How to leave the euro

Prospect Magazine

How to leave the euro

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For a country to leave the currency, it would first have to suspend democracy

A replica of the last edition of the drachma in central Athens—but could the currency make a comeback if Greece leaves the euro?


How do you get out of the eurozone? Leaving a monetary union is about the messiest thing that a country can do, short of entering into a war. But what if you have to leave the eurozone? Greece might soon be in that situation—so too Portugal.

Assume that something goes wrong in Greece. Perhaps Lucas Papademos cannot hold his quarrelling coalition together. Perhaps Greece will not be able, or willing, to comply with the austerity demands of the International Monetary Fund and the European Union. Perhaps Greece and the banks cannot agree a deal to restructure the debt. Countless other things may happen: an outbreak of violence, the murder of a foreign diplomat—the kind of event that used to trigger a war, and that would now trigger an exit from the euro. What then?

First, it is legally not supposed to happen. The euro is the currency of the EU. Just as Scotland cannot break out of the pound, Greece cannot break out of the euro. Britain has an opt-out, and so does Denmark, but for the others, the euro is obligatory. Once you are in, you are in. The only way to get out is to leave the EU, which is possible under the Lisbon Treaty. So the strict legal answer is that, to leave the euro, Greece would have to leave the EU.

European law has many trapdoors. A European official once told me that Greece could leave the EU on Sunday night, and re-enter on Monday morning. Sure, this is not what Article 50 of the Treaty on European Union intended, but who knows what the European Court of Justice might decide if such a case landed on the bench.

At this point, we have to assume a number of different scenarios. Is this exit agreed with the others, and if so, will they support it financially? Or is it a unilateral act, which Angela Merkel learns about in the newspapers? An agreed exit could come about when a consensus is reached both inside and outside Greece that the adjustment burden is too high, and that the costs of subsequent rescue programmes would become economically and politically indefensible. A sudden exit could be the result of an accident, or a mistake. I would assume Greece would remain in the EU in the first scenario, but not in the second.

In the worst-case scenario, an enraged Greek prime minister gets his cabinet to vote to exit the euro on a Friday afternoon. At this point, he cannot go to parliament. He must issue a decree—a temporary act to be ratified by parliament later—to leave the euro and reintroduce a national currency.

When he leaves the cabinet meeting, he will have to commit a raft of legal and constitutional breaches, possibly even crimes. He will immediately have to do the following: close the borders; enforce a prolonged bank holiday; stop all transactions; and cut off the banks from international communication, including via satellite. He might have to send in the police or army to enforce the transactions ban. The bank holiday will last as long as it takes, perhaps a week.

Once he has secured the borders and throttled the banks, he goes on television and announces the decision. Of course, he will ask parliament to ratify this decree subsequently, but first he will have created all the facts. It is, of course, impossible to leave a monetary union while going through an open parliamentary procedure. The banking system would have collapsed before the opposition leader had a chance to speak. Secrecy is important for this to work. For a country to leave the eurozone, democracy will have to be suspended.

At that point, the changeover starts. All money held in accounts, and all securities, would be redenominated in new “Greek euros” at a conversion rate of one-to-one. You might call it a drachma, but at this stage you are not going to fuss over the name or look of your bank notes. There is no time to issue notes and coins anyway. All euro banknotes in the banking system will have to be stamped. Obviously, you cannot stamp all the money in circulation. You either decide to take the hit, or to maintain border controls indefinitely, preventing people from leaving the country with suitcases of unstamped euro banknotes. Within Greece, old euros would cease to be legal tender, and the central bank would exchange old euro notes for stamped ones at the official conversion rate of one-to-one.

The prime minister would also immediately announce a default on all foreign debt. There is no way that Greece, or any other country likely to leave the euro, would be able to service the euro-denominated debts. At this point, there will be no more capital inflows from abroad. Greece would be in a position where it needs to raise all public spending from domestic taxes. But since Greece has a primary deficit—a deficit after interest payments—the government must immediately impose an extreme fiscal contraction, much larger than anything that has happened so far.

This fiscal contraction would initially much outweigh the benefits of a depreciating currency. The banks would collapse, and have to be propped up by the new central bank, which has now regained the monopoly to issue a new domestic currency and to act as a lender of last resort to the banks and the government. New Greek euros would soon be convertible, and then depreciate. The government would impose stringent wage and price controls to ensure that the rise in wages does not outweigh the improvements in competitiveness. On the bright side, Greek tourism would suddenly become ultra-competitive. But we should not fool ourselves. By that time, Greek economic output would have collapsed.

What difference would a consensual exit make? The eurozone could agree to continue to support the Greek banking system for a while. It could help Greece fund the deficit, allowing a more gradual reduction of the primary balance. Greece would continue to receive structural funds from the EU, which would not be the case if it were to leave the euro. An agreed separation would be preferable to a violent, unilateral exit. But of course, it would be hard to get agreement if you default on your debt. And without being able to default on your debt, it would make no sense to leave.

The only country that could conceivably exit unilaterally, and still breathe afterwards, is Italy, which has a primary surplus. It could afford to default on its foreign debt and still function. But it would be an incredibly violent act against the rest of the eurozone, triggering a potential collapse of the financial system, especially given German and French exposures.

There is no way that Mario Monti, Italian prime minister and a former European commissioner, would take such a step. He could have threatened to do so when Merkel imposed an austerity regime on everybody. But he did not. He could have extracted eurobonds as a quid pro quo for accepting a German-style fiscal regime.

Given the crisis remains unresolved, an exit of one or more countries may become inevitable. But it would be indescribably messy and at best borderline legal. It would create financial instability in the country and elsewhere. And it might trigger further exits. So be careful what you wish for.

  1. February 24, 2012

    ROBIN_FOX

    I’m amazed the socialist parties of Europe support the fiscal conservatism that results from continued membership of the euro.

  2. June 7, 2012

    Christopher_Birchenhall

    Wolfgang

    One way or another Europe has to recreate itself and all options will have strong opponents. I see no “win set”, no agreement that will be ratified by all parties. As market forces rush head long into a political brick wall the rule books will crumble. Many of our current assumptions will be no longer be valid. You hint at this with your discussion of Grexit but you retain a lot of assumptions about what rules will be upheld. Pushed to the limit nothing will be sacrosanct. One way or another the underlying fundamentals will have to be realised. Europe has to allow its productive base to function. Finance is a derivative and is worthless without that productive base, if it gets in the way then the financial rules will have to give way.

  3. June 28, 2012

    C Young

    “Within Greece, old euros would cease to be legal tender”

    In theory but not in practice. This account is sadly over optimistic.

    Who is going to hand over their stash of good Euros for stamping without violence ? Who will sell exportable goods (most foods) for stamped Euros without violence ? And who will think of holidaying in Greece while it still resembles 28 Weeks Later ?

    Anyone who can keep using real Euros will do, this means the public sector starves. The EU will be forced to pay the army in real money not to take power for themselves. Food will have to be extracted from farmers at gun point to keep the towns alive.

    What’s ironic is that the people who are going to be living on leaves and bark post an exit are precisely the people holding out against the memorandum – the public sector employees.

  4. July 31, 2012

    manish kumar

    knowledgeable article

  5. August 1, 2012

    Vijayaraj R

    deciding to leave the euro would be a big catastrophe to the economy. instead approach the wealthier persons of the country to payoff the debts will not make any foreign debt and help the country to came out of the crisis. German have to do it first.

  6. August 5, 2012

    nirav

    BRILLIANT ARTICLE !!

  7. August 6, 2012

    shwetima

    it would adversely effect the greece economy

  8. August 13, 2012

    Nichol Brummer

    .. this is why Greece probably also has the option to default while NOT exiting the EURO. They just have to unilaterally break all their contracts, also those under ‘UK law’, and decide not to leave the EU. They cannot be thrown out. In fact: they have been doing this in small steps, and nobody can stop them.

    This is why Draghi was correct when he said it is a problem if the ECB cannot control interests – it will have to buy up bonds to limit the interest spreads. And Germans can complain, but in the end they have a choice: pay up themselves, or allow the ECB to absorb greek bonds at a more realistic, lower interest rate. And Merkel will eventually have no choice but to accept this role for the ECB.

  9. August 13, 2012

    sanjiv

    how is it inevitable that one or more country may exit….
    Neither Greece nor Italy is going to exit as both will trigger instability…

  10. August 13, 2012

    sanjiv

    how is it inevitable that one or more country may exit….
    Neither Greece nor Italy is going to exit as both will trigger instability…

  11. August 13, 2012

    Rinkul sharma

    Nice article

  12. August 14, 2012

    Jonathan

    Greece is in such tough shape that none of this might work. What if the government is overthrown by armed revolutionaries? What if the police refuse to support the government because there’s no money to pay them?

  13. August 20, 2012

    Abhi

    Nicely Written Article .It shows the amount of complexity that Greece is about the face if it all takes the decision to leave the eurozone.

  14. August 23, 2012

    rohan

    nice knowledgeable one!!

  15. August 24, 2012

    deepali jain

    nice article n very knowledgeble…….

  16. September 23, 2012

    Siddharth Sharma

    a good one….

  17. September 26, 2012

    praveen

    nice one ,but i think every start need some sacrifice ,difficulties,but in the end it is definite that this will going to happen so preparation can be made instead of thinking what bad can happen.

  18. November 10, 2012

    RomeStatesman

    From the vitanomics — the revolutionary antithesis to economics — point of view the scenario of Greece leaving the euro is a typical economics inspired nightmare.

    The problem is not the euro. It’s the debt. If Greece has to default, it’s better it defaults within rather than outside the EU.

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