Wednesday, 17 November 2010

Getting out of the euro

Ireland and Greece and maybe Portugal and Spain could do with getting out of the euro and into a currency they can devalue at will. How easy would that be? Well imagine the Irish government announces that Ireland is breaking free, the euro is to be canned and the punt is coming back. What happens next?

The euro was adopted with a big-bang switch over. All savings accounts, all debts, all contracts were instantly converted to the euro, and cash was changed over the course of a few weeks. In fact Ireland was the fastest switch over country, most cash had changed in the first two weeks. This was made possible by the fact there was a hard lock between each national currency and the euro - everyone knew what they were getting years ahead of time. Reversing the operation you could attempt a hard lock, one punt equals one euro or similar, but everyone would know that the punt was destined to be devalued and they would struggle hard to keep their savings in euros. If their bank account were due to be converted on "punt day" they would move to a foreign currency account, or just plain withdraw euro cash.

On reversion to the punt the Irish government would undoubtedly like to redenominate its national debt into punts. And why not? Long dated Irish bonds were denominated in punts before the euro dawn and would be returning to their original currency. But the markets would regard that as an effective default and would sell up before punt day. Yields would shoot through the roof. The Irish government would be unable to fund its deficit.

In short, converting to the euro was an easy option, getting out would incur the wrath of all concerned. In fact it would be necessary to run both currencies in parallel so people felt secure. Bonds would have to stay in euros to keep the markets happy. People's savings would have to stay in euros to stop runs on the banks. This means debts would have to stay in euros as well. (Otherwise lenders would be out of pocket.) Later when the new punt had found its right level people would be happier to convert, at the going rate.

Contracts would be problematic. If they weren't implicitly changed (eg contracts of employment and salaries) there would be little point leaving the euro in the first place since devaluation is what it's all about, but if they were changed there would be all sorts of problems where a liability remained in euros but payments were converted to punts, for example a contract to supply goods sourced overseas at a particular price.

Clearly it would be massively traumatic for Ireland to leave the euro.

Quite the reverse would apply in the Germany. If Angela Merkel announced the return of the Deutschmark the German people would be extremely happy. They would know that a liberated DM would rise relative to the euro and they would be delighted to have their savings automatically converted. There would be a small number of losers - people with contracts committing them to buy in DM goods previously priced in euros, but most people would be better off, at least initially. Later they would suffer a little by losing market share to cheaper eurozone countries.

And Germany leaving the euro would cause a euro devaluation which would benefit the weaker euro countries without them having to leave the euro.

So it looks like Germany must leave the euro.