A minimalist roadmap to leaving the Euro

This article was originally written in November 2011. I thought of adapting it, because many things happen between then and now. And then I got lazy. Besides, the main message did not change.

As the weeks go by, the unavoidable nature of the impending default and collapse of the Greek economy is becoming obvious to everyone. To everyone, that is, except the obtuse European technocrats and politicians, who have too much of their own careers and reputations invested on the success of this monetary Frankenstein. In this circumstance, it is however remarkable that no serious economist or practitioner seem to be trying to think carefully and hard about the details of how to implement an orderly exit from the Euro for Greece (and probably a few more countries later). Most economists, especially those in the sell side (which have a lot to lose in the event of a Greek/Portuguese/Italian/French default) keep fretting about the horrible cost (for whom I wonder? For the Greeks or for them?) of an Euro exit, refusing to elaborate at all in the best of cases, or pulling numbers out of thin air in the worst. We are constantly reminded about the terrible (but vague) consequences of bank runs, run on financial assets, economic depression, and overall financial markets collapse. Some economists I used to respect are telling us that “the prospect of Greece exiting the euro area is seldom viewed with the proper degree of fear and trepidation.”[1] Oh really? And what about the prospect of living in a depressed economy for an indefinite number of years while the internal devaluation that Greece needs occur? The most astonishing feature of the current debate about the Greek Problem is that nobody discusses it. What we are discussing day in and day out, is how to save the necks of the gullible bankers that lent to Greece (and Portugal, and Italy, and Spain, and France) on terms comparable with those of Germany.[2] Nobody discusses how Greece will become a competitive and viable economy again, which is the crux of the real Greek Problem. The debt level stopped being an issue for Greece months ago. It cannot be paid, and that is the end of it. And the real Greek Problem is not discussed mainly because we all know that solving it would require a nominal devaluation (which is not possible within the Euro) or years of economic depression and deflation, which is too painful to contemplate carefully now, while Eurocrats are busy covering their behinds and pretending they can be part of a solution.

Last Friday I read for the first time in the WSJ online a “recipe” or to-do list of the things the Greek government should do in case it wants to leave the Euro. It goes like this:

·         Prepare for a run on banks through bank holidays, limits to deposit withdrawals.

·         Prepare for capital flight by introducing temporary capital controls, travel curbs.

·         Change the law to re-denominate wages, incomes in new national currency.

·         Re-denominate mortgages and other debts in new currency.

·         Prepare plan to recapitalize banks.

·         Plan to balance budget because government would lose ability to borrow.

·         Set fiscal and monetary framework to rebuild policy credibility.

·         Prepare new notes and coins for distribution.

·         Reprogram computers, change vending and payment machines

Allow me to give you some perspective on this… I am Argentine. I lived through the hyperinflation of 1989-1990, and followed closely the depression and default of 2000-2002. Any economist with a minimal of common sense should know that most of that list is not only wrong, but also dangerous. It is close to what Argentina did in 2002, and it is a recipe for disaster.[3] The right state of mind that a civil servant should have before beginning a forced process of monetary reform is one of humility. Hubris will not achieve anything good. Bureaucrats should not pretend to understand better than the affected people what their problems would be as a result of the monetary reform, and therefore they should not try to solve those problems for the people. Because the truth is that they have no clue, in general (otherwise a forced monetary reform would not be happening), and in particular, they don’t know anything about the personal tragedies that the reform will trigger. Therefore, they should NOT overregulate and/or attempt to overcontrol the process. And above all, they do NOT have to meddle with private contracts or attempt to separate people from their savings. They must take a minimalist approach, to disturb markets and society as little as possible (they have caused them enough damage already). They must set up a short number of simple rules that create the correct incentives for the markets (who are the people after all) to take the best decisions for themselves. They must explain clearly to the people the short and simple set of new rules. And then they just need to trust the people (i.e. the markets), which by now is completely clear are infinitely wiser than the idiotic and arrogant Euro-technocrats that got them in this mess in the first place.

With that said, let me enumerate the 10 measures I humbly believe Greece (and later Portugal, Italy, Spain, even France) could take to leave the Euro with minimum (though not small) cost:

1.      Stop paying the debt immediately, and began planning for a restructuring which should include a large nominal haircut across the board, including the ECB, the EFSF and other bilateral and/or multilateral official lenders, in addition to the private sector. Be ready to wait a few years before the restructuring is finalized, because it will take a while to figure out what debt level is sustainable for Greece.

2.      DO NOT LEAVE the Euro overnight. Just re-introduce the Drachma and let Greece be a bi-monetary economy. The idea is that the stock of pre-existing contracts should not be overruled or redenominated (by the Government), but the flow of new economic activity will be denominated in Drachmae from the point of monetary reform on. Over time, by Gresham’s Law, the bad money (Drachma) will take over the good money (Euro) in exchanges, and the economy will be naturally Drachma-tized slowly over time. The Euro will naturally fade and become at best a unit of account. The Government should take care of renegotiating its own contracts, with its suppliers (including workers).

3.      Impose capital controls to avoid a massive run of hard currency out of the country. However, do not impose restrictions in local foreign exchange markets, and let the new Drachma float freely. It will be a wild ride at the beginning, but with the capital account effectively closed, the initial volatility should abate quickly.

4.      Remove the Euro’s legal tender: even though outstanding contracts (and even new contracts, this will be a bi-monetary economy) can be denominated in Euro, actual payments could not be requested in physical Euros. All payments in the economy should be redeemable in physical on notional Drachmae, converted at the exchange rate of the day for Euro-denominated payments. However, note that the fact the Euro loses legal tender means only that payments cannot be requested in Euros, but anybody can voluntary choose, if his counterparty agrees, to cancel his payments using Euros (for instance in his bank account). That would avoid a massive contraction of means of payment at the beginning of the transition, before Drachmae get broadly distributed in the economy once again.

5.      DO NOT REDENOMINATE private contracts from Euro to Drachma, including loans, rentals, insurance policies, private labor contracts, BANK DEPOSITS. The private sector should take care of renegotiating its own contracts.

6.      Nationalize bank deposits, NOT the banks themselves. Moreover, the Government should offer a 100% guarantee on all deposits it takes (more on this later). Therefore, the government will be in effect wiping out the liability side of the banks’ balance sheet, “recapitalizing” them. In so doing, it will give the banks enormous flexibility to renegotiate their loan contracts (including commercial loans and mortgages) with their customers in the best possible ways for all the parties, without the government picking winners and losers. And trust the bankers: they cannot profit from a bankrupt client, and they really hate to repossess real estate, so with the flexibility of a clean balance sheet, they will surely offer their customers (and the voters that politicians care about) fair terms.

7.      Keep people and businesses’ full access to bank deposits (now on government’s hands). Under NO circumstance limit bank withdrawals. That is a recipe for rioting, spike in suicides and overall unrest. But remember: Euro has not legal tender. Make sure to explain clearly that people can always access their deposits, and even withdraw them if so they want, but they will be receiving the Drachma equivalent of their deposits in Euros, at the prevailing free-market exchange rate. As long as they keep their money in their bank accounts (now managed by the Government), it will be indexed to the Euro, and it will NOT be converted, re-denominated or confiscated, and they can use that money to make payments in Euro or in even in Drachmae (CRUCIAL), at the prevailing free-market exchange rate. On the other hand, as soon as they withdraw their money from the bank, presumably to buy Euros in the exchange rate market, they will be subject to exchange rate risk.

8.      Keep interest rates, exchange rates, prices, unregulated and un-restricted. No price controls, no exchange rate bands, no interest rates ceilings. Let the private sector do its work. Based on the outstanding evidence, it is unlikely to do a worst job than regulators and bureaucrats already did over the last 12 years.

9.      Set clear rules for a central bank concerned with price stability above anything else. However, allow for a transitional period (with an explicit, realistic and credible ending date) during which the central bank will be allowed to finance the government by monetizing its debt. Needless to say, that period should be as short as possible. A credible plan leading to a balanced fiscal result within that period would be quite convenient.

10.  A (short) banking holiday might be needed to get the government’s logistics ready to deliver the new Drachmae to the market in case it is necessary. Explain the measures carefully. Sit back… and pray.

And yes, don´t forget to re-program those vending machines.

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[1]  “Exit would be a mess for Athens”, WSJ online, November 4^th 2011.

[2]  And don’t forget the regulators that encouraged that lending through preposterous capital regulations, which subsidized government borrowing. Simply explained, the regulations in place during most of the previous decade allowed the banks to lend to governments, all of them, from Germany to Greece, without having to put aside any capital reserves to cover for potential defaults. That arrogance (or bad faith) is one of the causes that brought ruin to Europe.

[3]  Do I have to remind people about the 16% contraction in private consumption over 3 quarters? Do I have to remind people of the loss of life and property? Do I have to remind people of the toddlers feeding off trash cans? That some shameless ideological bigots like Paul Krugman are currently exhibiting Argentina as an example would be funny, were it not so tragic and insulting.