With Greece in turmoil, Spanish banks under pressure and the future of the euro at stake, Channel 4 News looks at five approaches to managing a possible break-up of the single currency.
“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 membership?”
That was the challenge set by the organisers of the Wolfson prize. With the winner scooping £250,000, it is the second most lucrative award for economics after the Nobel prize and is sponsored by the Conservative peer and Next chief executive, Lord Simon Wolfson.
The question is ever more urgent, and even EU Commissioners are at cross purposes on the question: Trade Commissioner Karel De Gucht said on Friday that emergency contingency planning had begun for a Greek exit, whereas Commission Vice President Olli Rehn told Channel 4 News: “We are not preparing for any Greek exit.”
As for economists bidding for the Wolfson prize, there were more than 400 entries, which have now been whittled down to five. The winner is announced in July, and with the European sovereign debt crisis swirling around us on a daily basis, Channel 4 News has been looking at the recommendations. As you will read, some are more pessimistic than others about what a break-up would entail.
This analysis, from a team at Capital Economics led by Roger Bootle, looks at the departure of one country from the single currency.
Its approach is calm and business-like and offers some reassurance to those who fear that what is happening in Greece will tip Europe over the edge.
The authors say the exiting country would leave the eurozone, introduce a new currency, which would fall sharply in value, and then default on a large part of its debt.
Preparations would have to be made in secret for an exit, to ensure that money did not leave the country and cause a banking collapse.
Just before this exit, capital controls would have to be put in place – that is not allowing money out of the country. Afterwards, new notes and coins would be produced as soon as possible.
Roger Bootle and his colleagues believe this new currency would depreciate by 30-50 per cent, pushing up inflation, which would find itself on an upward trajectory before falling.
Money owed by the government would be redenominated in the new national currency and debts renegotiated. Inflation would be carefully monitored, with tough rules for government spending and restrictions on wage increases.
To ensure that the crisis in one country did not spread to others, the stronger members of the euro might then have to accept faster progress towards full fiscal and political union.
The authors say: “Overall, our analysis has revealed a series of very tricky issues which any exiting country would need to face. But all of these difficulties can be overcome.”
Catherine Dobbs, who has worked in the financial sector for Natwest and Gartmore and is a now an active personal investor, does not mince her words.
She believes that if any country leaves the euro, the world economy could receive a bigger shock than after the collapse of Lehmans, which preceded the first global recession since the end of the Second World War.
A redenomination of debt could affect the viability of banks in several European countries, leading to a substantial reduction in credit.
If there was a suspicion that a country was going to leave the euro, companies and investors would move their money elsewhere, restricting future prospects for growth within that nation.
This is what has happened to Greece, where 70bn euros have reportedly been withdrawn from banks and investors have sold Greek government bonds.
But while the EU and IMF bailouts may be able to cope with “capital flight” from Greece, there are no guarantees they would be sufficient to deal with a similiar scenario in Spain and Italy.
Catherine Dobbs proposes that if there is a break-up of the single currency, all euros, wherever they are held, are treated equally. This removes the incentive for “capital flight” and protects people’s assets.
Ultimately, there would be a split, with current members of the euro divided into two or more regions, some of which would be countries – with their own central bank, currency unit and interest rate.
While action to prevent “capital flight” might allow for a country’s orderly departure from the euro, it could also help to keep the eurozone intact. “So paradoxically, a plan designed to allow a member state to leave the monetary union could facilitate it staying together.”
This analysis, from the global investment bank Nomura, says that the relative calm in the financial markets over recent months is attributable to the European Central Bank’s cheap loans to European banks, which have been buying government debt.
While this has been welcome, it “hardly constitutes a long-term solution” and “will increase longer-term systemic vulnerability”.
There are three options. The first is the current path of fiscal austerity. But there are no guarantees this will work because recovery depends on growth in the rest of the world and energy prices, which cannot be controlled by European politicians.
The second is closer fiscal integration – eurozone countries co-ordinating their policies on taxation and public spending – which has a greater chance of success from an economic point of view, but is politically controversial.
The third is the orderly break-up of the euro, with depreciation an option for uncompetitive countries. This would help these countries export, at a time they are struggling with austerity.
The authors say a break-up would have “disastrous economic consequences” if it was not planned properly.
But they say a cost-benefit analysis of an orderly break-up should be considered “given that no other alternative offers a clearly superior outcome for Europe”.
Jonathan Tepper, a best-selling author and chief editor of the macroeconomic research group, Variant Perception, is keen to stress that if the euro broke up, it would not be the first currency union to do so. In the past 100 years, there have been 69 unions have fallen apart.
The precedents are encouraging – in most cases, “the transition was smooth and relatively straightforward” – and Greece and Portugal, and possibly Spain, Ireland and Italy, may decide it is in their interests to leave the euro.
Jonathan Tepper says adopting a new currency could be accomplished quickly. Money and debt could be redenominated into the new currency, with old notes stamped to allow them to remain legal tender until they are withdrawn, and controls imposed at borders to stop unstamped notes from leaving the country. In the meantime, new notes could be printed swiftly.
Leaving the euro would lead to debt defaults. While some debt would still be paid back, repaying in drachmas, liras or pesetas would reduce countries’ debt burdens because of the devaluation of their new currencies.
The euro is described as “a modern day gold standard”, which punishes weaker members of the currency union. Because individual members have no power over their exchange rates, wages are cut if countries need to make adjustments.
Although exit from the euro would be painful, defaulting and devaluing would lead to growth. But with ageing populations and “a structural propensity to overspend”, this would not be enough: reforms would also be needed.
Neil Record chairs Record Currency Management, whose clients include companies, pension funds and charities.
He is blunt in his message: if one country leaves the euro, the entire project is dead. He believes Germany should be responsible for planning for the break-up in secret, possibly with France on board as a junior partner.
He has reached the conclusion that it would be all or nothing because he thinks that if one country left the single currency, the markets would reach the conclusion that monetary union was no longer “unbreakable” and would continue to target weaker nations.This would mean “continuing crisis” and “the slow-motion dismemberment ” of the eurozone.
The German-run plan would only kick in if it became apparent that the exit of a country was inevitable.
Neil Record envisages Germany telling other eurozone countries at an emergency meeting on a Friday, after the markets have closed, that the euro should cease to exist immediately and should be replaced by national currencies.
The European Central Bank’s balance sheet would be distributed to individual countries according to their shareholding in the ECB, each country’s debt would be redenominated in the new national currency, and euros would become denominations of these new currencies. Countries would then start to print new banknotes and coins.
Because of their lending to weaker economies, banks in stronger economies “would be very badly damaged by redenomination, and would undoubtedly need rescuing by their respective national governments”, while financial institutions in weaker economies would not be as badly hit because their loans to stronger economies would go up in value.
These weaker countries would become more competitive in export markets, but stronger economies would suffer, due to the fall in value of weaker currencies and the rise in value of stronger ones.
In the long run, Neil Record believes the end of the euro “could mark the start of a new and vibrant period in Europe’s history”.