How do you withdraw from a currency union? (eg. Greece)

Factual Questions
1

Newbie here-- sorry if this has been asked before (I did a search, and don’t think it has…) Basically, apropros to the situation with the euro and Greece, but more of a general hypothetical, I’m wondering if anyone has thought about what the mechanics and consequences of withdrawing from a currency union (particularly when under national financial duress) would be.

Personally, from my (limited) understanding of finance and economics, I don’t understand how it could be anything less that a complete disaster. Reasoning is as follows:

Entering a currency union is (relatively) easy, if you’re withdrawing a national currency in favor of a supranational one all at once. After some period of enforced exchange parity via market mechanisms, a magic day arrives when your central bank links up with the supranational bank, lots of accounting magic ensues, your entire economy switches to the new currency (with some grace period for converting your M0 cash) overnight, and, AFAIK, your old currency no longer legally exists (right?).

Now that your entire economy is denominated in this supranational currency though, how are you ever going to leave? Sure, you can create a new national currency, and maybe even legislate usage of it in stores so people have to start carrying it around in cash. Also, maybe you can legislate that, within your borders, you have to start paying wages and taxes with this new currency. But what do you do about every private contract out there, including all financial instruments like bonds, mortgages and the like? Since the supranational currency still exists and your new national currency floats against it, you cannot convert them all at a fixed exchange rate in an NPV neutral way, as the fair rate to convert each at will be different dependent on expected FX, IR, and credit forwards, which will constantly be in flux.

The government as a whole can probably get away with unilaterally refinancing its debt in its new currency at some rate, since it’s a sovereign power. But what’s every single other borrower or lender inside or outside your country going to do? In particular, if you’re doing this because of financial distress, every single borrower with income in the new national currency but debt still in the supranational currency is basically screwed, as far as I can tell. At very least, this seems like a very efficient way of bankrupting every mortgagor in your country. Perhaps I’m wrong about this, though, and a more graceful way of handing this could be done…?

Even worse, AFAICT, the market as a whole has no way of knowing, in advance, how an exit from a supranational currency will legally happen until it does (what contracts, if any, are automatically converted to this new currency, and what aren’t? labor contracts? government bonds? corporate bonds? etc.) so it has no reliable way of pricing in the risk of a currency withdrawal ahead of time. (or does it?)

So, does anyone have any idea how this would really work in real life? In the particular case of Greece, have any workable possibilities for withdrawal been floated around yet? I’m an American, so the the coverage I get here is relatively limited, but some Google News searching seems to suggest that the idea has been at least discussed.

Also, the upshot of all this is that I feel like the euro should really have been kept as a “virtual” currency for longer, or at least for the less stable members of the eurozone (obviously, though, hindsight is 20/20…). The national currencies could have been maintained as fixed currency board-enforced pegs to this virtual euro currency, so day to day exchange rate risks would be eliminated, and no one has to look up the exchange rate on a given day to do currency conversions. However, contracts and such would still be denominated in the national currency, so, if push came to shove, a relatively graceful exit would be possible, which could be priced in over time as idiosyncratic country risk. Does this make sense, or is there something else I’m missing here? (Maybe I am straying too far outside of GQ-territory here, please, mods, let me know if I am…)

Thanks in advance for any insight! (especially from anyone working in European finance…)

2

Well, there are precedents. In the late 1970s, for example, Ireland decoupled the Irish pound from the pound sterling (to which it had been linked in a 1:1 fixed exchange rate since 1922) and let it float within the (then) European Exchange Rate Mechanism. It isn’t quite the same thing, since the Irish pound technically always was a distinct currency, but to all intents and purposes it was simply a differently coloured pound sterling until one morning in (I think) 1978.

Greece would have to (in effect, and by whatever name) create the “Greek euro”, and declare all euro deposits in Greek banks, and all euro-denominated domestic obligations in Greece, to be denominated in Greek euros. They would issue new banknotes and demonetise the existing ones, exchanging euro notes for “Greek euro” notes. Then they would manage the euro/Greek euro exchange rate however they saw fit.

They could convert Greece’s foreign borrowings – government bonds and so forth – to Greek euros, but it’s perhaps unlikely that they would, if only because they still need to borrow, and doing this would strongly discourage anyone from lending to them. But they could certainly issue new bonds in Greek euros if they wished.

3

Regarding this part : the Euro did exist as a virtual currency.

The ECU (European Count Unit) was created during the late 70s. It was based on a basket of currency (say, 20% Deutshmark, 15% French Franc, 10% Italian Lira, etc… Those are random numbers. I’ve no clue what the real repartition was) and worth at start US $1. It was used mainly to issue bonds (the ECU being a basket was more stable than individual currencies).

Then, was created the EMS (European Monetary System). The concept was that currencies should stay within a small fluctuation band (say + or - 5%. Again I’ve no clue what the real margin was). Central banks would act as needed to help maintain this stability (for instance, all central banks would buy Liras if this currency was plummeting on the markets). Note that this limited the ability of individual countries to use monetary policies (for instance, they couldn’t use a “competitive devaluation”). It didn’t work perfectly (change of fluctuation margins, currency dropping out the system completely when coming “under attack”, etc…

Finally, the Euro was created. Its value was 1 ECU (which explains why the Euro’s value was in the same range as the US $. Obviously, the ECU had fluctuated since the 70s, but it still was still in the same ballpark). The parity of the Euro was the parity of the ECU at the date of the change, and the parity of the individual currencies wrt the Euro was fixed at the same date. So, for instance, the French Franc happened to be worth 0.15268957 € (again, I picked random decimals, that’s not the real value). The European Central Bank was created.

From then on, although people still used Deutshmarks, Francs, Liras, Pesetas, etc…, since there was a fixed rate, our currency was in fact the Euro. Only the Euro was traded on the markets, accountancy was done in Euros,etc… After two years, the actual Euros bills and coins were released and replaced the local currencies.
Note that there were conditions to join. The public debt had to be lower than 60% of the GDP, the deficit, the public deficit had to be less than 3%, etc… Some exceptions were eventually made, in particular for Italy, so that those countries wouldn’t be left out. I don’t think that Greece was amongst them (but, then again, their figures were bullshit, so…). No country was significantly outside the limit fixed then.
Nowadays, a western country with a public debt of only 60% of the GDP would be viewed with amazement :rolleyes:

4

Then prepare to be AMAZED by Australia, where public debt is around 22% of the GDP.

List of sovereign states by public debt. We’re at number 107. Just a little higher than China at 111 and Saudi at 112.

5

I don’t see how they could force people to turn in their Euros for Drachmas (as I will call them for convenience). Bank accounts yes, but a Euro bill is a bill. The coins are different since they are “local” but not the bills. But there are too many Greek Euro coins outside of Greece for that to make sense.

The way I see it working is that Greece could print drachmas and announce that they were legal tender everywhere in Greece. And they could nationalize all bank deposits. The money in people’s hands, they probably wouldn’t touch. I guess if I were Greek, I might start investing in my mattress.

At first, the new currency would be essentially a scrip, but gradually it would take over.

6

One big problem is that there is no provision in the treaty that created the Euro for a country to withdraw from the currency. It simply never occurred to anyone that a country would ever want to do such a thing. So it’s not clear that any attempt for Greece to do so unilaterally would be legal, by whatever method.

7

I suspect that notes and coin are only a small part of the total Greek money supply. How much of your total assets are kept in notes and coin?

Plus, Greeks would convert some of their cash into Greek currency; how else are they going to pay busfare or buy bread?

Yes, I suspect that a fair proportion of euro currency in Greece would disappear over the border and into accounts in euroland. But does that make the overall project impossible?

If, by “nationalise” bank deposits, you mean confiscate them, I don’t see that that would be necessary or helpful. They can just statutorily convert them to Greek euros (in pretty much the way that, when the euro was rolled out, drachma deposits were converted into euros).

8

There is already a sort of low key, slow motion run on Greek banks taking place, as people move their Euros out of the country. If I had any money in Greek banks, I’d get it the hell out of there. It’s not like they’re going to warn people “hey, we’re going to reintroduce the drachma next month”. It would have to be sudden. One wonders what sort of planning is going on in top secret in Greece and indeed various other Eurozone countries…

9

And New Zealand at 97 at 30.3%. We’re higher than Aussie, we’re higher than Aussie! Oh, wait a minute…

10

I imagine most of the “smart” money in Greece has long ago moved their assets into Switzerland, Monaco, etc. It wasn’t as if the signs were not there-Greece has always run massive deficits, because tax evasion is a national sport.
When Greece reverts to the drachma, it will be a great place to vacation-the exchange rate will be very favorable to the euro and US$-I’m planning a trip now!

11

The government would declare one day that all accounts that were euros are now the new Greek currency, the “Floater”. (Seems an appropriate name) Your Greek IRA/401K, your bank account, your salary or pension, rent, etc. - all are in Floaters as of midnight such-and-such a day. Since the new currency is arbitrary, it can be 1-to-1 making conversion easy on F-Day.

The problems are:
If people knows this is coming, they will move any liquid assets into Euros. Greek banks guaranteed to almost go mams up due to withdrawals unless they offer euro-denominated accounts.
Guaranteed in the first few months, the Floater will sink like a non-floating turd. This reduces the Greek government’s problem - they only have to borrow 1 euro instead of 10, to pay 10 Floaters of pension or salary since the floater ends up being 1/10 of a Euro.
Of course, they won’t be able to convert external contracts - like outstanding loans to French and German banks - so their expenses will still be pretty high, and taxes will be in Floaters, so their incoming revenue sucks too. (One story says they only collect about half the taxes they could. There’s another way to tick off the voters - enforce the law).
It’s political suicide, since Greeks will not be able to travel outside Greece unless extremely rich.
Of course the rich will be the ones able to export their wealth ahead of F-Day, and foreigners also will be resented for coming in and buying up Greek properties super-cheap.

12

Right, but isn’t that the whole problem? What happens to every Greek entity that has debt denominated in Euros? They have to refinance their debt into their new floaters as fast as possible, and there’s basically no chance that it’s going to be at a rate favorable to them, because everyone knows ahead of time that the floaters are going to sink like a rock.

It’s not even foreign debt that’s the problem, it’s all outstanding loans within the country too, even between two Greek entities. The government can’t unilaterally force every domestic borrower and lender to rewrite their contracts to each other in these new floaters, can they? (And how would you even define “domestic”? What if the borrower or lender is an entity that is half Greek owned and half German owned?).

13

Exactly, in this situation, even though the markets treated them as equivalent for all intents in purposes, all domestic contracts were still written referencing the Irish pound. So individuals did not have mismatch of income and debts denominated in different currencies, unless they were explicitly in the business of doing international trade.

In the Greek case, everyone’s debts are denominated in euros. So if everyone’s domestic income converts to euros overnight, basically anyone that has a long-term loan in euros is massively short euros.

The one way I can see this working is if most normal individuals don’t have long-term debt. Does anyone know if that’s the case in Greece? Do people have mortgages there, or does everyone just rent? If the latter’s the case, then I guess this could possibly work out. Still feels like a mess though.

14

Yep, you’re talking about the 1/1/1999-1/1/2002 period, right?

During that period, did your labor contracts actually refer to the euro, or did they still nominally refer to your national currency? Same thing with the mortages, loans, and other long-term debt: were they nominally in euros or Deutshmarks, etc…?

15

hoenikker, during the period you mention contracts were typically denominated in, e.g., Irish pounds. But these were just “national expressions” of the euro. So if I had a contract to pay you IEP 1, that was legally a contract to pay you EUR 1.28. You could be required to accept an Irish pound in settlement of the debt, since the Irish pound (and only the Irish pound) was legal tender in Ireland, but legally “Irish pound” was just a fancy name locally used in Ireland for EUR 1.28.

But if we entered into a contract in 1995, say, the Irish pound was a real currency (albeit with a managed exchange rate). And if that contract provided for payment of IEP 1 in ten years time, in 2005, then when 2005 came along and the contract mature I was bound to pay you, and you were bound to accept, EUR 1.28, and only that. So, yes, our privately agreed obligations could be and were compulsorily converted into obligations denominated in another currency. And there is nothing fundamental which prevents the Greek government from doing exactly the same thing in reverse.

The problem arises for Greek residents who have entered into obligations not covered by Greek law. Suppose Theo has borrowed EUR 100 from Deutsche Bank in Berlin, in a contract formed in Germany and governed by German law. When Greece leaves euroland, he still owes Deutsche Bank EUR 100, and if his income is all earned in Greece and he is now receiving in Floaters, he has a problem (and so, therefore, does Deutsche Bank).

This has to be managed. One option is not to let the Floater actually float freely, but to manage it in some way. Another is for Greece to make some euro reserves available to people in Theo’s situation on favourable, non-market terms. Still another is for euroland central banks to do that. (Remember, Deutsche Bank suffers a loss if Theo defaults.) By a combination of such techniques the loss can be spread between Theo, Deutsche Bank, the Greek economy at large and the euroland economy at large. It;’s messy, of course, but people may conclude that it’s the least worst option.

16

UDS, thanks, that makes a lot of sense. Basically, it’ll have to messy and managed, probably including various governmental meddling in the markets.

I can’t help but to think that the whole situation, no matter what happens, is going to open up opportunities for smart players to game the system and make out like bandits, a la George Soros and the Bank of England. Probably lots of hedge funds looking into the situation right now already :wink:

17

I suggest the Sinker.

18

The Greek government can change the denominating currency of any transaction they have jurisdiction over - all internal accounts, all internal contracts, all wages and rents and pensions, etc.

They cannot force the Deusch-bank or a bank in Paris or London to convert (althugh, they can force a local subsidiary doing business inside the country to convert.

So if Joe Plumbarolopolous borrowed 10,000 Euro from a bank in Berlin, sucks to be him- pay in Euros,while he earns wages in Floaters/sinkers. If he borrowed from the bank down the street, no international component to the transaction, lucky him.

There will be a lot of pain, not evenly spread out, until the local currency finds the proper level and then as people reconcile external and internal obligations. Many will likely go bankrupt, some will get windfalls. The government may have to prop up banks and some other key businesses (more debt) to ensure the economy does not grind to a halt.

Yes, the government will still owe its debt in Euros to outside agencies; but the thing that is killing it right now is that it also has to pay huge unfunded Ponzi Schemes, I mean pension funds; plus grossly overvalued civil service wages, and bloated payrolls. Converting this pay to floaters is just a cheap, less painful way of giving these people an across-the-board pay cut of real-value income.

They say a good comedian never explains their jokes, so let me explain. Hint, what floats?

19

By nationalize, I mean turn the deposits into drachmas. Mexico did this some years ago. A Mexican mathematician I met once told that he left Mexico (to take over the chair of an American university’s math dept., not a job any serious mathematician wants) because Mexico nationalized–in this sense–his USD bank account.

I agree that the money in the pockets is only a small part of the euro holdings of the average Greek.

I am not sure what the claim that such an action would be “illegal” can possibly mean. Greece is sovereign and make the laws applicable inside Greece. The EC could expel Greece of course, but that is more like a civil action.

20

Other than the cost of an airline ticket what’s to stop Greeks from fleeing to other EU countries like Germany or the UK? It’s all one labor market; there aren’t any immigration controls (other than an ID/passport check). Would Greece be forced out of the common labour market?