Rocky path for anti-euro party
Strategy for euro dismantlement strewn with pitfalls
Complicated role for France
by Gabriel Stein, Chief Economic Adviser
Mon 29 Apr 2013
Note: OMFIF members joined a conference call on 19 April with Prof. Lucke, founder and leader of the new German anti-euro party Alternative für Deutschland, centred on the party’s programme on how to phase out the euro as the single European currency, the technical and political feasibility of the party’s platform, and managing the denomination of a possible parallel currency. In the note below, Gabriel Stein, OMFIF’s Chief Economic Adviser, analyses Prof. Lucke’s suggestions for dismantling economic and monetary union (EMU) and its possible replacement by newly-forged national currencies and /or regional currency blocs.
OMFIF does not have a view on whether the views of Prof. Lucke and his party are right or wrong, and we are certainly not giving any advice on which parties the German electorate should favour in the September general elections, but we do consider it important that there is a proper debate on the issue of the future of the euro. In this context, we are sending out Gabriel Stein’s commentary to a wider selection of OMFIF readers.
No plan for dismantling a currency union – especially one that forms the world’s second most important reserve currency – can be free of strain, turbulence and political/economic pitfalls. In mapping the dissolution of the euro, the least disruptive potential way forward would be for the Club Med countries – including Italy – to leave EMU. This would leave a rump built around Germany, the Netherlands and Austria (with its two ‘suburbs’ Slovakia and Slovenia), with deeper integration culminating in political union that is both the ultimate goal of EMU and a necessity for its survival.
Finland, Estonia, Latvia and Lithuania would benefit from being part of such a polity for geopolitical reasons. Anything that anchors them further into western Europe and is a demarcation against Russia is worthwhile. At the same time, these countries are sufficiently small and similar in outlook to Germany to be no problem for the rump EMU. As for Belgium, Luxembourg and Ireland, they could be given the choice of continuing to use the euro or not.
Role of France
France is a much more complicated issue. In his book Diplomacy (1994), Henry Kissinger points out that after the Crimean War, France could no longer ‘dominate an alliance with Great Britain, Germany, Russia or the United States, and considering junior status incompatible with its notions of national grandeur and its messianic role in the world, France has sought leadership in pacts with lesser powers’. The EU – and by extension EMU – allowed France to have its cake and eat it, by being in an alliance with a greater power (Germany) yet dominating the alliance by virtue of historical circumstances (the Second World War). However, the balance of this Franco-German synchronisation has grown ever more skewed, and the political rationale behind it has grown more threadbare.
Were France to join a rump euro, it would be a periphery country in terms of production costs and competitiveness, but it would also be something of an outsider from an ideological point of view, an etatiste economy in a monetary union dominated by market liberals. Its influence within such a currency union would rapidly dwindle; outside the new EMU its influence would be even less. No doubt French politicians are willing to do their utmost to make sure this choice will never present itself, primarily by ensuring that at least Spain and Italy remain in EMU. But this risks hastening the permanent demise of the euro. It is difficult to see how this rather delicate conundrum can be resolved. Most likely, as Prof. Lucke notes, circumstances may necessitate the complete dissolution of EMU, rather than risk breaking the Franco-German alliance.
Challenges for phasing out euro
Prof. Lucke advocates a gradual phasing out of the euro, to be replaced by new euro-backed national currencies. However, it is doubtful whether such a gradual process is feasible. In fact, all experience of currency changes point to the desirability of a ‘big bang’ approach.
As for keeping the euro as a parallel currency, it is unclear whether Prof. Lucke proposes this for exiting countries, or in the background, as backing for their new currencies. While having a parallel currency in theory sounds attractive, there are substantial problems involved. Would the parallel currency be defined as the (still existing) euro or the new national currency? And which currency is legal tender (the currency in which payment of debts cannot be refused)? Is it both, neither or either?
Question of legal tender: three scenarios
This analysis is intimately tied to the question of the exchange rate. If both or neither currency is legal tender and the exchange rate between them is fixed, then Gresham’s Law operates and the perceived bad currency will drive out the perceived good. In other words, everyone will hoard the currency perceived to be more likely to maintain its value in the future, thereby leaving only the bad currency in circulation. For the purpose of this exercise, we can assume that the euro is the good currency and the new national currencies are bad. (This would not be the case in Germany or the Netherlands, but for the moment the assumption is that they will keep the euro).
By contrast, if the exchange rate between the two is fully floating, Gresham’s Law goes into reverse and good money drives out bad. In either case, the state will receive its funding in the bad currency, while recipients of state money can legally insist on receiving euros. This leads to the temptation to depreciate the national currency by offering a better exchange rate, e.g. for income tax, which would be paid in euros.
If only one currency is legal tender, it will be the new national currency – what is otherwise the point of having it? While that means that the state can enforce payments in the new national currency, it does not solve the issue of which currency is circulating. Essentially, unless the exchange rate is fully floating between the two, the new national currency stands no chance. But if it is fully floating, what is the point of having a parallel euro?
Financial market implications: currency board system
Prof. Lucke seems remarkably sanguine about getting markets to go along with different arrangements. He suggests that the new national currencies be tied to the euro through a currency board system. This implicitly assumes if not a fixed exchange rate, at least a managed one. However, the history of the past twenty years shows that currency board arrangements are only as stable and durable as the policy underlying them is credible.
Here we run up against two problems. First, if you leave the euro, you do so to devalue (and, by the way, default). Why else would you leave? Moreover, part of the problem for the Club Med countries has been the fixed exchange rate. Why would they abandon one fixed exchange rate with some influence (through their representation on the ECB Governing Council) for one without any influence whatsoever, but still subject to the restrictions imposed? Second, would the ECB be prepared to go along with such an arrangement? All currency board arrangements with the euro (previously Estonia, currently Bulgaria and Bosnia) are unilateral, with the ECB very clearly washing its hands of them.
Once the new national currencies find their level, to move afterwards to a fixed exchange rate system through a currency board may work – but, again, this relies on the credibility of the underlying policy. And if it is credible enough, you do not need the currency board. Ultimately, any new arrangement would be tested by markets. A German-dominated ECB is unlikely to be more prepared to help the new Greek obol than its Bundesbank predecessor was to help the pound sterling in 1992.
The fate of public debt
Can public debt denominated in euros and issued under international law be redenominated in new national currencies? Or will it remain, an appreciating millstone around the neck of the exiting countries? It is unclear what Lex monetae principles would prescribe. It can be assumed that countries could redenominate their debt at will, even if issued under – say – English law. In order to seek redress, creditors would ultimately have to go to the courts of the countries in question, who would be unlikely to acquiesce in bankrupting their governments.
The problem might be solved by defaulting, of course. History is quite clear: if the only threat your creditors hold over you is that they will not lend you more money, you should – provided you have a primary balance – default. Of course, if the euro disappears completely, this is no longer an issue, with all debt redenominated in the new currencies.
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