On Technical Barriers to Leaving the Euro and Learning from Others’ Experience
When discussion turns to the possibility that some country might leave the euro, much is often made of the technical difficulties of introducing a new currency, especially of the months, even years, of planning that went into launching the euro in the first place. Sample: “Computers will have to be reprogrammed. Vending machines will have to be modified. Payment machines will have to be serviced to prevent motorists from being trapped in subterranean parking garages. Notes and coins will have to be positioned around the country.” (Joshua Chaffin in the Financial Times, quoting a 2007 paper by Barry Eichengreen.)
Yes, there would be technical difficulties. Still, lots of countries have switched currencies in the past. Sometimes the process has been planned and orderly, sometimes messy and chaotic. One way or another, the job gets done. Anyone who thinks technical problems pose insurmountable barriers needs to look at the imaginative, pragmatic devices that other countries have used to ease the transition from one currency to another. Here are three lessons from other countries’ experiences that would be relevant to anyone now making plans to leave the euro.
Lesson 1: Use a Temporary Currency
Those who worry about technical barriers often point to the time needed to print notes, mint coins, and put them into circulation. That time can be greatly shortened by using a temporary currency during a transition period. Latvia’s exit from the ruble area is a recent case in point. First, in May 1992, authorities introduced a Latvian ruble as a temporary replacement for the old Soviet ruble. Only months later, after due preparation, did they put the new permanent currency, the lats, into circulation.
A temporary currency solves several problems. For one thing, it can be run off quickly and cheaply without all the elaborate counterfeiting safeguards of a modern currency. It won’t be around long enough to be worth counterfeiting.
The speed record for introduction of a temporary currency seems to have been set by the Soviet occupiers of eastern Germany after World War II. When the Americans, British, and French zones replaced the old reichsmark with the deutschmark in 1948, the Soviets were caught flat-footed. As now-worthless Nazi-era currency flooded into the Soviet zone, occupation authorities quickly printed paper stickers that they stuck on a limited number of reichsmark notes to serve as a temporary currency. Those were soon replaced with the permanent currency that became known as the ostmark, which lasted until reunification.
To simplify matters further, it is not essential to issue coins in the temporary currency. For example, when Kazakhstan switched from the ruble to the tenge in the early 1990s, there was a period in which there were no coins in circulation. Their place was taken by grimy little fractional banknotes, which were a nuisance, but got the job done. Nicely minted tenge coins came later.
Another advantage of a temporary currency is that it can absorb public disrespect. If the new currency is expected to depreciate, as would be the case in peripheral countries leaving the euro under current conditions, people are going to think up some derisive name for it and treat it with contempt. For example, a temporary Belarus ruble issued in 1992 was popularly called the zaichik or “bunny” after a whimsical picture on the one ruble note. The name fueled many jokes until a new, somewhat more respectable Belarus ruble (without the bunny) was issued later.
Giving the temporary currency the same name and denomination as the old one, as was done in Latvia and Belarus, simplifies accounting, signage, and other technical matters. Following that example, Greece might begin with a temporary Greek euro. A permanent new drachma could come later, after the government established sufficient credibility for its monetary management.
Lesson 2: Do not Fear Parallel Currencies
Some people who write about the technical difficulties of transition seem to have the misconception that a new currency would have to replace the old one all at once. True, that has sometimes been done. The 1948 introduction of the deutschmark, mentioned earlier, put the reichsmark out of circulation instantly. That is not always the best approach, however. Many countries have eased the transition from one currency to another by allowing parallel circulation during a transitional period.
Sometimes, as when the euro was first introduced, the old currency can be left in circulation for a while at a fixed exchange rate. Doing so makes sure that everyone doesn’t have to spend January 1 standing in line at their bank, and it gives technicians time to fix those pesky parking machines so that no one is trapped in an underground garage with the wrong coin in their pocket.
Parallel currencies with a floating exchange rate are also possible. The most familiar example is the spontaneous emergence of a parallel currency in countries experiencing hyperinflation. While the ruble or peso or whatever remains the legal tender, people start using a hard currency such as the dollar or euro alongside it. Typically, the rapidly depreciating local currency continues to be used as a means of exchange (at least for small transactions) while the more stable foreign currency serves as a means of account and a store of value.
In the hyperinflation case, parallel circulation often ends with the introduction of a new local currency having a fixed value relative to the unofficial parallel currency. For example, in the early 1980s, the value of Argentina’s peso was undermined by hyperinflation. As the peso became less and less dependable, people began to use U.S. dollars as a unit of account and store of value. In 1985, the Argentine government temporarily stopped hyperinflation by replacing the peso with a new currency, the austral, which it declared to have a fixed value of one dollar. When resurgent hyperinflation destroyed the austral in the early 1990s, it was ditched, in turn, in favor of a new peso, again declared to be worth one dollar. Germany in 1923, Estonia in 1992, and Bulgaria in 1997 are a few among many other examples in which parallel currency circulation preceded the introduction of a new, stable national currency.
If a country like Greece decided to exit the euro now, the situation would be different. Instead of moving from a less to a more stable currency, it would intentionally be abandoning the too-stable euro in order to achieve desired inflation and depreciation. It would be a little like running the Argentine movie in reverse. Instead of the euro gradually coming into broader circulation as the national currency became less stable, the new floating currency could be introduced gradually alongside the euro.
What would motivate people to use the new currency? One way to bring it into circulation would be to introduce it first where people have no choice. For example, if Greece were to leave the euro area, it could begin by printing a new, temporary, Greek euro, which at first would be used only to pay government salaries, pensions, and interest on the national debt, and also be accepted for payment of taxes. Gradually, its use could be extended, pushed along by administrative means as needed.
The Greek euro would float freely against the old euro. Based on the experience of other currency transitions, the exchange rate during the period of parallel currencies might be very unstable. For example, there was significant overshooting of the eventual equilibrium exchange rate between the lev and the mark during the period just before entry into the Bulgarian currency board in 1997, and between the peso and the dollar just after exit from the Argentine currency board in early 2002. It might be best to get through any such initial period of volatility before introducing a new permanent currency, say, a new drachma, in place of the temporary Greek euro.
Lesson 3: Default Early, but Not Often
As a further barrier to exit from the euro, skeptics often point out that devaluation would very likely force default on any obligations that could not be redenominated to the new currency. True enough. But then, if a country could service its obligations, it wouldn’t be thinking about exit and devaluation in the first place, would it? The fact is, if a country is insolvent, it is going to have to default in one way or another. The only question is whether default with a change in currency is preferable to default within the old currency.
In general, the best strategy for anyone who can’t meet financial obligations is to default early, but not often. That means stopping payments on obligations as soon as it is clear that they cannot be met in full. The time to sort out any partial payments is after default, not before. A prolonged period in which default appears increasingly certain, but has not yet occurred, only encourages bank runs and capital flight.
One form of “defaulting often” is to ask for evergreening. Evergreening occurs when creditors make additional loans to debtors they know to be insolvent, with the intent that the proceeds of the new loans be used to keep payments current on the old ones for a little while longer. As PIMCO’s Mohamed El-Erian recently told Fareed Zakaria, that is not kicking the can down the road, it is rolling a snowball down the hill. The problem gets bigger and bigger the more you roll it.
Another mistake is to try to negotiate terms of default in advance. Visiting the barber every week for another haircut is another form of “defaulting often.” There are three problems with this strategy. First, the debtor’s bargaining power is likely to be weaker if nonpayment is only a threat, not a fact. Second, the debtor is subject to pressure to accept terms like mandatory austerity measures that reduce its actual ability to repay. Third, there may simply be no way to know what kind of partial payment is realistic until some time has passed and the dust has settled.
Argentina in 2001 and Russia in 1997 are examples of countries that followed the “default early” strategy. Greece is being hounded into a “default often” position that is likely to be more damaging in the long run.
Not all exit problems are mere technicalities
Not all barriers to switching currencies are mere technicalities. The combination of default and devaluation will cause real pain to foreign creditors, and the defaulting country is likely to suffer as a result. In today’s world, the consequences are unlikely to include an invasion of the debtor by the creditors. France and Belgium occupied the Ruhr in 1923 in an attempt to collect defaulted German reparation payments, but that didn’t work out so well, and no one has tried it since. Still, that does not mean defaulters can expect to get off unscathed.
For one thing, defaulters may end up with limited access to international credit markets, as Argentina has found. Default by a member of the euro area, followed by an attempt to redenominate debts into a devalued currency, would create thorny legal problems in view of the many financial and nonfinancial firms that operate across national borders. National courts of creditor countries might attach any extraterritorial assets of the defaulting country, or its citizens, that they could get their hands on. They might even make it hard for government officials or private citizens to travel without threat of legal action. No one really knows.
Furthermore, exit from the euro plus devaluation would not solve all macroeconomic problems, or perhaps we should say, it would solve one set of problems but raise others. If the operation were carried out by a new populist government that abandoned structural reforms and budget discipline, it could be hard to achieve lasting stability. Again, Argentina is a cautionary tale. Despite the country’s admirable growth record since it abandoned its currency board, the Argentine government has not succeeded in controlling inflation and may now be facing a new time of troubles.
In short, there are many reasons why no euro member has yet left the currency area. The pros and cons of doing so remain open to debate. However, as the debate goes on, let’s hear more about the real issues and less about technicalities like printing banknotes and reprogramming parking meters.
One Response to “On Technical Barriers to Leaving the Euro and Learning from Others’ Experience”
Excellent article, thank you!
One thing to keep in mind in all of the E non-U is that a hard currency is needed to obtain fuel from Middle Eastern exporters. As long as there is a euro the exiting countries will have need for it so black markets will stand in for 'white' markets. Redenominations and bouts of inflation would result in re-application of the euro at some latter date or substitution of the dollar.
Another immediate issue is the perception of Germany as one above the rest. If a large number of E non-U countries exit and default, why would Germany not do the same? Germany is caught in a perception trap. If Germany stick w/ status quo, she winds up 'holding the bag' on the E non-U euro denominated liabilities. If Germany makes noises about exiting, this would be perceived as a 'spoil sport' default on Germany's part..
Common sense: if all of the E non-U defaults, why would Germany hold the fort and be the exception? This perception dilemma would tend to amplify the malady that the Germans are desperate to escape.
E non-U is flat broke, more non-performing assets on the books than capital,, bondholder liability combined, This is what happens, waste-based consumption economies devour their capital, check mate.