to intervene at the floor of the band; and the exiting-country NCB unlimited new
local currency to intervene at the ceiling. In this case, the policy and political commitment would be the key to
success, rather than the quantity of available FX reserves or the capacity to borrow reserves from the IMF.
Creditor countries have an interest in being repaid by public or private debtors as fully as possible. It will
therefore be in their interest to support the exchange rate-targeting framework once it is agreed.
We deal in Chapter 3 with the specifics of macroeconomic and financial management under this exchange rate
targeting. The political-economy, the incentives and the precedents for this policy change concern us here.
Prior domestication of as many international assets and liabilities of exiting countries as practicable during the
negotiation phase and before the transitional phase to exchange rate targeting will help mitigate the amount
of money creation and thereby the risk of rising inflation and loss of credibility in the rump ECB and the core.
III. Ensuring the Viability of the Exit Strategy and the Rump Euro/Rump ECB
Market participants and the general public may not believe that the rump ECB would create as many euros
as the market might demand at the floor of the band, but precedents exist for currency support by national
central banks in managing exchange rate regime changes, and preventing disorderly currency collapses.
During the classical gold standard, there were gold loans by creditor countries to debtor countries because of
their shared interest in avoiding a disorderly collapse of the financial system and exchange rate. Clearly, in an
era of modern democracies with universal suffrage, it has proven harder to generate political support for such
actions, even if they take the form of loans rather than transfers, than when political influence was
concentrated among relatively few property rentiers and titans of financial and industrial capitalism.
However, there have also been modern, cooperative exchange rate management strategies. The Bretton
Woods Treaty of fixed but adjustable exchange rates could not be sustained when the domestic economic and
political objectives the United States came into conflict with her international obligations during and after the
Barry Eichengreen makes these points cogently in A History of the International Monetary System.
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Vietnam War, leading to the abrogation of the Treaty; the same could be said of her partners and creditors in
this gold-dollar exchange standard, who lost control of domestic base money and inflation rates. But the
Louvre and Plaza Accords were achieved to facilitate economic adjustment, while mitigating the real economic
and financial effects of exchange rate misalignments.
Policy responses to prior European currency crises offer an important precedent that demonstrates the
willingness to cooperate in smoothing or preventing exits. Within Europe itself, when the ERM-I crisis
(Exchange Rate Mechanism of the European Monetary System—EMS) struck in 1992-93, Germany helped
France to avoid the severe currency pressures under a speculative attack. Notably, several let us call them noncore EMS members fell out of the ERM and devalued—the United Kingdom, Sweden, Italy, Spain among the
major ones. Portugal, Ireland, and Denmark also faced severe pressures and devalued.
This episode offers key precedents for our orderly, amicable divorce proposal, which should be discussed by
leading policy makers and politicians with the media, financial economists and market participants, once the
exit strategy has been announced and implementation begun, to signal credibility and commitment:
First and foremost, Germany and the Deutsche Bundesbank have in the past provided currency
support for reasons of political-economy when there were severe exchange rate pressures; in
particular, Germany was willing and able to support the core Franco-German axis of European
integration, even when the self-directed defence by other countries was failing or had already failed.
Second, this episode not only drew a dividing line between France, which Germany did support, and
other countries, which had to exit ERM-I; it also created fault lines within the EU, as three ERM
exiters opted out of EMU, and today’s EZ, and as five more are now under strain within EMU.
Among the countries that exited ERM-I, the United Kingdom, Denmark and Sweden have not joined
EMU; the first two negotiated a derogation giving them a permanent opt-out; and the third is
avoiding the EZ simply by not satisfying the entry criteria. Among those that did exit ERM-I yet did
enter EMU are the countries now in distress with excessive imbalances at risk of exit once again.
Last but not least, while Germany was unwilling and/or unable to support non-core EMS members,
this does not signal that it would not do so this time around vis-à-vis our amicable divorce plan.
Germany would be an even more important member in the rump ECB than it is in the current
construct, so its active engagement is a sine qua non for our plan. Its political and economic incentives
are far greater this time around than at the time of the ERM-I crisis. The claims of creditor countries
led by Germany are far greater than ever before; smoothing the exit would help mitigate the credit
and currency losses compared with both a disorderly exit or to the risk of cascading defaults within
the monetary union under the self-defeating approach now in play. Furthermore, a significant
German and rump ECB monetary commitment to sustaining the European project in a post-EZ 1.0
world would make EZ 2.0 and the EU far more robust and better balanced, while avoiding the political
morass of fiscal transfers and bank recapitalizations.
Direct fiscal support would be financed by redirecting already allocated or planned official resources and
borrowing capacity from supporting a futile “Plan A” of fiscal and structural adjustment that is exacerbating
the downturn, to bridge the transition. Such a redirection would quickly help restore market confidence in the
viability of the distressed country, the rump EZ and the EU as a whole; it would therefore significantly ease the
funding constraints that have hamstrung the European Financial Stability Facility (EFSF) by making a virtue of
the implicit caveat that EZ exits might impair its credit standing. These resources include the EFSF (€250 billion
of remaining firepower); the European Stability Mechanism (ESM—€80 billion of capital with the potential for
€500 billion of usable resources via leverage); and the IMF, with potentially an additional US$600 billion of
usable resources. The three program countries may not regain market access for some years, perhaps the
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duration of the gradual release of the exchange rate or pending adequate external adjustment once the real
exchange rate has depreciated. Therefore, the program countries will need immediate bridge financing as well
as public debt restructuring to avoid excessive monetization that conflicts with the gradual exchange rate
release strategy. Spain and Italy could lose market access, though they are in a far better position to maintain
primary surpluses and achieve debt rollovers with continued rump ECB liquidity support for their exchange
rates and of the newly free NCBs to provide liquidity to domestic banks.
Following the exit of several of its members, it will be essential to defend under any and all circumstances
the lines that have been drawn—both the gradual release of the exchange rate valve for exiting countries,
and the integrity of the slimmed-down rump EZ. Following the exit of the five members, the market will
instantly look towards the new weakest link. Hence, it will be important to clarify and demonstrate that all
continuing countries will remain permanent members—all the more so because our amicable-divorce exit
strategy could in principle be re-opened in future. Given that the members of the EZ 2.0 are much more alike
with regards to economic characteristics, this would be a major opportunity to take steps towards a fiscal
union. Germany would be more open to a fully fledged fiscal union accompanied by steps towards shared
liabilities—Eurobonds as the ultimate demonstration of the irrevocability of EMU 2.0 and tougher fiscal rules
with partners that are more homogenous—because that would help facilitate economic and fiscal
coordination and integration. That said, of course, Germany and all other creditor countries would want to
know for sure that all rump EZ members are subject to hard budget constraints; fiscal liability pooling,
Germany has signalled, will come only after deeper integration and probably thereby pooling fiscal receipts
and greater economic harmonization.
IV: How to Decide Who Should Stay or Go
Our amicable divorce proposal on how to manage a break-up of the EZ in an orderly fashion can be applied
to any number of countries exiting in principle, but in practice, we exclude a single exit and a full dissolution
(i.e. 17 exits). We rule out a single exit because of the high risk of contagion. In addition, we do not think that a
complete dissolution of the monetary union will maximize overall welfare and prosperity; there are clearly
trade and investment benefits to be gained or retained by avoiding the reintroduction of transaction costs and
a lack of price transparency across borders in the new rump EZ.
In our view, ideally five countries—Portugal, Ireland, Italy, Greece and Spain—should exit to ensure their
own viability as well as the stability and durability of the EZ 2.0. Countries with a competitiveness problem,
large deficits and poor growth prospects need to exit so as to avoid a decade of painful structural adjustment
and anaemic growth, by regaining control of monetary policy to achieve a more rapid real devaluation led by
the nominal exchange rate. The rump EZ would benefit from a slimmed-down membership with fewer
fundamental imbalances. Debtors would be in a better position to repay by rebalancing to export-led growth
through a weaker currency, instead of deflating and aggravating their real debt burden. Creditors would be
repaid more if erstwhile client states could boost exports. Above all, a flexible currency regime would offset
structural rigidities in the EZ periphery, helping to prevent the re-emergence of excessive intra-EZ imbalances.
A single-country or few-countries exit scenario would not restore stability for the exiting countries or rump
EZ under any policy strategy—other than substantial debt forgiveness, major offsetting structural reforms
and inflation/deflation processes in the EZ core and periphery. And that in turn would require enormous
resource transfers from creditor to debtor countries, the difficulty of achieving which is the core of the
existential crisis. Presentiments of this risk have already contributed contagion to the solvency and liquidity
risks facing Spain and Italy, on occasions when Greece in particular seemed to be under threat of expulsion or
secession (as when Chancellor Merkel and President Sarkozy hinted that Greece might have to go, after former
Prime Minister Papandreou of Greece tabled a referendum on EZ membership). Nor would an exit by the three
Refer to Chapter 7—Historical Comparisons
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program countries that have already lost market access—Portugal, Ireland and Greece—suffice to restore the
economic and financial stability of a rump EZ that still included Spain and Italy. A widely held view is that Spain
and Italy are fundamentally solvent, but illiquid due to dysfunctions in the EZ banking system. However, their
national solvency is far from assured if they remain within the EZ.
We take it as given that the three program countries—Portugal, Ireland and Greece—should and shall exit.
The evidence on Greece is clear and speaks volumes for itself, given the classic debt trap in which
Greece finds herself, chasing fiscal deficit targets as economic activity spirals down.
Portugal is heading in a similar direction after a decade of stagnation since joining EMU; the market is
starting to price in a restructuring and/or the exit of Portugal from EMU at this writing.
Ireland seems to have a fighting chance of sustaining its external adjustment, having shifted to
current-account surplus thanks to a brutal wage adjustment. However, this has been achieved at a
time when the rest of the EZ is growing, demanding Ireland’s relatively high value added exports,
which in turn reflects its attraction to multinationals from outside the EZ, thanks to an exceedingly
low corporate tax rate of 12.5%. Despite its current-account reversal, Ireland faces an excessive
burden of public debt, resulting from the takeover of bank liabilities and nationalization of much of
the banking system. Ireland is the case par excellence of a country that was bankrupted by the
financial crisis. It began the crisis with only 15% of GDP in public debt, but one-off bailout costs and
liabilities as well as automatic stabilizers multiplied that eight-fold within just two years, closing off
market access.
Spain may seem viable within the EZ, but it faces severe actual and prospective challenges that call for exit.
Spain has an excessive external debt burden of over 80% of GDP, a graver threat to national solvency than its
relatively modest explicit public debt of 75% of GDP (by RGE’s reckoning, Figure 1). However, the public debt,
although it appears generally stable, is exposed to significant underlying pressures. These include
unrecognized contingent liabilities in the financial sector, especially regional banks, which continue to be
understated in our view. One-off recapitalization costs range from €60 billion-€160 billion by our estimate—
absent disorderly developments elsewhere in the EZ periphery. Dynamic provisioning and close supervision
and regulation prevented its banks from suffering the worst onslaught of the 2008 Global Crash. Despite all
that and the fact that Spain has close to zero population growth and plenty of land, it still experienced one of
the most extreme housing bubbles in the world, with an increase of about 300% in house prices. Today, the
cajas and other domestic facing banks are marking their books and foreclosed properties at some 10-15%
down from the peak as per the official real estate indices; but actual transactions are taking place at some 4050% below the peak. Even if the banking system is able to earn its way back to recapitalization—though it is
hard to see how if real interest rates on public debt are to fall and private credit extension is to contract, as
they should—external, fiscal and structural adjustment imply continued pressure on labour markets and
activity. With unemployment above 22% and youth unemployment stratospheric, approaching 50%, it is very
difficult to see Spain pulling itself up by its bootstraps and booming again anytime soon.
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Figure 1: Spain Government Debt Projections (as % of GDP)
MoF Debt Projections
RGE Debt Projections
Source: MoF, RGE
Italy should also exit. Italy has far less external debt than Spain, but far more public debt, at 120% of GDP
(Figure 2). Plus, some 40% the public debt is estimated to be held abroad, the current account has
deteriorated since the Great Recession, from 3.3% of GDP in 2010 to 3.5% in 2011, taking external debt to
115% of GDP—at a time of weak domestic demand growth. Thus, the path is well-laid for further episodes of
contagion and self-fulfilling runs on public and private, particularly bank debt. Much is made of Italy’s high
levels of private debt, in the hope that an asset tax levied over a period of years can help reduce public debt
substantially over time. This is of course mathematically true, but the economic logic needs to be carefully
assessed. Italian household net wealth is put at about €8 trillion, against gross public debt of some €1.9 trillion.
The optimistic view is that this wealth can be taxed to help reduce the public debt. In principle, yes of course.
But in practice, this is not so straightforward. Some 60% or more of Italian household wealth is tied up in real
estate, which may make it easier to allocate the wealth tax; but with the asset illiquid, the asset tax would
have to be spread over years and drawn from income. Furthermore, the value of wealth went up sharply in the
last decade, a time when Italy hardly grew and the heavy home bias in household portfolios did not improve
via diversification despite EMU. The main driver of gains in household wealth was the fall in real interest rates
due to the “convergence trade”, which raised the value of the cash flows in the Italian economy without an
increase in the underlying economic growth rate. Now that the convergence trade is being unwound because
the divergences between the EZ north and south have become clear, real interest rates and risk premia have
risen, threatening to reduce the risk-adjusted return on those same cash flows and thereby to reduce Italian
wealth. Fiscal, structural and external adjustment would also reduce the growth rate even further, also
pressuring wealth. In particular, a tax on private wealth large enough to meaningfully reduce the stock
problem of excessive public debt would worsen the flow problem of low growth, as reduced net wealth
induced negative income effects. In coming years, Italy may well stagnate and deteriorate, if it sticks to Plan A.
Figure 2: Italy Government Debt Projections (as % of GDP)
MoF Debt Projections
RGE Debt Projections
Source: MoF, RGE
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The internal devaluation route is self-defeating throughout the EZ periphery. On average, the EZ periphery
must deflate unit labour costs by at least 30-40% to reverse the increase relative to Germany over the past
decade, to restore competitiveness. This applies as much to Spain and Italy as the three program countries.
Given the pressure to repay external debt, they might have to go even further to generate large currentaccount surpluses. Such a protracted deflation would almost certainly exacerbate already high unemployment
as well as the real burden of public and private debt. Annual deflation of 4-5% would imply a depression to
restore competitiveness. To be sure, much of the unit labour cost reduction could be achieved through growth
and productivity-boosting structural reform, but this takes years to bear fruit. Even Germany endured over a
decade of gradual liberalization after reunification and corporate restructuring after EMU and the 2001
downturn before overcoming the sobriquet of sick man of Europe. Plus its initial impact would be to raise
unemployment, reduce growth and domestic absorption and pressure the fiscal accounts even further. Such a
protracted adjustment would not only be socially unsustainable, but would raise private default rates; capital
pressures in the banking system; contingent fiscal liabilities in the form of nonperforming loans (NPLs) in the
banking system; and in toto, the threat of systemic, cascading defaults—a lose/lose proposition for creditor
and debtor countries alike. The ECB’s newly extended three-year long-term refinancing operations lend time
to address these issues, but do not change the underlying macroeconomic, political or social dynamics; a still
excessive external and/or fiscal debt burden weighs on the economy of each distressed country, requiring debt
forgiveness and currency depreciation to restore growth.
Figure 3: Real Effective Exchange Rates: EZ Core Continues to Gain Competitiveness vs. EZ Periphery
V. Mechanics of Negotiation and Announcement
To prevent any dislocations from word leaking out of exit strategy planning, the key elements of the effort
need to be agreed at the highest levels, behind closed doors, representing all concerned parties. EU heads of
government and central bank governors; the ECB President and Governing Council; the IMF Managing Director
will all need to be at the table. Many of the required changes require domestic legislation and some will
contravene existing treaty obligations; these legal issues are addressed in Chapter 2, but for now suffice it to
say that exigent domestic circumstances can and have often outweighed international treaty obligations.
The wider EU would have to be involved because the structure and balance of the EU between EZ and non-EZ
members would permanently change. This would affect not only matters of trade and investment, but also
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intra-EU and EZ/non-EZ central bank relations. All EU member NCBs have a subscribed share in ECB capital that
is proportional to their GDP weight in the European economy; EZ members’ paid-in capital is 100% of their
subscribed capital; non-EZ members’ paid-in share capital is 21% of their subscribed capital. These weights
would change; but so would the exposures, through domestication, about which more in Chapter 3.
There are also major global dimensions to any EZ exit strategy, but the prospect of an orderly, amicable
divorce that finally puts to rest the most important systemic risk to global financial stability and economic
growth would be well received once clearly and cogently articulated. The continuation of IMF programs or
their expansion in size for the current program countries and widening to Spain and Italy imply that the IMF
executive board would have to be informed in due course. The effort would therefore have to occur after a
further expansion of the IMF’s usable resources, for which the planning is already underway.
The heads of major central banks that might have to provide currency swaps to the rump ECB or intervene in
response to collateral global effects once the announcements are made will have to be informed and
consulted in advance as well. Provision for currency swaps with reserve-currency and major central banks with
the ECB must be put in place beforehand, and announced at the word go, to convince market participants of
global coordination and obviate a run on the rump euro, in case the rump ECB loses credibility due to its
transitional commitment to support exiting countries’ exchange rates. Chief among these would be the U.S.
Federal Reserve and Treasury, given that the dollar is one leg of a super-majority of currency transactions
involving the euro and most other currencies; and given that dollar policy is a matter for the Treasury rather
than the Fed, even if the latter would implement the currency swaps. We do not envision difficulty with the
currency swaps, since these have already been entered into in the past. There is of course a risk that putting
the Fed’s balance sheet on the line with an ECB that will sooner or later have its capital reduced by the exit of
several sizeable members may create noise in Congress, but this can be managed as it has been until now.
Furthermore, the rump ECB would be a stronger counterparty for the Fed, given that the rump EZ would be
composed of a more homogenous group of countries, many of them net international creditors, and the rump
ECB balance sheet would be cleansed of significant amounts of exiting country exposures by domestication.
Announcement Effect: Surprise!
The negotiations and agreement must take place in secret to avoid self-fulfilling runs. Should rumours of a
possible break-up of EMU or the exit strategy involving exchange rate support leak before commitments and
adequate preparations are made, households might panic and market participants might engage in speculative
attacks. The consequences of a bank run could be very severe, even bankrupting the domestic banking sector
of exiting countries. Investors and foreign banks will immediately dump the sovereign debt they are holding of
exiting countries; domestic banks may have to do so too, to meet calls on deposits. Such developments were
foreshadowed in late 2011 when German chancellor Angela Merkel announced that a referendum in Greece
on the second bailout package could result in Greece exiting the common currency. The mere mention of a EZ
exit for any member state was enough to cause panic in bond and financial markets. A leak might require
deposit freezes and capital controls, which could otherwise be avoided by bank nationalization and liquidity
support once currency support, debt redenomination and restructuring are in place.
Resorting to popular referendums to legitimize exits may be the preferred, democratic modus operandi.
Though it would depend on the precise phrasing of any such referendum, most countries could not be counted
upon to vote in favour of an exit into intimidating, uncharted territory, until economic and financial conditions
were much worse, at which point the chances for an orderly exit would be remote at best. Furthermore, the
threat of an initial lack of confidence among households and investors in the will of the ECB to uphold its
promise to target exchange rates rather than inflation requires the initial conditions of domestication of assets
and liabilities to be well advanced to mitigate balance-sheet effects; with full agreement negotiated and signed
among all concerned parties. As individuals and businesses recognized that the ECB was demonstrating its
commitment to its new mandate, confidence would very slowly return.
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Chapter I—Negotiation Phase: The Political-Economy of an Amicable Divorce
Given the initial, and probably inevitable, uncertainty, it is very unlikely the public in the core or the
periphery would vote in favour of a break-up, but this does not mean that a break-up should not occur.
Without question, the decision to unravel the EZ without consulting parliaments is undemocratic. However,
most exchange rate regime changes have tended to occur in secret, or with legislative consultations in special
closed-door sessions. Even now, the effort to stay on track is arguably not democratic, since technocratic
governments have replaced some elected ones without a popular vote, even if they have been ratified by
parliaments; and national budgets have been reviewed and approved by creditors, whether Germany or the
IMF, before being submitted to parliamentary debate and voting. Countries remaining in the EZ will also have
to consider and justify the democratic deficit as they redefine the ECB’s mandate away from inflation targeting
towards temporary exchange rate targeting and accept the associated costs. After all, their central banks will
still be in charge of recapitalizing the ECB should that be required. In extremis, national governments could
declare a state of emergency based on the argument that sticking any longer with the euro would have very
negative consequences.
The exit announcement for all countries should be made in one joint statement by the European Commission,
ECB and heads of government late on a Friday evening in order to use the time during which banks are closed
to implement the most important changes. If necessary, governments of exiting countries could declare a bank
holiday, which could be extended until all necessary decisions have been taken. The bank holiday should be
kept as short as possible, no longer than a few days, in order to mitigate the panic that an extended bank
holiday could inspire. Alternatively, the exiting countries could temporarily resort to a non-cash payment
system using cheques and electronic funds transfers. In addition, the governments of exiting countries should
impose temporary capital controls to keep outflows at bay. Capital controls violate European law, but such
controls could be justified in such an emergency situation.
Once the decision that all currency, deposits and domestic-jurisdiction contracts will be redenominated has
been taken, the new currency/ies will need to be printed and circulated. Given the time needed to do so,
perhaps two months, the exiting countries would resort to cheques and electronic funds transfers and
payments, including credit and debit card and internet transfers. The new national currencies would become
the only legal tender in the domestic market, including all wages, transactions and tax payments—after a brief
period, perhaps two months, during which euros could continue to be used. Euros in circulation would initially
be hoarded, but would eventually be exchanged for the new national currencies, as and when confidence was
instilled by the exchange rate stabilization mechanism and transactions shifted to the new legal tender. The
government could extend the public holiday until the banks’ software has been adapted so that all bank
deposits are redenominated in the new currency and all ATMs have been reprogrammed. During the initial
transition period following the announcement, currency exchanges would be open 24 hours; afterwards, they
would return to business as usual, once the new physical national currency is in circulation.
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Chapter 2—The Legislative Phase: Contracts, Jurisdictions
Chapter 2—The Legislative Phase: Contracts, Jurisdictions
Much is made of legal and international treaty constraints to EZ exits, given the irrevocability of the decision
to join EMU—in particular the legal inference that no EZ exit is possible without EU exit, given that EMU
participation is a legal obligation of EU membership in the absence of a specific opt-out. However, we see
three main ways to overcome legal roadblocks, which given enough political will, would not be
insurmountable. First and foremost, the most expedient route is a mutually agreed and negotiated exit as
we propose, using provisions for limited treaty change incorporated in the Lisbon Treaty, which have already
been invoked for crisis management and establishment of the European Stability Mechanism. The Vienna
Convention on the Law of Treaties could provide legal cover for EZ exits, on the grounds that adverse
economic conditions render continued EZ membership impossible to sustain. These efforts would then
provide a basis for changes in treaty and domestic legislation consistent with EU and EZ obligations,
allowing for currency issuance and contract redenomination. In turn, many of the practical and logistical
elements of financial infrastructure, payments systems and market mechanisms and instruments remain
national, so would not require significant further legal effort, but be subject to policy decisions.
Where There’s a Will: Ways of Working With Legal Constraints
Assertions that the partial dismantling of the EZ is unworkable due to legal constraints are also overblown and
could be overcome to facilitate an accelerated, closed-door negotiation among key policymakers and
politicians. While those who created the single currency envisaged membership as irreversible, and did not
include a legal mechanism for exit in the Lisbon Treaty, there is not in itself any fundamental reason why
existing legislation could not be swiftly amended to facilitate one or more members abandoning the euro.
Indeed, there is already a clause within the Lisbon Treaty allowing for “limited” legislative alterations to that
text, without creating the need for revisiting the entire Treaty or opening up cumbersome institutional
debates, assuming the measures are agreed unanimously by European leaders with the EU Council. It was with
such “limited” treaty change that the European Stability Mechanism (ESM), the EU’s permanent bailout fund
(scheduled to come into force by mid-2012), was officially attached to the Lisbon Treaty in late 2010. European
leaders have already demonstrated in the past, for example when drawing up the original Greek rescue
package in early May 2010 and more recent fiscal compact, their capacity to work quickly under extreme
duress. Legal experts argue that the current treaty stipulates that an EZ exit would necessarily have to be
accompanied by an EU exit. We think this issue, too, could be addressed by writing new legislation, although
we acknowledge that the limited treaty change provision would not have included exit as a formal, legal
possibility. Nevertheless, as a practical matter, this is one way to provide legal cover to negotiate the exit
strategy and avoid a legal morass while finer points are considered and worked out. We touch upon these in
the remainder of our legislative discussion.
I. Legal Formalities of Exiting the EZ While Remaining in the EU
As explained by ECB legal counsel Phoebus Athanassiou, under the current treaty, a withdrawal from EMU
under Article 50 of the treaty is not feasible without a withdrawal from the EU. The unilateral EU/EMU
withdrawal interpretation, however, clashes with the irrevocability of the exchange rate clause in Article 140
(3), the irreversibility of the euro-ization process (with the complex network of Eurosystem rights and
obligations) and the fact that, “unlike EU participation, EMU participation is a legal obligation for all EU
member states,” unless there are opt-out agreements, as for the UK and Denmark. The only alternative
interpretation, therefore, is that only an agreed exit (including with the ECB) from the EZ is possible. Legally,
this would be the cleanest solution and the fairly quick agreement of the “fiscal compact” treaty suggests
that, when a broad consensus exists on a particular issue, treaty amendments can be performed fairly
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Chapter 2—The Legislative Phase: Contracts, Jurisdictions
A third possible exit route is the Vienna Convention on the Law of Treaties. Not all observers agree, but some
precedents suggest that international public law could indeed also apply to community law. For example,
Article 61 of the Vienna convention could be invoked for a unilateral exit on the grounds that certain treaty
obligations have become impossible to keep in view of adverse economic conditions (Dor, 2011). However,
not all EU members have ratified the Vienna convention on the Law of Treaties, namely France, Malta and
Romania. A fourth option sometimes mentioned could be a unanimous decision by the EU Council to issue a
simple EU regulation allowing a unilateral exit. However, this alone would contradict the treaty and result in
international non-recognition of the new Greek monetary law with a view to the redenomination of the
country’s debts into the new currency.
From a practical perspective, Scott (1998) points out that, although there is no formal exit process, there are
several important structural features of the EZ that make a break-up less problematic than it would
otherwise be. They include, first, the preservation of national payment systems, which are connected via
TARGET 2 rather than merged into a single platform; second, the preservation of national central banks and
national debt issuance, which would allow the immediate restarting of open market operations; and third,
the limited pooling of foreign exchange reserves, amounting to only about 20-25% of the EZ’s aggregate
foreign exchange reserves. The main break-up impediments therefore stem from the risk of currency
redenomination and the risk of systemic bank runs in the process if it occurs under disorderly circumstances.
I. A. Legal Steps Required Under Our Proposal
Given the highly sensitive nature of exit-clause negotiations at EU level, a realistic sequence of events could
therefore see the first exiting country invoke the Vienna convention as an emergency exit route, under the
assumption that all countries agree in principle to let that member country go (e.g. Greece—we refer to
Greece in this case simply as an example; the key legal concepts would be applicable to all exiting countries,
albeit adjusted to take account of any specific differences in national law). We acknowledge that such an EZwide consensus would have to be preceded by political consensus in the exiting country—for example, upon
election of an openly anti-EZ parliament or government—as, otherwise, a forced conversion of contracts and
deposits would amount to outright expropriation, bypassing the democratic rule of law. Besides being
welfare-reducing, we deem this course of action incompatible with the democratic values system. But we
would expect that before sitting down to negotiate the legality and mechanics of EZ exits, there would be a
domestic political consensus at least among the political class and policymakers to take such a decision in the
greater national interest. We also would expect such a consensus to attach to a critical mass of countries to
exit the EZ because of the accelerating economic burden of fiscal, external and structural adjustment. This
amounts to more of a political and practical consideration rather than a legal one, but it amounts to a
conceptual pre-requisite for the legal basis of exiting.
Given that the EMU’s irreversibility rule would clearly be broken at that point, EU leaders would at the same
time formalize an orderly exit mechanism in the treaty, which could be adopted fairly quickly (as the current
fiscal compact negotiations show) and without necessarily being subject to popular referendum since there is
no power transfer to the EU involved, but rather a power shift back to the single member states. Such an exit
procedure could, for example, be framed according to the German ruling party’s non-binding resolutions,
which call for a voluntary exit mechanism from EMU that does not, necessarily, lead to an exit from the EU
for those EZ member states permanently unwilling or unable to comply with the setting of EMU regulations.
The voluntary framework is important because forced expulsion would infringe a member state’s sovereignty
dramatically, and is extremely unlikely to receive unanimous approval.
2. Contract Redenomination Rules
The “monetary law” establishing the legal framework for the euro (see also Q&A) rests on regulations
implementing the treaty provisions. The first step for the exiting country, Greece say, would therefore be to
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Chapter 2—The Legislative Phase: Contracts, Jurisdictions
implement a new monetary law creating the new monetary unit (e.g. the new drachma). This law would also
have to prescribe a substitution rate at which euro-denominated obligations would be converted into the new
drachma (Procter, 2010). As long as the exit from EMU had occurred with unanimous agreement and a treaty
amendment, the new Greek monetary law would be internationally recognized (including by foreign courts) as
a basis for the continuity of contracts and contract redenomination.
However, even in the consensual case, the monetary laws of the euro and the Greek currency would coexist:
The question arises, which law would prevail for which contracts? As far as Greek courts would be concerned,
the new monetary law would apply to situations where 1) the contract is governed by Greek law; 2) where the
debtor is a Greek resident; or 3) where Greece is the place of payment. If none of these conditions apply, then
the contract would remain in euro.
With respect to foreign courts, contract redenomination into drachmas could occur in the event of the Greek
monetary law applying as above and as long as Greece’s exit had occurred on a consensual and lawful basis,
i.e. via a treaty amendment (Procter, 2010). For example, loans governed by English law made from a London
bank to a Greek debtor with the provision that the loan be repaid into an account in London, would still need
to be repaid in euros. The same loan would be redenominated into drachmas if the loan were to be repaid into
a subsidiary of the London bank in Greece (Procter, 2010).
Similarly, if a London bank were to enter an interest rate swap with a Greek counterparty governed by English
law, payments would still need to be made in euros, provided that the London bank had specified that
payments were to be made outside Greece. The same would be true for the Greek counterparty if payments
were stipulated to be made outside Greece. If the Greek counterparty had stipulated payments within Greece,
then Greek monetary law would apply and the London banks would have to pay in new drachma. This assumes
again that the new currency was established in a lawful manner, for English courts would otherwise disregard
the unlawful Greek monetary law and all contracts would remain to be paid in euros (Procter, 2010).
With respect to government bonds, the same principle applies: bonds sold domestically to residents would
face redenomination of payment obligations and international bonds sold abroad would remain payable in
euros (Procter, 2010). Long-term bonds issues pre-dating the introduction of the EU would also be
TARGET 2 credits, representing the ECB’s “flight to safety” accommodation away from the Greek banking
system and toward other EZ safe havens (especially Germany), represent another important liability of the
national central bank that in our view would remain payable to the ECB in Frankfurt and therefore expressed in
2. A. Contract Redenomination Under Our Proposal
The withdrawing country would undertake the following measures immediately after adoption of the new
monetary law (see also Dor 2011):
First, the reserve accounts of domestic banks held at the national central bank, covering deposits of
residents, would be frozen if necessary and converted into the new currency. As explained in detail in
Chapter 3, we suggest periodically widening trading corridor that permits a gradual depreciation
rather than a sudden maxi-devaluation, ultimately followed by a free float/inflation targeting.
Second, the central bank’s outstanding lending operations with domestic banks would also be
converted into the new currency. In the case of Greece, outstanding claims on domestic MFI
amount to €73.9 billion as of November 2011. ELA loans recorded under “other assets” reached
€58.5 billion.
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Chapter 2—The Legislative Phase: Contracts, Jurisdictions
Third, in our view, and consistent with Dor’s interpretation, NCBs’ outstanding TARGET 2 liabilities
to the ECB in Frankfurt would remain repayable in euros. In the case of Greece, the TARGET 2
liability has reached €109.3 billion. Chances are that the departing central bank would not be able to
meet these liabilities, even more so as the new national currency would depreciate against the euro.
Any losses accruing to the ECB would presumably be offset by the ECB’s general reserves fund of
€13.3 billion (at end-2010) and the remainder would have to be shared among the 17 EZ NCBs,
according to their ECB capital key, unless another arrangement with the central bank of the exiting
country could be found to roll over this liability indefinitely (for example, as suggested by Dor,
2011). The managed exchange rate path amounts to such an implicit loan extension arrangement
that would prevent the upfront crystallization of losses; for some countries, there could be a
specifically agreed redenomination of TARGET2 balances into new national currency.
At the same time, the exiting NCB would hold a claim on its transfer of foreign exchange reserves to the ECB.
Of the total €40.2 billion (i.e. only about 25% of the total EZ foreign exchange reserves) in foreign reserve
assets transferred to the ECB, the Bank of Greece’s share amounts to €1.1 billion. This share could be used to
start NCB operations after exiting, although it would presumably be redenominated into the new currency as
it would be payable to the NCB in Greece. Nonetheless, there might be a risk that the ECB could also retain
this share and cover some of its credit risk with respect to the TARGET 2 loan repayment. At the aggregate
level, NCBs have only transferred about 20-25% of their combined foreign reserve assets to the ECB. In the
specific case of the Bank of Greece, however, the available reserves are running thin.
Fourth, the NCB would receive the authority to conduct its own monetary policy, independently from the
ECB and according to its own rules. Since the loans to the banks and the domestic securities on the asset side
would be redenominated, alongside its capital and reserve holdings, the NCB would retain the tools to
resume open market operations.
Meanwhile, residents’ deposits in domestic banks (€181.5 billion) would be converted into the new currency.
All transfers from drachma accounts to euro accounts would be temporarily suspended and the bank
accounts frozen to avoid panic, if necessary. There is a significant risk that capital controls and / or bank
nationalisation might be required at any time during the process, especially when it dawns on the population
that their deposits might be redenominated into new drachma or other new national currencies. Such
heterodox actions might be of questionable legality and would almost certainly be politically damaging;
however, such considerations have not prevented redenomination, deposit freezes or capital controls when
hard fix, brittle currency regimes have broken in the past.
All domestic transactions such as loans, salaries, rents and bills to pay would be converted into the new
currency at the initial value, as specified in the monetary law, before the drachma’s new value is established
in the FX market. The drachma would be ordered as the sole means of payment.
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Chapter 3—Implementation Phase: Macroeconomic Management of EZ Exits
Chapter 3—Implementation Phase: Macroeconomic Management of EZ Exits
We describe a strategy for the implementation and macroeconomic management of the introduction of
exiting countries’ new national currencies. We preface the actual introduction of our exchange rate
stabilization mechanism with active national balance sheet management comprising the “domestication” of
assets and liabilities and a debt management program that includes the redenomination of domestic-law
contracts in all exiting countries, and the restructuring of public debt in all program countries. These
processes would reduce pressure on the exchange rate and the need for the rump ECB to intervene
aggressively to shore up the exiting country currencies, easing the path to an eventually floating and
depreciated real exchange rate, in turn permitting a far less onerous external adjustment.
I. Active National Balance Sheet Management—“Domesticating” External Public and Private Debt
The first stage of managing EZ exits will be an accelerated and extensive domestication of the public and
private external debt of the EZ periphery, to the fullest extent possible. Domestication and redenomination of
domestic-law and territorial-nexus debt contracts (about which more below) would reduce the balance sheet
effects within the EZ periphery and between the core and periphery, at the time of exit and the eventual real
and nominal depreciation of the new national currencies. This in turn would reduce the scale of fiscal and
exchange rate support required by the exiting member states.
In practice, this domestication is already well underway: The ECB and NCBs have stepped in as foreign creditor
banks have exited the refinancing of the external debt of distressed member states. In effect, a wholesale run
has hit EZ periphery banks starting at the bottom of their capital structure and worked its way upward, taking
down their equities, subordinated debt, interbank funding and senior, secured debt. The severe pressure on
the liability side of EZ periphery bank balance sheets required them to seek official refinancing, pledging all
available eligible collateral to the ECB, to head off an incipient run on deposits. But as they ran out of eligible
collateral, the Eurosystem faced the difficult question of how to keep banking systems afloat, especially in the
program countries (Ireland and Greece in particular). They resorted to “emergency liquidity assistance” (ELA),
in which NCBs create Eurosystem liabilities (print euros, so to speak) in exchange for whatever collateral they
deem acceptable, on their own recognisance with the fiscal backing of the national government, rather than as
a shared risk of the Eurosystem of central banks (ECB plus NCBs).
The amounts domesticated by this method are already substantial. Ireland’s ELA, for example, is now
approaching one-third of its GDP—small for the EZ as a whole, but an enormous difference for Ireland, one
way or another. Greece’s ELA is now also substantial, at about 20% of GDP.
It is worth noting at this juncture that domestication without redenomination and exit, will eventually transfer
the fiscal stress and repayment pressures, as well as the consequences of de jure or de facto default, to the
debtor country, condemning her to debtors’ prison for a protracted period. If the private debt, for example, is
domesticated and cannot be repaid to domestic banks and investors in the absence of a real depreciation and
return to growth, it will cumulate as NPLs in the domestic banking system—in a kind of de facto default.
Resident obligors will have to raise their savings effort above their natural equilibrium marginal propensity to
save, forcing the country into Keynes’s paradox of thrift. Since the entire EZ, periphery and core are at once
engaged in fiscal retrenchment, and the periphery in private-sector retrenchment, growth will be reduced. This
may assist the deflation of wages and prices required to restore competitiveness within the straitjacket of the
monetary union, but it will also aggravate the real debt burden and boost the risk of cascading de jure defaults
and national or even systemic banking crisis once again.
I. A. Bank Refinancing, ELAs, TARGET2 Balances and the ECB/NCB Nexus of Creditors and Debtors
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Chapter 3—Implementation Phase: Macroeconomic Management of EZ Exits
A corollary of the essential approach of refinancing banks as needed through NCB- (national) or ECBrecognisance (shared) credit is that bank balance sheet sizes are sustained well above their market-clearing
levels. So far so good, since without the central bank credit there would be an extremely vicious credit crunch,
causing a collapse in economic activity in the EZ periphery, which would perforce hit the EZ core very hard as
well. This is far from a hyperbolic assessment, since some 80% of EZ activity is funded through banks and only
20% disintermediated through capital markets—roughly the reverse of the ratios in the United States. The
effect of such a severe credit crunch therefore could be worse than the impact of the Lehman and Washington
Mutual failures in bringing about the Great Recession, the first global recession since the Great Depression.
Sustaining bank balance sheets above their market-clearing levels in turn means that the economic and in
particular the external adjustment is smaller than it would otherwise be—despite collapsing or declining
domestic absorption, depending on the distressed country in question. In effect, central bank credit augments
the flow of official foreign financing from the troika for program countries, and augments residual net private
capital inflows in other distressed countries that have not yet lost market access. The result is that the external
obligations of the fiscal and private sectors of debtor countries still running current account deficits (the entire
EZ periphery with the exception of Ireland at the time of writing) accumulate in the central banks’ balance
sheets. What might otherwise have been further accumulation of claims of say a Deutsche Bank on say the
Greek state or Spanish households and Italian corporations instead becomes a claim of the Deutsche
Bundesbank on the deficit country NCBs, through TARGET2. At this point, the specifics of TARGET2, its links to
the ELA and to macroeconomic imbalances require explanation and a role in sequencing amicable divorce.
The Role of TARGET2 in the Payments System and Intra-EZ Macroeconomic Imbalances
In view of time constraints, the first TARGET (Trans-European Automated Real-Time Gross Settlement Express
Transfer System) system for cross-border inter-member state payments was established in 1999 by linking
together the national RTGS (Real-Time Gross Settlement) structures with the ECB payment mechanism and by
defining a minimum set of harmonized features (TARGET Annual Report 2010). The main objectives were the
support of monetary policy implementations, the reduction of systemic risk and banks’ national and crossborder liquidity management. The main drawbacks, which led to the further development of the Single Shared
Platform of TARGET 2 (in force since November 2007), related to cost efficiency, service scalability and rules
harmonization. Importantly, despite the technical consolidation of TARGET2, the decentralized relationship
between NCBs and their banking systems was preserved regarding monetary policy implementation and
lender of last resort relationships (i.e. ELA). Indeed, the preservation of the payment system along national
borders as well as the preservation of NCBs and national debt instruments (instead of Eurobonds, for example)
in addition to the limited pooling of FX reserves represent structural features that effectively facilitate an
eventual break-up, according to Hal S. Scott (1998): “It is as if EMU countries have hedged their bets on the
success of the euro by leaving in place the key institutions for a return to national monetary systems.”
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Chapter 3—Implementation Phase: Macroeconomic Management of EZ Exits
Figure 4: Structure of the SSP
Source: ECB
Currently, there are 24 central banks of the EU and their respective user communities connected to TARGET2:
the 18 EZ central banks including the ECB, plus six central banks from non-EMU countries (Denmark, Poland,
Latvia, Lithuania, Bulgaria, Romania). The Bank of England decided not to switch to TARGET2 from TARGET in
May 2008, whereas the Swedish Riksbank discontinued membership at the end of 2006.
Extricating the National Central Bank from the Eurosystem
One major practical hurdle for leaving EMU is the extrication of the NCB’s assets and liabilities from the
Eurosystem of central banks. One important balance sheet item in central bank statements are TARGET2
balances related to intra-Eurosystem transactions. The ECB’s October 2011 Monthly Bulletin describes in
detail the link between private banks’ loss of market access and increases in the need for central bank
financing, with a resulting increase in TARGET2 liabilities vis-à-vis the ECB (NOT vis-à-vis central banks with
positive TARGET2 balances) in financially distressed countries. Large positive TARGET2 balances, on the other
hand, are an indication of the “flight to safety” that occurred mainly within the EZ, given the EZ’s broadly
balanced external position (Figure 5). The increase in overall TARGET2 balances during the crisis is a direct
consequence of the increase in the Eurosystem lending operations to accommodate banks’ unrestricted
liquidity demands (Figure 6).
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Chapter 3—Implementation Phase: Macroeconomic Management of EZ Exits
Figures 5 and 6: TARGET2 Balances of NCBs (€, billions) and Liquidity Provision in the Eurosystem Monetary
Policy Operations to Euro-Area Counterparties (€, billions, end-of-month data)
Source: NCBs
Figure 6 note: Last observation: end-September 2011
Hans-Werner Sinn summarizes the credit and counterparty risks involved in the sharing of the TARGET2 system
as follows in his November 2011 report, while also highlighting the effective balance-of-payments distortions
reflected in these TARGET2 balances:
“1. The Target balances are a statistical item of no consequence, since they net each other out within the
Eurozone (source: Bundesbank).
2. Germany’s risk does not reside in the Bundesbank’s claims, but in the liabilities of the deficit countries.
Germany is liable only in proportion to its share in the ECB, and if it had been other countries instead of
Germany that had accumulated Target claims, Germany would be liable for exactly the same amount (source:
Bundesbank and ECB).
3. The balances do not represent any risks in addition to those arising from the refinancing operations (source:
Bundesbank and ECB).
4. A positive Target balance does not imply constraints in the supply of credit to the respective economy, but is
a sign of the availability of ample bank liquidity (source: ECB).”
From a legal perspective, TARGET Guidelines state that: “In disputes concerning payments between TARGET2
component systems, the law of the Member State where the seat of the Eurosystem CB of the payee is located
shall apply.” (Article 12.3.) Assuming that countries with TARGET2 liabilities towards the ECB are the primary
exit candidates, we infer that the NCB’s liability to the ECB remains to be repaid in euro. Our proposal for a
negotiated exit opens a window to extricate these bilateral claims including also the ECB capital share as well
as the transferred share of foreign reserves, while bypassing disruptive valuation changes.
One option is if the remaining NCBs buy out the departing NCB’s capital share and the ECB would return the
departing bank’s FX reserves (which account for only about 20% of total national FX reserves). Alternatively,
the paid-in capital share could be left with the ECB together with the central bank’s foreign exchange which
could represent a welcome buffer against excessive devaluation pressures (Dor, 2011). We note that non-EZ
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Chapter 3—Implementation Phase: Macroeconomic Management of EZ Exits
EU members, such as the United Kingdom, Denmark and Sweden, have a subscribed share capital in the ECB in
proportion to their weight in EU GDP; however, their paid-in capital is about 30% of total ECB paid-in capital—
and these weights as well as the nominal amount of ECB capital would change with the exits, particularly of
Italy and Spain, respectively the third and fourth largest economies in the EZ. Given the imperative to keep the
EU intact, complete with the remaining non-EZ obligations of EU membership, the fraction of subscribed
capital represented by the paid-in capital exiting NCBs in the ECB capital would be retained; however, the
quasi-fiscal costs of exchange rate support would fall on a smaller base of ECB capital and provisions, and may
require another round of recapitalization. Nevertheless, we believe this would be far easier than cascading
credit events or even significant orderly sovereign defaults, which would require far more explicit, politically
difficult creditor-country recapitalization of private banks.
If a member state were to exit the EZ, extricating the NCB from the Eurosystem, its TARGET2 balance would
in principle be a euro-denominated external liability of the exiting NCB. Chances are that exiting NCBs would
face pressures in meeting these liabilities; the quasi-fiscal costs of so doing would rise as the new national
currency depreciates against the euro. Any losses accruing to the ECB would have to be shared among the
remaining NCBs, according to their ECB capital key, unless another arrangement were achieved, perhaps
even to the extent of rolling over this liability indefinitely, for example, as suggested in Dor (2011). ELA loans
that are under the competence of the NCBs and extended to their national banking systems, on the other
hand, would arguably be converted into national currency, as they fall under the domestic monetary law.
This in turn is another argument for further domestication of exiting member-state external assets and
liabilities to the fullest extent possible.
Ireland’s handling of Irish Bank Resolution Corporation (IBRC) offers an interesting case study on the
restructuring of the banking system without defaulting on senior bond holders, while taking advantage of the
NCB’s money printing powers (ELA) without resorting to nominal devaluation. In short, the subordinated
bondholders of Anglo Irish and Irish Nationwide (merged into the IBRC) were written down without, however,
treating the few remaining senior bond holders after large recapitalization efforts by Irish taxpayers. As Karl
Whelan explains, IBRC’s principal assets now consist of “promissory notes” from the Minister for Finance.
“These notes promise to provide Anglo with €3.1 billion on March 31 every year up to 2023 and then an
additional €7.6 billion in payments up to 2031.” On the liabilities side, the vast majority are ELA loans (about
€42 billion). In practice, the payment instalments on the promissory notes are handed over to the NCB to pay
down ELA loans. Given the large opportunity costs involved for taxpayers at this juncture, this kind of
arrangement is questionable from a welfare perspective. We concur with the author’s suggestion for
nationalized banks to negotiate a long-term agreement with the NCB (and by extension the ECB) to the effect
that ELA will be paid back at a pace consistent with the pace of the economic recovery fuelled by a gradual
devaluation. This example reinforces our preference for a negotiated and managed conversion of financial
liabilities to preserve the largest-possible degree of stability without stifling growth prospects.
ELAs and TARGET2 Obligations: Redenominating, Reprofiling or Restructuring Obligations?
The fast-accumulating balances of creditor country NCBs in the TARGET2 system, boosted by ELAs in some
countries, represent external claims on the NCBs of debtor countries. In principle, there is no credit risk
associated with these claims in the absence of exits or defaults by the NCBs of debtor countries—which there
would not be because it is a major source of foreign financing.
Nevertheless, in an exit scenario, there would be a major quasi-fiscal exposure of the creditor country NCB to
the credit risk of an exiting country, including its NCB; or if claims were legally redenominated, as by
negotiation, the exposure to the exchange rate of the exiting country. Furthermore, the nature of the
Eurosystem ECB/NCB nexus and the TARGET2 system rules mean that these balances are in effect the only
joint and several obligation in the EZ construct as it currently stands, since any credit or other P&L losses
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within the TARGET2 system are shared by Eurosystem NCBs in proportion to their capital keys, in turn a
function of each member state’s EZ GDP weight. The scale of these quasi-fiscal exposures and their share
across all EZ member states on the basis of GDP regardless of their economic or fiscal gains from associated
exports, represent another reason for continuing EZ members to support exiting members—crucially,
regardless of whether the claims could be redenominated or not.
The imperatives of the macroeconomic management and coordination of the amicable divorce call for a
judicious approach to handling these thorny issues. The best way to proceed would be differentiation: To
negotiate redenomination for those countries that would have the most difficulty repaying in FX because of
limited tradable goods or services sectors and/or extreme levels of net external debt. In contrast, retaining
euro-denominated claims for those countries with relatively large tradables sectors or moderate net external
debt would help induce external adjustment over time.
Such a differentiated, case-by-case approach to official and bilateral debt is normal practice in sovereign debt
workouts. Portugal, Greece and Spain all share a large net external debt burden in the mid-high 80% of GDP
range, well above the net external debt of Italy and Ireland. Net external debt is the relevant metric here, since
a high level of gross foreign assets would help private obligors generate FX with which to pay their debt; and
creditors, debtors and referees of international financial bargains, like the IMF, would prefer to avoid moral
hazard and giveaways beyond what is absolutely necessary.
Furthermore, it is typical of sovereign debt restructuring exercises for bilateral obligations to be restructured in
line with private claims. In contrast, multilateral obligations to the IMF for example, who lend into crisis and
even into private-sector arrears, are in practice accorded preferred creditor status.
I. B. The Three Rs: Reprofiling, Reducing, Redenominating the Gross Public and Private Debt
We now turn to the thorny issue of public debt restructuring, reprofiling and redenomination. The main
principles at work in our Legislative Phase, the key factors in managing the transition:
All domestic jurisdiction contracts should be redenominated, shifting exposure from credit to
exchange rate risk. The exchange rate stabilization mechanism, detailed shortly, will provide an
opportunity for creditors and obligors to manage, reduce or hedge exposures, essential because they
signed up for a different kind of exposure than they will now get.
Foreign jurisdiction contracts without a domestic territorial nexus should remain in foreign
currency, exposed to credit risk, as now, plus a new component of credit risk, the exchange rate risk
and mismatch of any obligor. Again, the transitional exchange rate targeting system will provide time
and resources for creditors and obligors to manage credit exposures and hedge currency exposures.
Unsustainable public debt shall be rescheduled or restructured with debt reduction; debt perceived
to be more sustainable shall remain intact. The distinction between sustainable and unsustainable
shall be based on debt dynamics calculations conducted by the IMF using scenario analysis based on
market interest rates and potential growth rates, incorporating both fiscal and structural adjustment
programs as well as EZ exits.
Bank debt shall be handled on a country-by-country basis, with temporary nationalisation in many
cases. The risk of deposit flight and further wholesale runs on banks will remain very high, particularly
in the weakest countries, perhaps requiring deposit freezes or capital controls, over and above bank
nationalisation, in extremis in the weakest countries (see Chapter 4, Managing the Financial System,
for more specifics). However, we expect liquidity provision by the exiting NCBs, currency support by
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the rump NCB and nationalisation to help avert such heterodox actions as deposit freezes and capital
Household and non-financial corporate debt shall be handled on a case-by-case basis, as per the
credit risk of the individual obligor—as is the case now, regardless of EZ exit and redenomination,
respecting the core principle that domestic jurisdiction contracts will be redenominated, foreign
jurisdiction contracts will not.
We draw a clear distinction between the three small program countries, which should restructure public
debt, and the two major sovereigns that together comprise our exit group, Spain and Italy, which should
not. Countries that have lost market access have generally been candidates for debt restructuring or
reprofiling throughout the long and storied history of sovereign default. Some debt restructuring is inevitable
and desirable from both a political and public policy perspective. Moral hazard should be mitigated without
causing counter-productive financial instability simply to make the point that private creditors should bear the
cost of their decisions. Furthermore, as relatively small countries, it is practicable to restructure their public
debt without wiping out the EZ and EU banking system at a stroke, whereas the risks of so doing are far higher
with Spain and Italy.
Greece is already setting the precedent of substantial nominal debt reduction in a sovereign debt deal
without an actual non-payment. This should go forward, now that the reputation of Greece as a debtor is as
weak as ever; recorded sovereign defaults begin with Greek city-states and the modern republic has been in
default or rescheduling for a super-majority of its time since independence from the Ottoman Empire. We
would not go beyond the current 50% debt reduction, but would eliminate the credit enhancement of UK law
off the table. The trade-off is simply that a Greece with its monetary sovereignty eventually restored and a
freely floating currency is less likely to need a future debt restructuring.
For Portugal and Ireland, we envision a case-by-case approach based on IMF projections. Our own debt
sustainability analysis suggests that both will benefit from a meaningful debt reduction, though should need
much less forgiveness than Greece.
The current imbroglio entrenches contagion to the remaining program countries and threatens Spain and
Italy with the same fate as Greece in the long run: As official financing cumulates, subordinating private
creditors, a disproportionate private haircut will be required, yet provide inadequate debt relief. The current
IMF baseline scenario anticipates that Greece will end up with a 120% of GDP debt burden by 2020, even with
some 50-60% debt forgiveness—of private debt—the level at which market access was lost in 2010. This
morass is substantially because official creditors and bondholders, particularly the ECB are militating against
taking a debt write down, in turn due to the implicit quasi-fiscal costs, not just of sovereign debt restructuring
in Greece, Ireland and Portugal, but for when Italy and Spain’s turn comes.
Spain and Italy can and should avoid a debt rescheduling if they exit in relatively short order, before more
activity and hence debt/carrying capacity are forgone. The bond market exhibited concerns about the
sovereign risk of each country: Real interest rates and spreads over bunds were rising to the point where Italy
in particular was in danger of unsustainability and the 7% nominal interest rate threshold of unsustainability
where the program countries had to seek official support. Still, nothing remotely approaching a debt
restructuring was priced-in, even before the ECB’s new three-year long-term refinancing operations. Each has
a large tradable goods sector that has shown itself capable of competing in the European and global
economies, in contrast to say Portugal and Greece, whose structural rigidities have prevented them from
developing dynamic comparative advantages in new sectors. Furthermore, Italy has been able to stabilize and
carry large public debt loads by generating substantial primary surpluses in the mid-single digits as a share of
GDP during the 1990s, when it had the benefit of devaluation and robust export growth at a time when both
the European and global economies were reasonably strong.
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Chapter 3—Implementation Phase: Macroeconomic Management of EZ Exits
Last but far from least, every effort should be made to avoid compounding the debtor moral hazard from
financing an orderly and amicable divorce with a debt forgiveness plan as well (NB: creditor moral hazard is
addressed in part through a restructuring of the public debt of Portugal, Ireland and Greece). Such balance
sheet effects of a joint Spain and Italy sovereign debt write-down large enough to assist their rehabilitation
would impose a severe burden on both domestic and creditor country banking systems. Foreign holdings of
Italy’s public debt alone approach €750 billion or 40% of the total and of Spanish public and private debt
perhaps another €500 billion. A meaningful rescheduling of Italian public debt of about 120% of GDP would be
of the order of magnitude of at least 30% of Italian GDP. Taking all the key issues into account, we are of the
view that only the three program countries should restructure their public debt.
II. The Exit Strategy in Depth
The Sum of All Fears: The Exchange Rate
Ensuring that EZ exits do not precipitate self-fulfilling speculative attacks and runs on banks, on exiting
countries and their new currencies, perhaps even on the euro, the ECB and the EZ core, because of risks to
social, political stability and EZ/EU cohesion, requires a focal point for stability. Stabilizing the exchange rate of
each exiting country is the most logical and simplest vehicle to corroborate the announcement effect of plans
for an orderly, amicable divorce.
Once exits are announced, the exchange rate will become the focus of all fears in the market place, whether
for the real or external value of deposits, government debt or all private-sector liabilities—Announcing a
redenomination of both assets and liabilities will only partly alleviate this problem: The public may not believe
that minimizing balance sheet mismatches will reduce the risk of a destabilizing collapse in the new currency
by better matching financial assets and liabilities. Financial market participants will want to speculate on the
risk of a run and a failure of the announcements and plans to function as envisioned.
In the immediate aftermath of the exit and redenomination announcements, there will be a rush for foreign
assets. Depreciation pressures on the new national currencies will find a counterpart in sharp falls in domestic
asset prices of all kinds—financial asset prices including corporate equity and public debt, as well as real
estate. Stabilizing expectations for inflation, the exchange rate and the success of the amicable divorce itself
will require taking due precautions against these fears and making full use of the potential for speculative
attacks as well as their reversal. The asymmetric intervention commitment will eventually calm the FX
markets, providing rational pricing and increasing liquidity in spot and forward markets, allowing normality to
return to trade, investment and hedging transactions across borders.
As the markets test the resolve of the exiting-country NCBs and the rump ECB to defend the new currency
trading corridors, the low levels of domestic asset prices will become very attractive. This is because the
overshooting pressure that normally causes the exchange rate to collapse well below any fundamental fair
value will be confined to those asset classes that residents and market participants can sell, but be constrained
in the price of FX. Instead of overshooting, the currency will be stabilized by a demand-driven expansion in the
supply of FX as needed—in both spot and forward markets.
The depressed level of asset prices will be tantamount to extremely tight domestic monetary and financial
conditions in the exiting countries, in sharp contrast to still very accommodative conditions in the rump EZ, the
rest of the EU and the wider Western world, compressing demand and restraining inflation. This relative
difference in monetary stances and financial conditions would accelerate the external adjustment that is so far
held in check by the flow of official foreign financing and ELAs; eventually as the exchange rate is released, and
a large maxi-devaluation with price stability is eventually engineered, exports and external adjustment would
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Chapter 3—Implementation Phase: Macroeconomic Management of EZ Exits
As early as possible in this process, two-way volatility should be introduced into FX markets, so market
participants recognize that both depreciation and appreciation are possible. The combination of some
volatility and demonstrated commitment to intervene with unlimited central bank firepower, as required by
the transitional exchange rate-targeting mandate, would eventually discourage the market from taking the
new currencies to the extremes of their trading corridors. All that said, it would be desirable for the spot
exchange rate to depreciate relative to the central parity of 1:1 over time, in the weaker half of the band, with
two-way volatility by the time of say the third band widening, to signal clearly that a real depreciation is
The state-contingent approach to the band widening—based on stabilizing inflation and currency expectations
as revealed in the term structure of nominal and inflation-indexed bonds and spot and forward FX markets—
implies bands widening at different times in different countries. This too would fit with the case-by-case
approach to the economic conditions and prospects, public finances and structural conditions of each
economy. Rather than lumping them all together as the EZ “PIIGS,” as is often discussed, the markets would
differentiate them on their own (de-)merits—all the more so given that each would eventually enjoy national
monetary sovereignty—subject to the constraint of a congruent medium-term inflation target.
Figure 7: A Stylized Trajectory for the Nominal Exchange Rate of a New National Currency During Its
Transition Phase Trading Corridor and Free Float EZN/EUR
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Chapter 4—Financial and Real-Economy Impact: Managing the Financial System
Chapter 4—Financial and Real-Economy Impact: Managing the Financial
A managed currency band that is progressively, but slowly widened will limit the rapid deterioration of
balance sheets that are associated with the exiting of a fixed exchange rate regime. To ensure an orderly
exit, sovereigns will need to pass legislation allowing for broad resolution authority and create new
liabilities to minimize long-term pressure on its banking system. Financial entities will face runs on shortterm liabilities, so temporary deposit freezes, guarantees and limits on cash withdrawals will be necessary
for the preservation of systemic stability, and to limit the rise in the sovereign debt burden. Deep bank
restructuring may be necessary, particularly where there are significant mismatches in FX assets and
Redenomination or de-pegging a national currency has potentially enormous ramifications for the domestic
and inter-linked financial systems, particularly where there is a significant asset-liability mismatch vis-à-vis
duration and/or local and multiple foreign law jurisdictions. The proliferation of swap transactions and other
OTC derivatives, increasing levels of asset encumbrance, official sector financing of interbank borrowings and
potential and actual deposit or wholesale funding runs have magnified the complexity of resolving modern
banking crises, relative to previous eras. The most “orderly” and rapid solutions for mitigating the shock of EZ
exit and redenomination to the financial system will require significant ex-ante legislation, heavy-handed
intervention by central banks and the state, infringement of property rights and, possibly, increases in the debt
burden of exiting sovereigns. This is all common to most financial crises, and so should not be surprising, but
that does not minimize its possible disruptiveness. In this section, we anticipate and “solve for” deposit runs,
ballooning FX liabilities, sovereign debt restructurings and nonbank intermediaries, and suggest steps to
minimize the resulting chaos.
In brief, governments will need to pass legislation with comprehensive powers, including the authority to
resolve banks. Financial institutions would need to be broadly nationalized, to aggressively stem bank runs via
deposit freezes or securitization. With resolution powers and ownership rights, sovereigns would have greater
options vis-à-vis private creditors to resolve the financial system, from wind-ups, to managed sales, bank
restructuring and voluntary liability restructuring. Policy should strive to adapt capital or exchange controls,
where applied, to preserve servicing of derivatives obligations and forestall termination or default events, as
these are known to unleash pandemonium and damage confidence, and can have unforeseen negative effects.
We would expect a high level of asset defaults under a redenomination of the currency, hence the sovereign
will likely incur new liabilities to support the financial system, as detailed in Reinhart and Rogoff’s research on
the aftermath of financial crises. This effect would be exacerbated if the sovereign in question needs to
undergo a debt restructuring and where bank liabilities cannot easily absorb losses (i.e. collateralized or official
sector claims).
In the absence of policy intervention, bank and nonbank intermediaries will face a run on their short-term
liabilities as depositors fear the prospect of holding an asset whose real value will be eroded in the ensuing
depreciation of the new currency. This is typical in EM “maxi devals” when a previously pegged exchange rate
is floated, even when a new currency is not introduced. In a scenario where a credible, external institution
commits to preserving an inflated exchange rate with uncapped resources, we would nonetheless expect
depositors to flee to prevent balances from depreciating as the currency band widens. Bank solvency would
quickly be wiped out by forced asset disposals to service deposit withdrawals and asset prices would drop
sharply, as both banks and nonbank intermediaries dump assets into the market. Furthermore, the assets of
these intermediaries may be encumbered, rendering it challenging to divest assets. Without policy
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Chapter 4—Financial and Real-Economy Impact: Managing the Financial System
intervention, intermediaries will be unable to meet the demand to make good on their short-term liabilities,
instigating more panic and significant civil disorder.
Corralito—Freezing Deposits
There are several ways in which the incipient run can be dealt with, each one reflecting a tradeoff between
preserving property rights and limiting inflationary pressures in the exiting country. Our preferred approach—
unpalatable, but the lesser evil—entails a redux of Argentina’s “corralito”, which involves temporarily freezing
part or all of the deposit base and setting a cap on withdrawals until the managed exchange rate regime ends.
This approach is “beneficial” in that it limits the crystallization of the deposit guarantee and the expansion of
the domestic monetary base. However, it would be hugely unpopular as it forces the negative real adjustment
upon depositors. Furthermore, this approach would be particularly painful for countries with large, informal
economies where transactions are cash-based and thus bypass the banking system. To allay concerns in nonexiting countries, legislation explicitly stating depositor preference, and announcing temporary guarantees on
bank liabilities, would be advisable.
Deposit Securitization
A more extreme approach to managing deposit flight would take the maturity extension inherent in a deposit
freeze one step further, by securitizing deposits, as in the case of Argentina’s “Bonex”. Here, deposits can be
exchanged for marketable government debt or bank debt securities. This would allow depositors to liquidate
their deposits, without creating inflationary pressures. However, depositors would still face a negative real
adjustment on their savings—as in the case of corralito—as the value of the securitized obligations would likely
trade well below par for some time, particularly if the obligations were linked to the issuing bank rather than
the sovereign.
Finance the Run
Yet another approach would be to let deposits fly. Given the ECB’s commitment to support an overvalued
exchange rate in our scenario, the NCB of the exiting country can choose to finance the run on the bank,
allowing depositors to liquidate their deposits and convert them into the “stronger” euro. While this would be
the approach with the most popular appeal, it is problematic inasmuch as it rapidly expands the monetary
base—rendering the exchange rate targeting by the ECB more onerous and the domestic inflation pressures
more severe—and will make the domestic banks almost wholly reliant upon the NCB/domestic sovereign.
Furthermore, unbridled deposit flight in one or multiple exiting countries may trigger deposit flight in other
countries choosing to remain in the euro.
Extricating the NCB from the Eurosystem
The ECB will have a significant claim on exiting banks, which are collateralized and intermediated by the NCB
(or ELA). One option is for the ECB to continue rolling over this loan to the exiting banks, but once the currency
of the exiting country redenominates, the ECB will hold credit risk, in addition to existing counterparty risk. As
time passes and the currency band widens, the exiting bank will find it increasingly difficult to service this
foreign-currency (euro) loan, unless it has sufficient foreign-currency assets to match it. Given that the ECB will
have committed to exchange-rate targeting in our scenario, one option to prevent the relative appreciation of
FX liabilities would be for the NCB/ELA to dis-intermediate the ECB by purchasing the private bank’s collateral
off the ECB, using euros effectively printed via ELA; these euros would effectively become part of the monetary
base in the exiting country and like physical currency, would represents an IOU of the sovereign, continuing to
reside on the liability side of the NCB balance sheet. The ECB claim on the NCB would be replaced by newly
issued currency of the non-exiting union and the NCB would be the ultimate creditor of the previous ECB repo
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operations to the private bank. Ideally, these balance transfers occur before redenomination so that at the
point of redenomination, the asset and liabilities of the NCB redenominate into the new currency,
extinguishing both the NCB’s and the private bank’s foreign currency liability to the Eurosystem.
Other Counterparties and Secured Creditors
Banks are major counterparties to myriad swap and derivative transactions, and are also major borrowers of
short-term collateralized funding. Such transactions will need to be quickly resolved to mitigate the cost of
bank restructuring and the threat of ballooning FX liabilities. Foreign creditor financial institutions and
counterparties face potential losses and, while courts may rule in their favour, enforcing said claims on
domestic assets of exiting banks will prove challenging, if not fruitless.
A termination event or an event of default may trigger a cascade of defaults across the borrower’s
counterparty agreements, and in turn trigger automatic or early termination of those agreements. This may be
mitigated by a temporary stay of termination rights (as under Dodd-Frank). As mentioned earlier, caution
should be taken when implementing exchange or capital controls to prevent panic or sudden non-performance
of the significant counterparty obligations of exiting banks.
Redenomination per se does not necessarily trigger a termination event or an event of default. If obligations
continue to be serviced in a new currency that is equivalent to the previous currency (or that of the original
contract), or equivalent collateral is presented, then there is no clear case for termination or default. However,
a termination or credit event, which may trigger early or automatic termination across all or most of the bank’s
counterparty agreements, could be triggered if there is an issue of “illegality”, the bank is unable to service its
obligations or the bank is prohibited from servicing said obligations due to capital/exchange controls.
Regulators, NCBs and finance ministries in the exiting countries and rump euro area must quickly assess the
impact of these mismatches and terminations, and if need be, intervene and supply funds to allow for orderly
unwinding of exposures, providing liquidity. However, the sudden disappearance of hedges and appearance of
currency risk will generate market volatility, particularly if the leaving country has large, systemically important
international banks.
For collateralized short-term borrowing, the NCB/ELA can replicate the strategy taken to extricate itself from
the Eurosystem, effectively disintermediating the ultimate foreign lender in the transaction and alleviating the
potential FX liability of the private banking system. Another option is for these transactions to be left or moved
into a rump entity with the matching underlying assets in the process of deep bank restructuring, with the
foreign lender ultimately absorbing some losses.
Private-Sector Bank Bondholders
Treatment of private creditors holding direct claims on the exiting banks will depend upon the jurisdiction
prevailing over the contract. For Greek law contracts, the bonds would redenominate to the new currency with
bondholders facing a devaluation of their claims. Foreign law contracts would not redenominate into the new
local currency and thus create exchange rate risk for the bank and greater credit risk for the bondholder as the
liability becomes more expensive to service over time as the currency band widens. If, as we envision, the
band widens very slowly and the default rate of bank assets does not generate excessive provisioning, future
earnings may suffice to cover this increased interest burden. However, principal repayment will be increasingly
onerous, the longer the duration of the FX liability. To service these redemptions, banks will need to dispose of
assets or hoard the cash from loans that mature (retarding credit expansion). Where there is a shortfall, the
banks will need to borrow the residual. In aggregate, however, the debt burden of FX liabilities will be greater
at redemption than at the point of redenomination.
If there are significant concerns about the capacity of the institutions to preserve the currency bands and there
are insufficient matching FX assets, exiting banks should 1) enter into FX swaps with willing counterparties to
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Chapter 4—Financial and Real-Economy Impact: Managing the Financial System
hedge the rate risk; or 2) negotiate a change in terms of the debt. Official sector entities like the ECB may be
the only willing counterparties in such an FX hedge transaction and will absorb the devaluation should the
counterparty sustain an inflated exchange rate. A change in terms could entail either an extension of the
maturities of the debt or an immediate prepayment. A change in the law governing the contract or insertion of
CACs would likely not be well-received by creditors wishing to sink their heels in and happy to fight in English
courts. An extension may be negotiated, but will ultimately prove more expensive to the debtor than
negotiating an immediate prepayment, financed by the NCB and executed at a still favourable exchange rate.
However, given the desirability of containing the cost of resolving the banking system without further
pressuring the finances of the state and limiting the legal delays likely imposed by disgruntled creditors, the
sovereign may choose an aggressive restructuring path under the newly minted resolution powers. This could
have the double benefit of not only containing the cost of restructuring (via burden sharing with debt holders),
but also isolating the impact of severe mismatches in FX assets and liabilities. Ideally, domestic deposits and
NCB claims would be “sold” with matching assets to a stronger bank, with the purchase financed by the
sovereign (or official sector). Some foreign currency assets would move with the deposit base, to minimize the
cost to the state as defaults rise sharply. The rump entity would have its bank licence revoked and become an
asset manager with an objective to wind-up while minimizing losses, and would isolate private sector and
foreign claims with a stack of residual assets, which may comprise a large portion of the original bank’s foreign
assets. Ultimately, the default rate of the matching assets and the FX mismatch will determine the solvency
implications of the widening of the currency band. The solvency shortfall (and the breadth of deposit leakage)
will have direct implications for the support the exiting sovereign will need to provide to its domestic banking
We assume that the NCB has unwound the repurchase and other collateralized financing agreements between
the exiting banks and other counterparties, effectively becoming the domestic banking system’s lender of last
resort. A sovereign debt restructuring implies similar solutions to a high default rate which follows the
transition away from a fixed exchange rate regime. The writedown of government claims will reduce the
capital of the bank. Should the writedown drive the bank into insolvency, the state can choose to recapitalize
the bank or provide a waiver that effectively suspends capital requirements during the restructuring process.
Recapitalizing the bank is, in many ways, “easier” than restructuring the bank. It is, however, more costly and
may unfairly restrict burden-sharing to depositors while making bondholders whole. With resolution powers,
the sovereign can aggressively restructure the bank(s), as discussed in the section above.
Insurance companies have predictable claims to pay out, but short-term liquidity runs are not an issue unless
policyholders wish to surrender and take a loss through a penalty. Asset managers, including hedge funds and
money market funds, could see a run on their liabilities, which are generally short term in nature and easily
redeemed (with a penalty for less liquid investments like private equity). Redemptions and policy surrenders
would likely need to be suspended and domestic liabilities face forced redenomination. Where a fund manager
is notably leveraged and the debt is financed externally, there is certainly an asset liability mismatch and the
investor may need to default on the creditor or face a takeover by creditors. Generally speaking, traditional
asset managers rely on little to no leverage, with insurers being perhaps the most reliant upon capital markets,
and policyholders or “depositors” tend to be domestic residents. This minimizes the potential FX asset liability
mismatch, relative to banks, at the point of redenomination. However, a sovereign debt restructuring could be
detrimental to the solvency position of some of these institutions. In the case of insurance companies, it is
likely that the brunt of this burden would be borne by shareholders, so as to limit the potential of disruptions
in payments to policyholders.
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Chapter 5— Financial and Real-Economy Impact: Capital Markets
Chapter 5— Financial and Real-Economy Impact: Capital Markets
Ensuring that capital market disruptions are kept to a minimum in the aftermath of an exit of one or more
members from a monetary union is important, as it will:
Directly preserve the wealth of savers and investors, and thus indirectly lessen the impact on
economic activity through wealth effects on consumption and investment;
Establish a positive precedent and serve as a template for future exits, if such exits are
eventually warranted (despite any official denials and adamant statements about uniqueness,
investors will inevitably assume this); and
Limit economic and financial contagion to other parts of the EZ, and keep the US$700 trillion
derivatives doomsday machine from becoming unstable, as it became during the LTCM and
Lehman Brothers episodes.
We will address the following instruments and sectors in this section:
Sovereign Debt
Corporate Bonds and Loans
Equity Markets
“Shadow Banking”: repurchase agreements, futures markets and OTC derivatives such as interest rate
swaps, currency forwards and CDS
Sovereign Bonds
Within the confines of a single currency, single states with low growth and high fiscal deficits can struggle to
achieve debt sustainability. However, following the introduction of a new currency, as described in Part III
(Legal Implications), all local-law payments would be redenominated into the new legal tender. This makes
things different. Certain constraints, familiar from emerging markets with external debt, disappear, as the
country now has its own central bank that can finance deficits. Rather than being compared with Argentina or
Russia in the 1990s, a better comparison is the UK (which can tolerate huge deficits today and survived with
huge debt after World War Two) or Japan in the past few decades.
To retain the maximum amount of household, pension and insurance company wealth, to limit disruption to
the banking system, which will already be traumatized by the currency change and possible deposit runs, and
to avoid becoming an international pariah, sovereign debt payments should be maintained and every effort
should be made to achieve a stable market. Ideally, the growth and inflation paths keep debt dynamics
contained, although this stabilization may take time and aid, transfers and subsidized loans will likely be
needed for a long time, but these should be mostly limited to financing fiscal deficits, not bailing out all
bondholders. The conditions, and thus, the goals for achieving a stable government bond market are as
Supply must meet demand. In the government bond market, fiscal deficits and maturities need to be
met with buyers, so a degree of financial repression and a central bank that is legally and
operationally able to purchase government debt might be needed. Eventually, a free-floating,
devalued (undervalued) currency that holds the promise of capital gains should obviate the need for
high interest rates and heavy-handed measures, since credit risk is not the key issue, and step-deval
risk is also not priced into yield curves.
Real interest rates must be contained. If none of the above measures work, and interest service
remains an increasingly intolerable burden on government finances, there will be a higher likelihood
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of default for political reasons, especially if much of the domestic debt is owned by foreigners and if
monetization leads to capital flight, currency-overshooting and inflation.
Fiscal balance. The above conditions should allow for manageable debt service and liquidity, but the
fiscal balance, including interest, must then be structurally stable and, cyclically adjusted, be in line
with nominal growth (note that small deficits are perfectly sustainable even over an infinite horizon,
and debt need never actually be repaid).
Fiscal austerity that causes a permanent recession or depression is self-defeating—although that
hasn’t prevented countries from trying it, or being forced onto such a path for the benefit of
creditors. In this case, supply and demand must be equal across the entire economy, which means
public and private savings and deficits must balance out. If the government attempts to save at the
same time as the private sector, “other sectors must save less”, and if households are still
deleveraging as well, the result will be to “demolish corporate profits” (Martin Wolf in the FT, Nov
2011, ““Why cutting fiscal deficits is an assault on profits” and Dec-2011, “Understanding sectoral
balances for the UK”).Thus, pursuing the stability of the public sector balance sheet might have to be
deferred until the private sector deleverages sufficiently or finds its animal spirits reawakened, both
of which depend on confidence in future prospects.
If these conditions are not met even after (IMF, rescue fund and bilateral) money, political capital and patience
is exhausted, debt may need to be reprofiled or restructured, but we would still urge the exiting country to
avoid the disruption of a unilateral default, as practiced by countries from Weimar Germany and the newly
independent USSR to Ecuador and Ivory Coast. These are not examples to emulate, if history is anything to go
by. Rather, small countries like Jamaica and Uruguay have provided a good template, while Israel and Lebanon
show that generous aid and direct transfers can preserve stability, and sustain the unsustainable until better
times arrive, or do not.
A realistic debt sustainability exercise might show that even tremendous austerity and subsidized rates along
with some financial repression leads to insolvency (as is clearly the case with Greece today, and quite likely
Portugal, even with monetary independence). In this case a debt exchange with principal reduction, and
possibly debt forgiveness by the official sector as well, will be needed. For countries that need to restructure
their economies and reorient toward export growth, a straightforward five-to-seven year extension of
maturity with coupons on bonds are kept unchanged should be tried first. The tremendous waste of bailout
money being used to finance the not-so-slow exit of investors as billions upon billions mature month after
month is thus avoided. The insertion of collective action clauses (CACs) into local law bonds, as Greece is now
doing, gives an orderly restructuring a much better chance of pressuring hold-outs, especially as local banks
and investors can be encouraged to participate for the sake of the nation. If the CACs then need to be used,
CDS will be triggered, but with recovery values in the high 90s, the disruption should be minimal, as it was
when Fannie Mae and Freddie Mac triggered their CDS. Banks may need to call on additional capital, and the
ECB should take its losses along with other senior unsecured bondholders, as it made the choice not to lend on
a secured basis, and can operate completely unaffected by such losses. As with many of our solutions, this is
not necessarily an optimal solution, especially from the creditor nations’ point of view: if foreigners own a
large proportion of the debt, and the fiscal situation is dire, the temptation to default may be rational and the
benefits outweigh the costs. However, from the standpoint of stability and wealth preservation for the exiting
country and the EZ alike, maintaining the status quo and keeping bondholders whole is the best path, and in
our view, an achievable one.
Corporate Bonds and Loans
Domestically traded bonds that were originally issued in euros will, in most cases, be redenominated into the
new home currency. However, as the initial devaluation is small, the future cashflows will be severely
discounted in nominal terms to price in the future devaluations, resulting in a price decline of 30-50%. This is
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Chapter 5— Financial and Real-Economy Impact: Capital Markets
therefore a direct wealth transfer from creditors/investors to debtors, just as with sovereign (local) bonds.
However, for local pension funds and banks, whose deposits, liabilities and other obligations are likewise
transformed into the new currency, the reduced assets match reduced liabilities and no mark-to-market losses
need to be taken as long as bonds remain current. Many issuers, having taken the precaution of removing their
deposits from domestic banks, might even take advantage of the situation and use their hard currency to
conduct buybacks and deleverage. Others will face higher real rates when they need to refinance in domestic
or foreign currency, and some bankruptcies and restructurings may occur as a result.
For bonds issued on international markets, whether denominated in euros or dollars or other currencies, the
option of local-law cramdown is not available, although in some cases European or international law may favor
redenomination on the basis of lex monetae. We strongly advocate the EU passing clear laws on when this
applies, lest the lack of clarity results in a mass of litigation across the continent. For most loans and
international bonds governed under laws other than those of the exiting country/countries, the currency
would not revert to the home currency/currencies. Our reasoning is as follows, with excerpts taken from the
offering circular of Greece’s Hellenic Republic July-2018 FRN used as a concrete example:
Despite the obligor being a local firm or government, the fact that the borrowing took place in an
international setting, makes it hard to argue that the location of the transaction is the domestic
Paying agents are typically in London or Luxembourg and frequent references to “external
indebtedness”, defined explicitly as “expressed or payable or optionally payable in a currency
other than the lawful currency of the [borrower]” or “borrowed from or initially placed with a
foreign institution or person under a contract governed by the laws of a jurisdiction other than
the [borrower]”, making it harder for courts to defer to local jurisdiction.
Bonds might specify that “the courts of England [or other governing law] are to have jurisdiction
to settle any disputes which may arise … and that accordingly any suit, action or proceedings …
may be brought in such courts….The Republic hereby irrevocably waives any objection which it
may have now or hereafter to the laying of the venue of any such Proceedings in any such
On the other hand, investors’ claims on sovereign or corporate debt in case of default will still
face a daunting task, and in those cases may be bound by language specifying that
“Notwithstanding the foregoing, the property of the [borrower] is subject to execution and
attachment to the extent permitted by the international conventions and [home country] law.”
Thus, in many cases, assets and income streams will be greatly reduced in real terms, while the liabilities
remain in “hard” currency, causing the notorious “balance sheet effect” for companies with domestic
orientation (multinationals and exporters will benefit). Those with short maturities may be able to take
advantage of the initial overvaluation of the exchange rate, and pay off the bonds with overvalued domestic
currency that is sold to the ECB.
Equity Markets
There should be no need for interference with stock exchanges, which even in the event of disorderly
devaluations or terrorist attacks, have continued to function in an orderly manner. With the removal of the
chaotic, uncontrollable tail risks of default and massive devaluation, and the preservation of strong ties and
support with the EU, a large rise in equity prices would be likely, especially once the first few mini-devals are
out of the way and expectations settle down.
The main change will be to shift the denomination of equity share prices into the country’s new currency,
which may require several nights of reprogramming and tests, but should be completed within a few days at
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most. It will be left up to the stock exchange directors whether a short closure is needed during this period, or
if stocks can continue to trade and systems can be adjusted.
In principle, financial contracts are agreements between private parties, typically under U.S. or U.K. laws or
jurisdiction, subject to some regulatory oversight and governed (by mutual accord), by an the International
Swaps and Derivatives Association (ISDA) agreement. So, in accordance with the legal section of our proposal,
and the foreign-law bonds remaining unchanged, we would expect derivatives to stay largely unchanged. This
may create severe difficulties for the local entities, who now have hedges they don’t need and foreign
currency exposures (i.e. euro) that do not match up against assets that have been redenominated (mortgages,
local bonds, etc.)
Because derivatives have a buyer and seller of the underlying risk, the new regime and shift in prices is likely to
create a winner and a loser – it is unlikely that both will have the same financial incentive to unwind or
redenominated the contract. However, ISDA can aid the process by advising guidelines and providing fixing
rates for those who do want to cancel or unwind exposures.
The area of shadow banking is probably both the most dangerous one and the most challenging to control. As
Lehman showed: exposures and counterparty risk embedded in hundreds of trillions of dollars’ worth of
contracts is difficult to predict and can be extremely destabilizing. Several law firms have commented on the
prospects for this market under an EZ exit, but have not reached strong and solid conclusions. In addition,
while ISDA can make decisions that are fairly binding, especially if it clarifies what outcome would result
following arbitration, every individual pair of counterparties has “ISDA Master Agreement” which govern
terms, but can vary considerably and contain unique and bespoke terms. The most worrisome aspect of a
currency exit and treaty change that may also involve forced redenomination of sovereign and private
contracts into a new currency is that termination clauses may thus be triggered. This may affect individual
swap or forward or option contracts, but it may also trigger wholesale counterparty risk, if certain events are
specified in the so-called “Additional Termination Events” (see Kramer & Levin for examples of typical clauses).
Counterparties that may want to reduce exposure may claim that the entire episode falls under force majeure,
that the capital controls, even if minor or temporary, justify termination, or that the forced conversion of a
counterparty’s assets is a “material adverse change in creditworthiness”. Another possible path to termination
is if (as described in the financial sector section), a financial institution’s bonds are redenominated into the
new currency, which is quite clearly an Event of Default and triggers CDS on that entity. That’s bad enough, but
the truly worrisome consequence would be if cross-default clauses in ISDAs are then triggered, which means
all the affected derivative exposures of a systemically important financial firm instantly disappear, resulting in
tens of trillions of notional amounts of derivatives being unhedged.
There is no way to foresee exactly what might happen, but a stress test should be run based on such a scenario
before the actual event, with regulators looking in detail with lawyers, accountants, risk managers, settlement
experts, and traders at the fine print. In case of likely widespread termination or mass litigation, the best way
forward would be to rewrite the laws and push ISDA to do a “big bang” reform to allow for a sovereign
currency to replace a currency union without termination. However, we would expect many in the industry to
strenuously resist, so reducing this potential nightmare is easier said than done.
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Chapter 6— Financial and Real-Economy Impact: The Real Economy
Chapter 6— Financial and Real-Economy Impact: The Real Economy
The economic logic for allowing a partial breakup of the EZ, and the net beneficial impact this would have on
the real economy for both exiting and remaining countries, is compelling. As developments since the onset of
the sovereign debt crisis have consistently shown, the strategy of policy makers to desperately defend EMU
(sarcastically referred to by some as an acronym for “Even More Unemployment’) in its current form is
pushing Europe’s periphery into ever deeper recession, while generating immense financial instability at the
same time. Recent economic data from the EZ continues to illustrate that dose after dose of fiscal austerity
in the name of returning sustainability to national public finances and restoring bond market sentiment,
especially when implemented in conjunction with the painful process of structural adjustment and internal
devaluation, leads to prolonged periods of GDP contraction. This inevitably translates into, among other
things, soaring levels of joblessness, particularly among Europe’s youth. There is a real danger that youth
joblessness could become structurally embedded in Europe’s struggling southern economies, with all the
lasting social, political and economic implications this will bring. There are clear signs that contagion from
the continent’s sovereign debt crisis has reached the EZ core, with escalated spreads between German
borrowing costs and those of Belgium and France, and recent data showing that even Germany and France
may have re-entered recession at the end of 2011.
Figure 8: Youth Unemployment in the EZ Periphery
Source: Eurostat
Figure 9: Manufacturing PMIs
Source: Markit
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Chapter 6— Financial and Real-Economy Impact: The Real Economy
Insufficient Crisis Response
The EZ crisis response as enshrined in the fiscal compact ensures that only some of the imbalances within the
EZ are being addressed. The EZ is being forced to make a completely asymmetric adjustment, whereby the
periphery must implement austerity that kills off domestic demand, rendering the weaker countries entirely
reliant on exports for growth. In the meantime, the core does not adjust its growth model at all. Each EZ
country has its largest share of trade with other EZ members, and consequently the plan to shift all EZ
countries to a model based on export-led growth simply cannot work. For the weaker countries to unwind
their current account deficits, the stronger countries must be willing to unwind their current account
surpluses. Continuing along the current path of retrenchment in the periphery with no adjustment in the core
will ensure that public debt burdens in the periphery continue their unsustainable upward trajectory and
ultimately lead to a damaging disorderly breakup of the single currency through a series of cascading sovereign
defaults. Only a rapid change in policy can alter what increasingly resembles an accelerating economic train
Figure 10: Share of Merchandise Trade Going to EZ
Source: Haver, RGE
Figure 11: Current Account Balances as a Share of GDP
EZ Core*
Source: Haver, RGE
**IT, GR, IE, PT, ES
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Chapter 6— Financial and Real-Economy Impact: The Real Economy
Rebalancing—The Ultimate Goal
The ultimate goal of a partial dismantlement of the EZ is to pave the way for a more balanced and therefore
more sustainable growth process among its current membership, and gradually eradicate the destabilizing
imbalances between the core and peripheral economies. We believe this would represent a positive
development for both exiting countries and the remaining rump euro membership, by ensuring similar
economic growth rates and a relatively equal distribution of wealth in Europe. Countries exiting the EZ and
those remaining in the rump euro would rebalance their economies. The peripheral countries that we expect
to exit would still shift their growth models away from external and public debt-driven growth and towards
exports, but this adjustment would be facilitated by a gradual devaluation of their new national currencies.
The countries that remain in the rump euro would also have to undergo adjustment away from their typical
export-driven growth models, becoming more reliant on domestic demand. This adjustment would be
facilitated as well by gradual currency realignment with the exiting countries, which would shift the relative
prices of tradables and non-tradables. Gradual nominal currency movements would entail far less of a shock to
the real economy than changing relative prices with a fixed nominal exchange rate, which implies severe or
protracted deflation in debtor countries and high or sustained inflation above target in surplus countries.
The benefits for struggling peripheral economies abandoning the EZ and gradually devaluing their currencies—
through a temporary shift from inflation- to exchange rate-targeting on behalf of the ECB and gradually
widening (crawling peg) trading bands before eventually introducing fully floating independent national
currencies (for a more detailed explanation, see Chapter 4)—would likely become visible within a relatively
short period of time, returning solid output growth to the periphery and starting the process of readjusting
hitherto unsustainable and destabilizing intra-EZ macroeconomic fiscal and private-sector imbalances.
Moreover, this rebalancing would also help the core, whose economies are now also showing clear signs of
distress arising from the sovereign debt crisis and worsening market sentiment, with corresponding negative
ramifications for governments’ budgetary positions, with the exception of that of Germany. The growth pickup
in Europe’s southern economies, alongside a generally more stable financial and macroeconomic environment
resulting from the newly returned solid output growth in the exiting members, would surely also benefit the
core countries, which, with the exception of Germany, would see reduced public borrowing costs. Indeed,
even Germany could see its borrowing costs fall following an exit of weaker countries from the EZ if, in the run
up to the exit, investors recognized that, whether the ultimate bill of kicking the can is traced through the
bailout programmes, through bailout fund guarantees or through the ECB, far and away the largest share of it
ends up with Germany. Germany’s borrowing costs have remained low (and for a short period of time were
negative) as investors have flown to safety, but eventually markets might lose confidence in Germany,
worrying that it could bankrupt itself by having to pay for the rest of the region.
Figure 12: 10-Year Government Bond Yields
Source: Bloomberg
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If weaker countries exit the EZ and are able to gradually devalue their new currencies and ultimately float
them, their external sectors would benefit significantly, with a substantial acceleration in export growth from
increased competitiveness, which would likely balance out any short-term decline in domestic private
consumption from the resulting fall in real wealth, increases in the price of imports and inflation. Conversely,
the rump euro countries might lose their trade surpluses, but consumers would benefit from cheap exports in
the periphery. While we would expect a big increase in the export and nominal GDP growth of countries
leaving the EZ (of which a great deal would obviously be captured by a sharp inflation hike, as occurred after
the partial breakup of ERM in the early 1990s), most peripheral economies would relinquish the euro with
elevated unemployment rates. This would to a considerable degree mitigate the risk of inflation feeding into
real wages and consumer price hikes spiralling out of control, and enable significant increases in real GDP
growth. This would particularly be the case if, as we assume, the exiting countries leave the EZ in an orderly
manner, with only gradual devaluations of newly minted currencies and national central banks in a position to
hike interest rates. This would also likely ensure that a larger-than-expected degree of increased nominal GDP
would translate into higher real GDP.
Moreover, the rebalancing process would also benefit the EZ core, with a greater emphasis on domestic
private consumption, most obviously in Germany, reducing these countries’ current over-reliance on the
external sector for output growth, while by no means eliminating a system of free trade between exiting and
continuing members. Of course, within the rump EZ, there would need to be greater economic, financial and
fiscal integration to maximize the single currency’s benefits and ensure its future stability.
Again, it is important to stress that allowing a number of current members to exit EMU need not eliminate all
incentives for these countries to proceed with existing and much-needed fiscal and structural reform
programmes, which would be crucial to place public finances on a downward trajectory, create lasting and
sustainable economic growth through the boosting of productivity and eliminate current account imbalances.
Devaluation would not be allowed to take the place of structural reforms as it was consistently allowed to do
in the pre-EZ years for several if not all southern countries. The continued support of the ECB (as described
earlier) required to facilitate an orderly EZ-exit would clearly be strictly conditional on a process of gradual
devaluation and adherence to a reform program, to prevent both excessive domestic inflation and the
perception that these countries were benefitting excessively at the expense of the core from “beggar thy
neighbour” mercantilism. Monetary and financial support would be therefore conditional on the introduction
of wholesale labour-market and supply-side economic reforms to eventually facilitate sustainable economic
growth and gradual reductions in excessive public-sector debt (clearly a more effective method than envisaged
in the EZ’s watered down “Fiscal Compact”, which is just a slightly more robust version of the “Stability and
Growth Pact”).
The EU Can Remain Strong and Effective
Just as the EU has comfortably weathered the numerous existential crises since its inception as the Coal and
Steel Community in 1951, so would it likely survive the partial break-up of EMU, as envisioned in this essay.
Indeed, the process of European integration has not only remained intact, but has in fact prospered from the
multiple competitive devaluations that followed the exit of several countries from Europe’s ERM and
abandonment of a policy of pegging national currencies to the European currency unit (ECU) by several other
EU member state in the early 1990s. There is little to suggest that the partial break-up of the single currency
would precipitate the rapid unwinding of the EU and significantly reverse over 60 years of European
integration. The EU’s existing institutional, cultural, social and economic fabric is too firmly intertwined and
embedded in member states’ economies to facilitate its collapse. While accepting that our proposal for
abandoning the euro as it currently exists would have significant costs, with some actors inevitably gaining
more than others and the ECB paying the most, an orderly breakup of the single currency represents the most
efficient means of ensuring an overall equitable distribution of wealth in Europe.
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Chapter 6— Financial and Real-Economy Impact: The Real Economy
Despite the break-up of the EZ in its current form, member states would inevitably wish to remain part of a
union that retains its current political and economic fabric and regulatory institutions because it is widely
perceived to have successfully worked in both the common and different national interests over the past 60
years. Indeed, a somewhat paradoxical phenomenon of the EU of the past 20 years is that the member states
that have traditionally been the principle sceptics of monetary union, and have chosen to remain outside the
single currency (notably the UK, Denmark and Sweden), have been among the most ardent proponents of the
common market and of further increasing the liberalization of trade and services within it. So attractive is this
economic integration that non-EU European countries such as Norway and Switzerland are de-facto bound to
play by the EU’s rules, even as they have given up a direct voice in determining those rules, and several other
countries are also currently seeking membership.
While we are convinced that EMU can indeed be successfully dismantled in an orderly fashion, there are clear
economic, political and social benefits attached to EU integration, principally as a platform for intra-European
commerce (with the associated freedom it brings for the movement of goods and services, capital and people)
for all EU member countries. Assertions to the contrary by political leaders, including French and German
leaders Nicolas Sarkozy and Angela Merkel, should be considered little more than the scaremongering to force
peripheral members to get their fiscal houses in order. As part of the orderly EZ dissolution, such comments
should be withdrawn and a renewed commitment to a multi-currency EU should be made.
As consistently articulated by the founders of EMU, at its core, the single currency zone was perceived as a
political rather than economic project, with European federalists regarding the euro as the logical point of
progression following the economic reforms of the 1980s that created a much deeper EU common market
under the European Commission presidency of Jacques Delors. The euro was therefore conceived and
introduced as a mechanism to deliver enhanced political integration aimed at fulfilling what prominent
continental leaders hoped would eventually become an economic, fiscal and political “United States of
Europe”. That this much anticipated European political and fiscal union has yet to materialize, almost 20 years
after the single currency was first legislated for in the Maastricht Treaty, has exposed the flawed assumptions
underpinning the euro’s design.
The Political and Social Costs of Sticking With the Euro
While principally focusing our attention on the macroeconomic case for abandoning the euro, we also argue
that the measures required for its survival are politically outdated and increasingly out of sync with the mood
of national electorates. Just as electorates across the member states are increasingly aware of the inherent
flaws in the EZ’s construct, so are they also waking up to the full implications of its retention in its current form
for national, economic and political sovereignty. Empirical evidence of increased voter concern about the
consequences of the cost of saving the euro in its present form are evident from the rise of right-wing and
populist national political movements across the continent—in the Netherlands, Finland, France and Ireland to
name but a few. Unlike the conventional wisdom frequently promoted by European policy makers, that a euro
breakup would create conditions for social and political upheaval across the continent, it is at least as likely
that a continuation with this failed monetary experiment and measures required to ensure its survival,
“whatever the costs”, could lead to a return to unsavoury 1930s-style ideological nationalist extremism. This in
turn would likely pose a far greater threat of EU breakup than a partial unravelling of the euro. Moreover, this
rise of popular anger, and mistrust in the response of policy makers to the EZ crisis is increasingly a feature in
both core and peripheral economies, with debtor countries just as likely to suffer from bailout fatigue as the
creditor countries of the EZ core.
Furthermore, the concerns of several leading policy makers and influential commentators that an EZ break-up,
orderly or otherwise, could not only lead to the reversal of European economic and political integration, but to
a return to continental military conflict, are unrealistic. Indeed, the status quo of forcing painful deflationary
adjustment in the European periphery may well be just as likely to result in social upheaval, the return of
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dangerous reactionary politics and a disorderly EZ break-up with possible conflict, than an orderly exit of one
or several members.
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Chapter 7— Lessons of the Past for Those Who Make EZ History
Chapter 7— Lessons of the Past for Those Who Make EZ History
The historical and contemporary experience of monetary unions provides useful compares and contrasts for
EMU: The success stories tend to provide object lessons about what to do to preserve the rump EZ. Most
monetary disintegrations tend to offer cautionary tales about what not to do to achieve an amicable,
orderly divorce—though some show that orderly disunion is possible. In addition, the experience of different
countries in exiting the gold standard during the Great Depression suggests sooner is better—itself a
potential marker for the today’s EZ predicament.
Two key elements that differentiate EMU form other monetary unions are the operational practices and the
institutional framework in which those unions were embedded. In this chapter, we consider:
Broad-brush implications from the theoretical literature on monetary unions
Contemporary and historical monetary unions
The distinctive operational and institutional characteristics of EMU
A selection of relevant historical episodes of the construction and disbandment of monetary regimes.
General Historical and Theoretical Lessons from Monetary Unions and Regime Shifts
The optimum currency area literature is relevant insofar as it predicted the importance of fiscal shocks in
destabilizing EMU. Moreover, it suggests that the requirement of high labor mobility within the currency
area—identified by Robert Mundell—may be less crucial than the requirement for fiscal union, identified by
Peter Kennen. This in turn suggests that a rump eurozone may not need to evolve a common language, but
may on the other hand need to develop robust fiscal mechanisms that enable it to adjust to asymmetric
economic and financial shocks and use countercyclical fiscal policy across the region, while on the other hand
adopting balanced-budget rules at national level.
A major question is whether adoption of a new monetary regime, including monetary union perceived to be a
permanent or a temporary change. The literature suggests that a monetary regime will only be stable if it is
internally consistent (that is, if monetary policy, fiscal policy and exchange rate policy are consistent with each
other) and if the public finds the combination of these three policies credible. More specifically, taking stock
of advances in economic theory that consider the role of expectations in causing asset and commodity price
changes, the literature on monetary regimes has found that the credibility of the promise of the convertibility
of a currency hinges on two elements: long-run fiscal sustainability and the government’s reserve holdings.
The latter is perhaps most relevant for small countries and “emerging markets” that lack credibility and need
to defend their exchange rates, or in an externally fixed exchange rate regime with reserve backing for
monetary aggregates. But in an externally floating currency regime, such as EMU, credibility hinges on the
perceived stability of the rules of the game—in this case fiscal, financial and price stability. Unfortunately, so
far, there are two strikes.
Figure 13 summarizes these characteristics for eight historical and contemporary monetary regimes. Historical
precedents suggest that five characteristics help determine the stability of monetary unions. Those are the
presence of: (a) a political union—most durable monetary unions tend to be single-sovereign, even when they
are multi-nation monetary unions; (b) central oversight of monetary policy, the money supply and banking
system by a central bank; (d) fiscal transfers and fiscal federalism among member states, typically as a way of
managing the economic cycle and responding to asymmetric regional shocks, rather than bailing out excessive
member-state debt; implying (c) hard-budget constraints at the member-state or regional constituent level;
Bordo and Capie (1993, eds.)
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Chapter 7— Lessons of the Past for Those Who Make EZ History
and (e) a financial stability function for the central bank, typically incorporating strong and even automatic
fiscal backing to absorb quasi-fiscal losses.
Figure 13: Key Characteristics of Eight Historical and Contemporary Monetary Regimes
of member
control of
supply by
of CB
Regime type
to Gold Standard
monetary union
hardbudget constraints
Civil War
Added CB financial
stability function
Yes (mostly)
U.S. (post1935)
exchange rate
monetary union
CB’s control of MS
Sui generis
Contemporary Monetary Unions
The United States
The U.S. evolved a national monetary union in steps over two centuries, ultimately producing a fully fledged
monetary and fiscal union. While the U.S.’s monetary arrangement is perhaps the most relevant comparison
for EMU, no monetary union exactly corresponds to EMU.
Figure 13 shows that EMU is a unique institutional arrangement. EMU is highly coordinated at the monetary
level (the ECB has centralized control over the money supply and an implicit financial stability function, and
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Chapter 7— Lessons of the Past for Those Who Make EZ History
financial markets are deeply integrated), but it is neither politically unified nor fiscally coordinated. In contrast,
the U.S. first integrated politically and fiscally before deepening its monetary unification. The table also reflects
the importance of elements of the optimum currency area theory, combined with political dimensions. While
the U.S. did not evolve a fully fledged monetary union, with centralized control by the central bank (the
Federal Reserve’s board of governors) of the money supply and a financial stability function for the central
bank, until 1935, it laid the groundwork for monetary union by developing strong fiscal mechanisms over the
course of the 19 century. It first developed the ability to assume state debt and rely on a federal tax revenue
base and issue federal debt. It then refused to bail out states following the panic of 1837, leading states to
adopt balanced-budget constitutional provisions. The Civil War destabilized this robust fiscal union and added
barriers to monetary integration by suspending payments between the U.S. and the Confederate States, but
the construction of monetary union resumed after the war and was solidified by the creation of the Federal
Reserve in 1913 and the Banking Act of 1935, each of which was a step towards the centralization of the
control of the money supply by the central bank.
One particularly important difference between the U.S. and EMU is that the original intention of U.S. leaders in
the 18 and 19 centuries was to create a fiscal union, without being preoccupied with the type of monetary
regime in which this fiscal union operated. The debate about the first and second Bank of the United States
and the role of private banks issuing private currencies illustrates this hesitation with regards to monetary
integration. Conversely, the architects of EMU sought to use monetary unification as a step towards political—
and therefore, inevitably, fiscal—unification. The sequencing is therefore the opposite.
Equally important, the U.S.’s fiscal union was made more robust by the refusal of the federal government to
bail out states that were unable to repay their debt, and thus defaulted following the Panic of 1837. These
defaults together with the subsequent introduction in the 1840s of balanced budget rules in state
constitutions in large measure reversed the apparent moral hazard created by Alexander Hamilton, the first
Secretary of the Treasury and imposed hard budget constraints. 49 of the 50 states now have such balanced
budget amendments, the sole exception being Vermont; all new states had to adopt balanced budget rules in
acceding to join the United States. Indeed, after these financial and political threats to the integrity of fiscal
and political union that the usage was changed from plural to singular; before then, it was, “The United States
are…,” whereas now, one says, “The United States is….” or refer to the President of these United States,
whereas nowadays, it’s the President of the United States.
Today’s central bank, the Federal Reserve, only emerged in 1913 (in response to the bank runs during the crisis
of 1907) and only gained complete centralized control over the money supply with 1935 Banking Act, at which
point it also acquired the function of stabilizing the U.S. financial system. In contrast, EMU has achieved
extensive monetary integration, including the provision of an implicit financial stability role for the ECB
(through its mandate of ensuring the proper transmission of monetary policy mechanisms), but has failed at
introducing hard-budget constraints at the member-state level, let alone political unification.
Moreover, the repeated violation of the stability and growth pact by several large EMU member states since
1997 has undermined the monetary integrity of EMU. The absence of adequate structural fiscal transfers
within EMU has reduced the union’s ability to deal with the asymmetric financial and economic shocks, as was
made painfully clear in the aftermath of the 2008 crisis. Ultimately, the EMU’s set up—extensive monetary and
financial integration, but no fiscal coordination—is such that it is likely to eventually force one of three
outcomes: significant political and fiscal integration (at the EMU or EU level) to accompany monetary
unification; an extremely disorderly break-up; or a managed, orderly break-up.
Eichengreen (2008c)
Sargent (2011)
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Ruble Zone
The lesson for EMU from the chaotic break-up of the ruble zone in the 1990s is the importance of credibility
and central bank reserves. The collapse of the Soviet Union in 1991 caused a loss of credibility in the central
banks of periphery members of the ruble zone. Financial distress was contained by extensive capital and
exchange controls. Restrictions on withdrawals worked well due to the underdeveloped banking system of the
successor states to the former Soviet Union. Exchange controls similarly proved effective because the
successor states did not have a commitment to a single market. Currency redenomination was straightforward
because the economies did not rely on information technology in their banking systems, in contrast to the
EMU economies. Despite these supporting forces, the break-up took several years and was extremely
disorderly. This suggests that, for countries exiting EMU, emergency liquidity assistance (ELA) should be used
to move the assets and liabilities of the exiting member state back to that country, in line with our proposal.
Historical Monetary Unions and Regimes
History can show the differences between EMU and previous monetary union dissolutions. We discuss five
monetary regimes: the Latin monetary union, the Scandinavian monetary union, the Gold Standard,
Argentina’s peg to the U.S. dollar and the Czechoslovak monetary union.
Latin Monetary Union
The Latin monetary union (LMU) included four of the EZ’s current members—France, Italy, Belgium and
Greece (the other member was Switzerland). The LMU is interesting for two main reasons. First, it shows that a
monetary union has already existed in Europe. Second, the LMU suggests that the idea of circulating a parallel
currency would be unworkable in the case of EMU.
The LMU was created in 1865 out of the will of Belgium, France, Switzerland and Italy (and later Greece) to
harmonize the fineness (silver content) of their coinage. This was done to avoid the practice of reducing the
fineness of coins, which drove neighboring countries’ coins out of circulation (an example of Gresham’s Law).
The 1865 conference that founded the LMU did not address the issue of the paper notes in circulation,
meaning that members of the union retained a large degree of monetary independence.
The LMU was de jure on bimetallism, but its reliance on a 15.5:1 ratio of silver to gold made it, de facto, a gold
standard. Some saw it as a step toward the gold standard. As the relative price of gold increased, silver
became overvalued at the mint. This created arbitrage incentives and drove gold out of circulation—
Gresham’s Law, again. The LMU’s transition to the monometallic gold standard began in 1873, with restrictions
of the coinage of silver in the Netherlands, France and Belgium, which were then extended to the entire union
in 1874. By 1978, silver coinage had been suspended and the union had fully moved to the gold standard, but
de jure it remained in place until the early 20 century.
Scandinavian Monetary Union
Denmark, Sweden and Norway formed the Scandinavian Monetary Union (SMU) in 1873 following Germany’s
shift from silver to the gold standard. The members of the SMU traded heavily with Germany and were
compelled to follow suit. The fact that these countries’ currencies were already interchangeable increased the
appeal of coordinating the transition.
World War I imposed large financing needs on the SMU members, and large amounts of paper money were
issued without being recognized as legal tender. This put an end to both the SMU and the LMU. The break-up
of the LMU was straightforward, as member countries retained their own central banks and domestic
currencies. However, in the case of the SMU, capital controls were imposed to prevent the outflow of gold
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when the convertibility of national currencies into gold was suspended. Accordingly, exchange rates varied in
relation to the member countries’ respective monetary policies. The SMU’s dissolution was gradual: first,
national banknotes were not traded at par; then, gold coins were prevented from circulating between
countries; finally, coins were not traded at par.
Bilateral monetary unions, such as that between the UK and Ireland (dissolved in the 1970s) and that between
Luxembourg and Belgium, were terminated without major repercussions. The key factor in these successful
multinational monetary union break-ups was the maintenance of national central banks, which could quickly
reintroduce a national monetary union once the multinational monetary union was dissolved. The fact that
national central banks in EMU have remained fully operational, as demonstrated by the sizeable operations
undertaken under emergency liquidity assistance (ELA), gives further support to the feasibility of our plan.
The Gold Standard
One of the main lessons of the collapse of the gold standard in the early part of the Great Depression, starting
in 1929-30, is that the tension between internal and external policy objectives can become binding. In the
1920s, the external economic policy objective (“sound” fiscal and monetary policy aimed at preventing
currency depreciation—sometimes at the cost of deflation—and thereby defending convertibility) began to
compete with the internal objective (expansionary monetary and fiscal policy to alleviate unemployment). The
increase in the franchise was part of the reason that the internal economic policy objective began to win out.
One of its effects was to weaken the credibility of monetary authorities in fighting capital flows that weakened
the currency, meaning that capital flows could raise the pressure on the central bank, rather than reduce it.
The rise of unions in the 1920s caused downward rigidity in wages, which in turn increased unemployment
when economic disturbances occurred. This put pressure on governments to respond. The tight monetary and
fiscal policies that countries still on gold were forced to apply to defend their reserves further depressed their
economies. Expectations of changes in policy in those countries led to a sell-off of their currencies, which
forced central banks to raise interest rates, further deepening the depression. The expectation of an imminent
devaluation led to capital flight.
Deflationary price spirals clearly reinforced the case for going off gold convertibility. A number of Latin
American countries did this in 1929, while Austria and Germany implemented capital controls—and the UK
suspended convertibility—in 1931.
The effects of the depreciation were positive because they helped with the restoration of aggregate demand.
The first countries to depreciate their currencies were also the first to return to growth (Figure 14).
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Figure 14
Source: Eichengreen (1992)
The LMU experience contrasts with Argentina’s 2001 exit from convertibility. When Patacones were
introduced in 2001 as short-term notes to pay government bills (although they ultimately circulated as regular
currency), they gradually drove pesos out of circulation and depreciated. An implication is that, if the new
drachma, say, were introduced as a parallel currency to the euro upon the eurozone exit of Greece, those who
hold euro-denominated assets in Greece would foresee the eventual depreciation of the drachma and dump
their Greek assets, causing a self-fulfilling financial crisis.
Another lesson from Argentina is that redenomination should be comprehensive across all claims to avert the
potentially destabilizing balance-sheet effects and financial distress caused by partial redenomination. If wages
are redenominated into the new currency, several items must then be redenominated to limit adverse
balance-sheet effects and financial distress. Following wages, mortgages and other forms of household debt
should be redenominated, followed by bank deposits and, finally, all forms of government liabilities (in
addition to public-sector wages and pensions).
Czechoslovak Monetary Union
The Czechoslovak monetary union was able to dissolve without severe dislocations. Provisions for exit had
been included in an October 1992 agreement on monetary union, in contrast to the EU Treaty. While the
agreement originally planned for at least six months of monetary union, market expectations of divergent
optimal monetary policies between the two led to capital flight from Slovakia to the Czech Republic, forcing an
abandonment of the union five weeks after its creation. Controls were imposed on currency movement
between the two countries, and, over a period of six months, both countries’ notes were replaced with
national banknotes, while coins were allowed to continue to circulate in both countries for six months.
Several elements of EMU were lacking. Commercial banks were relatively new, and withdrawal restrictions
were relatively easy to implement. Three factors put a dampener on capital movements: capital controls had
already been established, there were no large or institutional investors able to make large capital shifts
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between the two countries and payments between the two countries were suspended to give time to the
authorities to settle the details of the separation. Finally, the fact that the Czechoslovak currency was set to
disappear made the adjustment process smoother, as it precluded the possibility of holding on to the
“stronger” currency with the aim of exporting it when movement limitations were lifted.
General Lessons from the Historical Experience of Fiscal Federalism: Regional Hard Budget Constraints
A key lesson from other positive and negative experiences of monetary union is the centrality of fiscal
federalism with regional hard budget constraints in sustaining political support for fiscal union. The United
States is able to maintain a fiscal union with elements of a transfer union, with rich regions subsidizing poor
regions and provide countercyclical fiscal transfers, without experiencing excessive political backlashes
because its constituent states cannot go on indefinite spending sprees. If they do, their creditworthiness will
deteriorate, constraining their fiscal room for manoeuvre, all the more so since their debt is not a systemic
exposure of the banking system—there’s no urgent financial need for a federal bailout. In many sub-federal
U.S. governments, debt obligations are their first legal spending commitment, coming even before wages and
salaries and various public services. Furthermore, the repeated experience of regional fiscal discipline has
resulted in Chapter 9 of the Federal Bankruptcy Code, which allows for court adjudication of municipal debt
workouts in 26 states.
Obverse examples also exist for the EZ and EZ 2.0 to draw upon. Argentina and Brazil, both single-state federal
monetary unions have a much less salutary experience of fiscal federalism than the United States. State
governors have repeatedly been able to overcome federal fiscal constraints, not least because they have been
able to borrow from local state-controlled banks. The excess of regional public and sometimes private debt in
these banks became systemic exposures which eventually required repeated federal bailouts. This indiscipline
eventually cumulated in the loss of fiscal solvency at the centre, and the loss of policy credibility in the Central
Bank of each country. The end result: Two classical hyperinflations in Argentina and a sustained hyperinflation
in Brazil in which economic growth was maintained and total financial collapse avoided through widespread
inflation indexation, which in turn served to perpetuate high inflation. Argentina to this day continues to suffer
from this same problem. Brazil to its credit has so far managed to restrain regional politicians, imposing fiscal
responsibility rules and legislation as well as privatizing state-level banks.
It is interesting to see that Germany and other countries are now considering or even implementing debt
brakes, legal prioritization of debt repayments, and sovereign debt restructuring mechanisms or a kind of
federal oversight of national fiscal and debt management policies, in addition to beefing up existing fiscal rules.
All this might well make the fiscal compact that much stronger, but it will still lack the counter-cyclical fiscal
policy and regional transfer mechanisms that balanced with proper discipline have worked so well in the
United States at least in the past. At the same time, the ongoing systemic banking exposures of member-states
and even regional governments in Spain and Germany, which so far retain regional banks with close links to
regional governments calls for far deeper reform—or perhaps for a rethink of the construct.
Bordo, M. (1999), “The future of EMU: what does the history of monetary unions tell us?”, NBER Working
Paper 7365, Cambridge: NBER.
Bordo, M. and T. Capie (1993, eds.), Monetary Regimes in Transition, New York: Cambridge University Press.
Chown, J. (2003), A History of Monetary Unions, London: Routledge.
Eichengreen, B. (2008a), Globalizing Capital, Princeton: Princeton University Press.
Eichengreen, B. (2008b), “The Breakup of the Euro Area”, NBER Working Paper 13393, Cambridge: NBER.
Eichengreen, B. (2008c), “Sui Generis EMU”, NBER Working Paper 13740, Cambridge: NBER.
Eichengreen, B. (1992), “The Great Slump Revisited”, Economic History Review 45(2).
Sargent, T. (2011), “The United States then, Europe now”, Nobel Prize Lecture.
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